Cryptocurrency-backed loans have become popular especially in the crypto community, but while they are hailed as a transparent and better alternative to traditional loans, crypto lenders too also have their flaws.
Crypto Loans vs Banking Loans
The current banking system practised across all countries in the world is modeled after the Bank of England; the first limited-liability corporation allowed to issue banknotes. Banks have grown in authority since then. And since most systems in the world are built on trust and finding a reputable middleman like VISA or SWIFT, banks have grown to become a respected authority in the field of loans.
The banking loan system that is most popular today involves banks standing as trusted middlemen between lenders and borrowers. Banks would often charge borrowers at maximum thresholds of about 25 per cent, with only 3-5 per cent going to the lenders. The balance becomes profit to the bank involved, a practice that has generated significant controversy as of its own, but without banks what else is there? Banks are about the only trusted financial institution—until now. While traditional loan systems are built on trust, crypto loans which have emerged as a stronger alternative are built on a trustless system called the blockchain.
By allowing borrowers to get loans through setting their personal tokens as collaterals, borrowers can bet against a certain cryptocurrency increasing within their loan period to cater to the 20 per cent profit imposed by crypto lenders. While this is an easier and less burdensome alternative, the situation becomes ugly when the crypto-collateral plunges below expected values. Even the lenders acknowledge it’s a risky bet.
According to a detailed study by Bloomberg, Edgar Fernandez, a former Wall Street trader used some of his Bitcoin as collateral to borrow nearly $100,000, a decision that let him keep his cryptocurrency and avert a tax bill on the newly acquired cash.
Like anything in the cryptocurrency industry, crypto loans exist, but the legal situations around them are still sketchy. While many crypto companies and startups are protesting against the United States Securities and Exchange Commission (SEC) from classifying their tokens as securities, they are quite satisfied with the IRS treating their digital assets as properties just like it does stocks.
However, crypto assets are a much different deal than stocks: they are much highly volatile. Investors and lenders, during the high time of 2017 when Bitcoin was worth more than $19500 would not have been smiling as much at the latter part of 2018.
Pat Larsen, the co-founder and chief executive of ZenLedger, said the dangers are to be expected and the company itself are not oblivious to its risks. “It’s always risky to get a loan with a highly volatile asset,” he said.
Crypto-backed loans are becoming great solutions to loans and tax perks, but the journey isn’t always a sweet pie, borrowers should be aware of the consequences too.