Bitcoin-backed loans are an innovative twist on traditional lending, merging it with the world of cryptocurrencies. These loans enable Bitcoin holders to utilize their digital assets without selling them, offering a unique avenue to access liquidity. The proliferation of crypto lending platforms has streamlined the process, making such loans increasingly accessible.
What is cryptocurrency lending?
Cryptocurrency lending is revolutionizing how individuals interact with digital assets, offering exciting new ways to borrow and invest with cryptocurrencies. At the heart of this system are the lenders who deposit their cryptocurrencies into lending platforms to earn high interest, surpassing traditional savings accounts due to market volatility.
Borrowers, on the other hand, gain access to capital without liquidating their crypto holdings. By providing collateral, usually in the form of other cryptocurrencies, borrowers can secure loans in stablecoins or fiat currencies, thus unlocking liquidity while retaining ownership of their assets.
A significant driver of this innovation is the rise of decentralized finance (DeFi) platforms, which use smart contracts to automate the lending process, eliminating the need for intermediaries and enhancing transparency and security. Showcasing the potential of DeFi to transform financial services, platforms like Aave, Compound and MakerDAO have become prominent players in this space.
In DeFi, lending Bitcoin (BTC) usually involves using Wrapped Bitcoin (WBTC), which is compatible with smart contract networks such as Ethereum, Arbitrum, Polygon, or Solana, enabling users to participate in decentralized lending.
Types of crypto loans
Crypto loans are typically offered as collateralized loans, meaning users’ crypto holdings secure them. Much like a mortgage or car loan, the collateral can be seized as payment if users fail to repay their loan.
Some platforms mandate overcollateralization, allowing users to borrow only up to a specific percentage of their deposited collateral. In overcollateralized loans, the value of the collateral exceeds the loan’s value, which can secure better loan terms by lowering the risk for the lender.
In contrast, uncollateralized loans, also known as unsecured loans, do not require any collateral. Loan approval processes for these loans depend on factors like a history of responsible credit use and timely payments.
When using cryptocurrency as collateral, users have two primary options. First, centralized finance (CeFi) loans involve borrowing money from a crypto or blockchain company that functions similarly to traditional financial institutions controlled by a private central authority, offering more stability and security.
Second, DeFi loans allow borrowers to access funds through decentralized blockchains. Managed by an open-source network instead of a single entity like a bank or government, DeFi products let users directly manage their digital assets. However, lenders can take…
Read More: What is a Bitcoin-backed loan, and how to get one?
