Cryptocurrency has become increasingly popular in recent years. Its exponential growth has propelled lending options and even mortgages based on crypto assets. Let’s look into what crypto is and how it works as loan collateral.
What is Cryptocurrency?
Cryptocurrency is a digital asset with value intended to be transferred over the internet. Bitcoin, the first and most popular form of crypto came out in 2008. It revolutionized the world of finance because, unlike traditional currency, its worth is not determined by a government entity, but by supply and demand. If there are more buyers than sellers, the price goes up, and if there are more sellers than buyers, the price will fall.
Unlike traditional currency, with crypto, there’s no need for a bank or payment processor. Its transactions are person to person. Crypto is built with blockchain technology to protect its users, and all that’s needed to buy and sell crypto is an internet connection.
What is Crypto Lending?
Crypto lending works similarly to conventional loans. The biggest difference is that the only assets used as collateral are cryptocurrencies. While getting qualified for a crypto loan, the lender would assess your crypto and determine what amount you qualify for.
If you have a lot of digital collateral, you may be considering using it as collateral to back your mortgage. Let’s walk you through the benefits as well as the risks.
Pros
No credit check: If your credit is on the low side of the spectrum, no worries. A lot of crypto-based lenders don't require a credit check. A crypto loan could be better than the traditional loan options for low credit scores.
Keep your crypto: You do not have to liquidate your digital currency because you use your crypto value as collateral.
Cons
The threat of margin calls: According to Drawbridge Lending, a margin call is “when the valuation of the borrower's collateral goes down to a point that the lending company will demand a “true up” to rebalance the loan to collateral ratio.” Cryptocurrency is highly volatile, leading to a higher probability of margin calls than other lending options. In the case of a margin call, the lender will likely require the borrower to “deposit additional collateral, repay a certain amount of the loan to balance it against their collateral, or have their coin liquidated by the lending company and face a heavy fee.” ¹
Large holdings necessary: For most lenders for a crypto mortgage, the collateral has to match the loan 100%. For example, MILO, a company claiming to be the world’s first crypto mortgage, will require 1,000,000 in crypto to back a 1,000,000 mortgage.
Ample documentation required for crypto and non-crypto lenders: Your crypto transactions must be thoroughly documented. According to Fannie Mae and Freddie Mac guidelines, any deposit that is more than 50% of the qualifying monthly income that’s awarded on a loan must be sourced. If you do not have proper documentation of your crypto transactions, you most likely would be unable to use that as an asset.
With any financial decision, be sure to do your research and find a solution that works for you. We like to keep our customers informed about current market trends and support their financial curiosities. If you are questioning what mortgage best fits your needs, please contact us today!
The Margin Call Problem In Crypto Backed Lending. Drawbridge Lending. https://www.tradestation.com/learn/market-basics/cryptocurrencies/the-basics/how-does-crypto-compare-to-traditional-currency/#:~:text=A%20cryptocurrency%20is%20a%20digital,to%2Dpeer%20without%20any%20intermediary.
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