Crypto guarantees on loans can be prohibitive; Here’s how to fix it
For investors who ‘own’ – from the enthusiastic novice to the whalebone with a diverse cryptocurrency portfolio – one of the problems of buying and holding crypto is that of liquidity.
While we would all like to have enough wealth to pour massive amounts into crypto and still have a lot of fiat for things like starting businesses, buying houses / cars, or sending kids to college, sometimes that isn’t just not feasible. The challenge for crypto believers is to achieve the optimal balance where they can invest as much as possible in crypto, while still retaining enough fiat liquidity to continue with 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 tokens have gone down in value. If they are too conservative, they could set aside more fiat than necessary and miss out on a significant increase in token value.
One potential solution that has emerged is the crypto loan model. Essentially, investors can place cryptos as collateral for a fiat loan and ideally have the best of both worlds. It sounds like a great solution, and it sure can be, but like everything, the devil is in the details. Let’s take a look at some key pros and cons of crypto lending, exploring why they can really solve the crypto / fiat balance dilemma. We’ll take a look at what conditions need to be in place for the best-case scenario to happen and what the consequences are if a crypto loan goes awry. Specifically, let’s take a look at the biggest downside to crypto lending – the 2x-3x collateral required – and how interesting tweaks to the model, such as Roobic’s lending structure, may be able to mitigate 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 the token values are relatively stable, the use of loans can open the door for those who need the 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 need a credit check. It is a game changer for those who don’t have or don’t have 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 good credit who don’t need the cash right away, 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 are right to ask yourself because, unlike a traditional loan, the interest received is not the key income for lenders. Instead, these lenders give loans to their clients because there is a chance that they will be able to collect the collateral involved if market conditions are right. This is because crypto loans are backed by collateral in the form of crypto tokens. Unlike a home loan, where the home is the collateral and is likely to hold or increase in value over time, crypto tokens can fluctuate wildly. A token can lose half of its value overnight, and for no discernible reason. For this reason, the lenders want to make sure that the collateral can cover the loan amount with high probability and will require 2-3 times the value of the loan in crypto equivalent value.
This is where the highest risk for borrowers and the greatest income opportunity for lenders come 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 in order to cover the value of the loan. If the borrower cannot provide this, the collateral is forfeited and additional penalties may be applied. Fluctuating prices and large potential losses make crypto loans seem less like the perfect loan and more of a high-risk way to get money – losing crypto and fiat, just because the unpredictable crypto market dives, even of short duration.
A possible solution to high-risk crypto loans
To sum up so far, crypto loans can be amazing due to no credit checks, same day cash, and low / zero interest rates. They can be a disaster if your value of 2-3 times the crypto collateral goes over a certain point and is forfeited to the lender. At this point, many articles on “crypto lending basics” will point their readers to safer alternatives such as loans from credit unions, 0% credit cards, or secured loans with more stable collateral. But none of these meet the needs of an investor who wants to use their crypto investment. Does this mean crypto investors are stuck with 2-3x guarantees? Well, depending on the lending platform Roobic, maybe not.
Roobic’s lending philosophy is less conventional than most platforms as it has developed what could be described as market making for crypto lending. Instead of requiring very high collateral for all loans to minimize its risk, it allows lenders to reach borrowers based on the terms of their loan. If a lender wishes to grant a loan to a person who requests it, he decides on the amount of collateral required. This may 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 a lower collateral. The key is that lenders and borrowers can find a match and a much wider range of loans can be successfully deployed, potentially improving the market as a whole.
Crypto loans are a new way to get your crypto and at the same time implement it through secured borrowing. With so many perks like getting cash fast, no credit checks, and little to no interest, there’s a lot to like. However, the sticking point of 2-3 times the collateral on crypto tokens can 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 crypto economy as a whole? It is too early to tell, but the concept is interesting enough to watch and may become a new opportunity both for borrowers who want to risk less collateral and for individual lenders who want to enter the market but don’t. lack the infrastructure to attract borrowers. Hopefully, this is another representative step in making the largest crypto industry an open market, decentralized and revolutionary global economy.