Crypto LoanYou must be careful with crypto loans, the unsteady value of crypto can lead to a margin call

The increased popularity cryptocurrency now enjoys among mainstream investors and consumers means it's becoming easier to buy, use and invest in. With some crypto exchanges and other platforms, it's also possible to use your digital asset holdings to secure a loan. The benefits of doing so can be appealing, but it's important to understand the risks associated with crypto lending before you apply. A crop of new-age ‘crypto banks’ is offering loans to people who own cryptocurrencies like Bitcoin, Ethereum, and Tether, among others. Crypto owners can pledge their digital tokens and avail of a loan in the form of cash or a stable coin, which in turn can be sold in exchange to get money in the Indian rupee in their bank account.

The Loan Factor

While there is no upper limit to the amount of credit one can borrow through this route, these loans are given at a loan-to-value (LTV) ratio of 50%-65% of the pledged cryptocurrency’s price.

Typically, loans against cryptos do not have a fixed loan term and they don’t come with a defined repayment schedule, such as an EMI, either. Essentially, a borrower can repay anytime and in any number of undefined installments as she wants. The annual interest rate on crypto loans ranges between a wide spectrum of 4% to 15%, depending on the type of token that is collateralized. For instance, Vault offers an annual rate of 7.5% on bitcoin and Ethereum, whereas stablecoin USDT or Tether is taken at a rate of 13%. There are zero overhead charges involved, as opposed to a personal loan that comes laden with the processing fee and foreclosure charges of 2%-3%.

The Risk of Crypto Loans 

The unsteady value of crypto can lead to a margin call, where the borrower must put up more crypto to maintain the value of the initial pledge. If the value of your pledged crypto declines below a threshold set by the lender, then you have a limited period to pledge additional crypto.

Minimum borrowing requirements can be high

While platforms can vary, you may simply not have enough holdings to secure the minimum loan amount the lender offers. With BlockFi, for instance, the minimum loan amount is US$10,000, and with a 50% maximum loan-to-value ratio, that means you need US$20,000 or more in holdings to get approved.

Repayment terms are short

Crypto loans typically have terms of 12 months or less, which means you don't have a lot of time to repay them, especially compared with personal loans, which can offer longer terms. If you default on the debt, the platform may liquidate your holdings, which could result in a tax bill if your portfolio has gained in value since you first bought the digital assets.

Margin calls are a threat

A margin call occurs when the value of your collateral assets drops below a threshold set by the lender. If the price of your crypto assets drops significantly—which is more likely with crypto versus traditional assets due to the volatility of the crypto market—you may need to deposit more into your account to keep your assets. If you don't, the platform may choose to sell your holdings, which could affect your tax liability.

Assets are inaccessible

As long as your loan is outstanding, you can't use or trade your crypto assets. In other words, if the price of your assets tanks, you're stuck, and there's no insurance against the loss.

Take an example of Nuggets News founder and crypto influencer Alex Saunders, who faced a series of allegations claiming that he had failed to pay loans and investment funds back in 2021. Those who were affected claimed that Saunders owed them Bitcoin (BTC). This compelled Australian media entities to conduct investigations and conclude that the influencer owes as much as US$7 million.