Collateral is frequently involved when it comes to lending agreements. It is an important component in loans as it acts as security for repayment. It is just as vital in crypto lending, but the incorporation and concept are somewhat different from what we know of when it concerns fiat currencies.
What is collateral?
‘Collateral’ pertains to an asset that a lender will accept as security for your loan. Usually, it will take the form of real estate, but there are other kinds of assets it can embody.
It mostly depends on what the purpose of the loan is. Collateral serves as protection in the agreement for the sake of the lender.In a circumstance where the borrower fails to pay off the loan, the lender is allowed to seize the collateral and then sell it to recoup the losses, whether part of it or all of it.
The loan type will usually predetermine the nature of the collateral. If you take out a mortgage, your home is most likely the collateral. If you take out a car loan, it means that the car is the collateral.
Lenders will usually accept collateral types that include investment accounts, bank savings deposits, and cars (though only when fully paid off). In contrast, retirement accounts are not typically accepted as collateral.
Connection to crypto lending
In crypto-backed lending, collateral is typically the crypto asset that the borrower pledges to guarantee the loan’s repayment. In traditional banking terms, a standard example of collateral is a mortgage.
The asset, a house or an apartment, that is being financed is usually the collateral that is securing the loan. The crypto collateral is returned once the credit has been fully repaid.
At its core, crypto lending is not so hard to understand. Borrowers are able to use their cryptocurrency assets as collateral in order to procure a fiat or stablecoin loan. Meanwhile, lenders provide the assets that are needed for the loan at an established interest rate.
This concept can work in the reverse as well. Borrowers can use fiat or stablecoins as collateral to be able to borrow crypto assets.
The practice of crypto lending is not quite groundbreaking as they can be easily categorised as collateralised loans. Truth is, collateralised loans are what they are essentially.
Although, lending and credit are financial primitives that hold immense power. They can open a wide variety of benefits and applications for users, traders, businesses, and institutions.
Furthermore, in the ever growing DeFi (Decentralized Finance) space, this primitive has been used for lending access that is open, composable, and permissionless.
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