All You Need to Know About Bitcoin-Backed Loans

What is a Bitcoin-backed Loan?

A Bitcoin-backed loan is a type of cryptocurrency reserve that serves as collateral and allows borrowers to have cash while maintaining Bitcoin propriety. This type of loan is designed in the same manner as traditional lending with a few changes such as the use of digital assets.

This loan allows Bitcoin investors to use digital assets without selling and offering a unique avenue to collect liquidity. However, investors can access this type of loan via digital trading platform for easy accessibility.

What is Crypto Lending and How Does It Work?

Crypto lending allows investors to use digital assets to acquire borrow funds. There are different variations of crypto lending on different trading platforms. However, the underlying idea is that investors send Bitcoins to a lending protocol in order to earn high interests.

The yields generated from Bitcoin loaning are often higher in comparison to the interest rates offered by a savings account.

The higher APR of the crypto lending protocol is attributed to the higher price volatility of Bitcoin. On the other side of the equation, borrowing parties get the advantage of accessing capital without liquidity.

In addition to Bitcoin, digital lending protocols support different types of digital assets. It is important to note that in exchange for digital holdings, borrowers can earn loans in the form of stablecoins and fiat currencies.

However, the investors do not have to give up propriety of their digital assets and also contribute to higher liquidity. Usually, lending protocols make use of smart contracts that automate the entire process and introduce decentralized mechanism.

In this manner, the investors do not have to depend on intermediaries which results in better security, lower fees, and offer transparency.

Types of Crypto Loans

Cryptocurrency loans are in the form of collateral debt that allows investors to withstand their propriety right. Traditional loans such as mortgage or car loan also use collateral in case that a debtor is unable to repay the loaned amount.

However, a majority of lending protocols utilize overcollateralization that sets a maximum limit on borrowed amount. An over-collateralized loan requires the value of the collateral to be bigger than the borrowed amount which warrants more security for lenders.

Crypto investors can also use uncollateralized loans which are also called unsecured loans. In this mechanism, investors get loan approval based on factors such as responsible credit score and timely payments. In the loaning protocols that use digital currencies as collateral have two models first is centralized and other is decentralized.

Centralized loans require investors to borrow funds from a blockchain network or issuers to be staked or locked as collateral. In this manner, the loaning contract has greater security and stability.

In the second instance of decentralized borrowing, the investors are able to access funds that are operated by an open-sourced network but the lenders have the liberty to operate in a manner that allows them to secure loans based on predetermined parameters.

How do Bitcoin-backed Loans Work?

Bitcoin-backed loans are based on collateral management that enables secure loaning access to investors as collateral for Bitcoin. In this instance, the investors may be able to access fiat currencies or stablecoin loans in exchange for locking their Bitcoin reserves as collateral funds.

The reason for thepopularity of Bitcoin on digital lending platforms is its stability in comparison to other cryptocurrencies. At the same time, the loan-to-value ratio of Bitcoin (LTV) is also higher.

LTV is used to calculate the value of loaned fund in relation to value of assets purchased. Analysts apply it as a metric to access their risk exposure. A vast array of centralized and decentralized platforms supports Bitcoin-based loans.

These trading platforms are associated with custody of Bitcoin and set security standards that resonate with Bitcoin investors and prioritizes the safety of investors.

How to Get a Bitcoin Loan?

Here are some the important steps needed to get a Bitcoin loan:

Apply for a Bitcoin loan on a centralized or decentralized platform after reading the terms and requirements such as payment timeline and interest rates etc.

The borrowers have to send Bitcoins into a lending protocol wallet for safekeeping as collateral and maintain the required value based on price fluctuations.

Lending protocols define the ratio of LTV and interest rates applied.

Loaned funds are sent to the borrower’s wallet in the form of fiat currencies or stablecoins once the loan is approved.

Conclusion

Bitcoin loan appliers also have to account for conditions such as regulatory changes, counterparty risks, price fluctuations, interest rates, and factors affecting spot prices.