For investors who “hold” – from the enthusiastic novice to the whale with a diversified crypto portfolio – one of the issues with buying and holding crypto is that of liquidity.
While we all wish we had enough wealth to pour massive amounts into crypto and still have plenty of fiat left for things like starting businesses, buying houses/cars, or sending kids to college, sometimes that’s not just not feasible. The challenge for crypto believers is to achieve the optimal balance where they can invest as much in crypto as possible, while maintaining enough fiat cash to pursue other purchases, expenses, and investments. If crypto investing is too aggressive, they might have to sell some suddenly to pay for an expense, and they might get caught when their token values have dropped. If they are too conservative, they could set aside more fiat than necessary and miss out on a major increase in token value.
One potential solution that has emerged is the crypto lending model. Essentially, investors can place crypto as collateral for a fiat loan and ideally have the best of both worlds. It sounds like a great solution, and it certainly can be, but as with all things, the devil is in the details. Let’s take a look at some key pros and cons of crypto loans, exploring why they can really solve the crypto/fiat balance dilemma. We’ll look at what conditions must be met for the best-case scenario to occur, and what the consequences are if a crypto loan goes bad. Specifically, let’s look at the biggest downside of crypto lending – the 2x-3x collateral required – and how interesting tweaks to the model, such as Roobic’s loan structure, may be able to alleviate the problem.
Advantages and disadvantages of crypto loans
Crypto loans can be very effective in providing liquidity to crypto holders without them having to sell tokens. As long as token values are relatively stable, the use of loans can open the door to those who need money and can eventually repay it. Crypto loans have additional advantages that make them extremely desirable for borrowers. Unlike a traditional loan, a crypto loan does not require a credit check. This is a game changer for those with no or bad credit and may be the only way to get a loan for some. Many loans can provide same-day liquidity, which is amazing compared to the weeks and sometimes even months required for traditional loans. The most telling benefit, even for those with great credit who don’t need the money immediately, is that many crypto loans have low interest rates; and some even offer a 0% interest rate.
This last point may make you wonder how these lenders make money. And you’re right to wonder because, unlike a traditional loan, interest earned is not the main source of income for lenders. Instead, these lenders provide loans to their clients as there is a chance that they may be able to collect the collateral involved if the market conditions are favorable. This is because crypto loans are backed by collateral in the form of crypto tokens. Unlike a loan for a house, where the house is the collateral and has a high chance of retaining or increasing its value over time, crypto tokens can fluctuate wildly. A token can lose half its value overnight, and for no apparent reason. For this reason, lenders want to ensure that the collateral can cover the loan amount with high probability and will demand 2-3 times the loan value in equivalent crypto value.
This is where the highest risk for borrowers and the greatest revenue opportunity for lenders comes to the surface. Part of the crypto loan agreement states that if the value of the collateral falls below a certain point, the borrower must immediately pledge additional crypto as collateral to cover the value of the loan. If the borrower cannot provide this, the collateral is forfeited and additional penalties may apply. Fluctuating prices and large potential losses make crypto loans seem less like the perfect loan and more like a high-risk way to get cash – losing crypto and fiat, just because the unpredictable crypto market dips, even for a short time.
A Possible Solution to High-Risk Crypto Lending
To summarize so far, crypto loans can be amazing due to no credit checks, same-day cash, and low or no interest rates. They can be a disaster if your value of 2-3 times the value of the crypto collateral falls beyond a certain point and is confiscated from the lender. At this point, many “crypto lending basics” articles will direct their readers to safer alternatives such as credit union loans, 0% credit cards, or secured loans with more stable collateral. But none of these meet the needs of an investor who wants to leverage their crypto investment. Does this mean crypto investors are stuck with 2-3x collateral? Well, according to lending platform Roobic, maybe not.
Roobic’s lending philosophy is less conventional than most platforms as it has developed what could be called market making for crypto lending. Instead of requiring very high collateral for all loans to minimize risk, this allows lenders to reach borrowers based on the terms of their loan. If a lender wishes to grant a loan to a person who applies for it, he must decide on the amount of security required. This can be higher for collateral based on highly volatile tokens, but can be much lower if the lender is motivated to find a borrower and is comfortable with lower collateral. The key is that lenders and borrowers can find a match, and a much wider range of loans can be deployed successfully, potentially improving the market as a whole.
Crypto loans are a new way to have your crypto while putting it to work through secured borrowing. With plenty of benefits like getting cash fast, no credit checks, and low or no interest, there’s a lot to like. However, the sticking point of 2-3x collateral on crypto tokens may be too high a risk for many. Will Roobic’s solution of matching borrowers and lenders based on collateral amounts create more value for the broader crypto economy? It’s too early to tell, but the concept is interesting enough to watch and could become a new opportunity both for borrowers who want to risk less collateral and for individual lenders who want to get into the market but don’t don’t have the infrastructure. to attract borrowers. Hopefully, this is another representative step towards the transformation of the broader crypto industry into an open-market, decentralized and revolutionary global economy.