Crypto Borrowing
If you own crypto, you can use it as collateral to get a loan. You may not want to go to a traditional lender for whatever reason—maybe most of your net worth is tied up in crypto you don’t want to sell off or you may not have a good credit score (which makes it harder to get a loan from a bank). Borrowing against your crypto offers a way for you to liquidity without requiring you to cash out of your crypto positions.
How can I borrow against my crypto?
Broadly, there are two ways to borrow with your crypto: centralized and decentralized borrowing.
Centralized Platforms
There are regulated, SEC-compliant lending platforms that enable users to take out crypto-collateralized loans. You can use Bitcoin, USDC, or any large-cap coin as collateral. These platforms work by matching crypto lenders with borrowers and make money by taking a spread, charging origination fees, and interest. (For example, a platform might charge a borrower 10% interest to borrow, pay 8% to a lender, and pocket 2%.)
These platforms include:
Higher Fees
The main challenge with these platforms is that the borrowing rates tend to be very high (5-10%). That may be prohibitively expensive if you are trying to buy a house for example, where you could get lower and more stable rates with a traditional mortgage (these loans have an interest rate lock period). If you're taking out the money to invest in assets that will yield higher than 10%, then borrowing from one of these centralized platforms may make more sense.
Note: On the flip side, as a Bitcoin lender, you can earn 5-10% a year just for lending out your crypto. We will cover how you can earn income on your crypto as a lender in another article!
Let’s look at an example of borrowing $10k from BlockFi, collateralized by ETH.
- Interest Rate: 12%
- Origination Fee: 2%
- Loan to Value (Loan Amount divided by Collateral Value): 35%
- ETH Price: $800
- Monthly Payment: $102
To receive a loan of $10k, you would need to post 36.07143 ETH as collateral. The origination fee is added to the loan balance, so you would receive $10k to your bank account and have a loan balance of $10.2k with BlockFi. From there, you make 11 monthly interest-only payments of $102 and a final payment of your principal balance of $10.2k + your last month of interest.
Your hope is that the price of ETH goes up because then you were able to stay long ETH and keep your position, while also drawing liquidity against it to make other purchases or take leverage.
Loan To Value and Risk of Liquidation
If the value of your collateral drops dramatically, the platform may become concerned you won’t be able to pay back the lender and require you to pay more crypto or liquidate you. For example, BlockFi lends at a 35% initial loan to value ratio because they did some risk modeling and determined this provides some buffer in the event of market volatility. In the example above, if the price of ETH drops dramatically, and your loan-to-value reaches 70%, they’ll give you 72 hours to post additional collateral or pay down the principal amount in USD. If you don’t pay more money or your loan hits a loan-to-value ratio of 80% or above (even within the 72 hours), BlockFi may immediately liquidate a portion of your collateral to bring down your loan-to-value ratio.
Given the high volatility of crypto, this is a greater risk than with traditional loans where your collateral’s value might be more predictable and stable.
Decentralized
The other way to borrow against your crypto is through a decentralized platform. Similar to centralized platforms, you put up your crypto as collateral and can draw a loan against it. The main difference is that with these decentralized platforms, you're not going through a company. There is no head trader or institution setting loan to value and managing risk. You’re only interacting with the protocol and the Ethereum blockchain. That means users need only trust that its code will execute as written.
These platforms include:
- Compound.finance (unaffiliated with us, Compound Financial, Inc.)
- Aave
- Liquity
- MakerDao
These smart contract-based lending platforms typically have much better rates (2-3%, some protocols like Liquity even offer 0% loans). Because they are trying to grow, many of these protocols subsidize rates or offer a cryptocurrency reward scheme where you get paid the native crypto token to borrow or lend.
Security Risks
Smart contract-based lending is by far the riskiest borrowing option for crypto holders. There's no institution determining how to manage risk. It's all done through smart contracts.
With these decentralized platforms, there is a chance that the smart contract that holds your collateral gets hacked and as a result, you lose your collateral. You should take precautionary steps like getting a hardware wallet and making sure you have backups if you do pursue this option.
Bottom Line
Crypto borrowing offers owners of cryptocurrency a way to draw liquidity without selling out of their positions. At the same time, borrowing from both centralized and decentralized platforms present more risk than borrowing from a traditional lender. There's almost no risk of your bank getting hacked and losing your collateral. The high volatility of cryptocurrencies also presents the risk that you have to pay more to re-collateralize or get liquidated unexpectedly. That being said, it may still be an attractive option for borrowers who might not have good credit or who want same-day or instant funding.