Bitcoin backed loans and cryptocurrency can be used as an effective way to leverage or cash out your cryptocurrency without actually selling your cryptocurrency holdings. Here’s how it works.
The Bitcoin backed loans industry is still new, but it can provide crypto holders access to fiat currency loans, backed by cryptocurrency capital, almost the same as traditional securities-based lending.
This type of loan works similarly, but has a number of other functions that help to hedge against the volatile market of cryptocurrency. Bitcoin backed loans are unique as they don’t require credit checks, income verification, nor are they usually subject to early repayment fees.
How Does Bitcoin Backed Loans Work?
It’s quite simple to access instant fiat currency via a Bitcoin backed loan. After choosing a Bitcoin backed loan platform, the borrower must provide an amount of Bitcoin as collateral.
Borrowers must be able to borrow up to 50 percent to 60 percent of the value of the collateral in fiat currency. Mostly, once collateral is provided, borrowers are immediately provided with fiat currency. This can be at least five minutes within the Australian banking system. Other platforms offer on-the-spot cash and immediate transfer.
The loan’s flexibility enables borrowers to just pay a monthly fee for as long as the loan is needed, without a set term. Loans can be repaid any time borrowers would like to take back control over their Bitcoin collateral.
Bitcoin backed loan platforms use cold wallets, which are kept offline, to hold Bitcoin collateral. As they involve fiat currency, Bitcoin backed loans usually require borrowers to provide Know Your Customer and Anti Money Laundering identity information.
Because cryptocurrencies are volatile in nature, Bitcoin backed lending platforms are required to include a margin call function in the loan contract. At the time of the loan, it is usually provided with collateral calculated on the price of Bitcoin. If the value of Bitcoin drops below this price, a lending platform may have to liquidate the position.
Lending platforms provide borrowers with margin call notifications and allow them to top up collateral, often provided in either Bitcoin or in fiat currency. In other cases, lending platforms can provide a partial collateral return if the value of Bitcoin significantly increases and remains higher than the original pricing for over 30 days.
Some platforms provide borrowers access to additional fiat funds according to the new value of the collateral.
If a borrower misses a margin call, lending platforms usually liquidate the Bitcoin collateral on a cryptocurrency exchange, record this transaction, and provide the borrower with the balance (less the principal owing and any accrued interest).
The Advantages of Using Bitcoin as Collateral
One of the advantages of Bitcoin backed loans is that those holding large amounts of cryptocurrency may take out a loan to “cash out” of the market without involving a taxable event. This can be attractive to initial coin offerings, seeking to free up capital minus the compromised cryptocurrency position.
Bitcoin backed loans may also be used to leverage cryptocurrency holdings. A borrower who purchased Bitcoin at a high price, may borrow against the cryptocurrency they own. Then, they can buy additional Bitcoin at a lower price if they think the price of Bitcoin will drop.
The Risks of Using Bitcoin as Collateral
While it offers lots of benefits, there are risks that must be considered as safety precautions in terms of Bitcoin backed loans.
The most vital risk to consider is the security of your crypto assets while they serve as collateral. Make sure that the platform you have selected does custodial practices and uses highly secure and advanced cryptocurrency storage and.
If a drop in the market price of Bitcoin causes a margin call, borrowers must have either fiat currency or cryptocurrency available to top up the collateral balance. If borrowers fail to top up collateral, the option to wait for the market to recover will be gone as the collateral is liquidated.
It’s vital to be diligent and informed on the behaviour of the cryptocurrency market and how it influences Bitcoin prices before taking out a Bitcoin backed loan. Should the market exhibit strong bearish signs, your loan will probably require additional collateral if the price of Bitcoin drops.
Assess the background of your selected platform. They should provide details on how Bitcoin collateral is stored, how collateral management and margin calls operate, and they must possess a strong track record in the financial industry.
If you liked our “Bitcoin Backed Loans — How Does It Work?” and found some valuable information, check this space regularly to get more updates on crypto-backed loans and cryptocurrency.