Imagine this: you've held onto Bitcoin for a while, witnessing its impressive growth. Now, an unexpected expense pops up. While traditionally, you might sell some BTC to cover the cost, an alternative you may want to consider is crypto collateral loans. This allows you to enjoy the best of both worlds as you HODL your BTC while enjoying additional liquidity for expenses when you borrow against crypto holdings.
Curious about how you can best make use of crypto collateral loans? From understanding the benefits and risks of borrowing against cryptocurrencies like Bitcoin to exploring the process of applying for such collateralized loans, our guide will cover everything you'll need to know about Bitcoin backed loans and how you can possibly set up a Bitcoin-backed mortgage in the near future.
What are crypto collateral loans?
Crypto collateral loans function similarly to traditional collateralized loans but make use of crypto as the loan's collateral. Instead of using cash or fixed assets like a car or house as collateral, crypto collateral loans allow for the pledging of cryptocurrencies like Bitcoin as collateral to secure a loan from the lender. By agreeing to borrow against crypto like your Bitcoin, the lender then provides you with stablecoins up to a certain percentage of your pledged crypto's value. This percentage is known as the Loan-to-Value Ratio (LTV) and represents the amount you can borrow up to.
Benefits of crypto collateral loans
Maintaining crypto exposure with leverage
Want access to funds without being forced to sell your Bitcoin? Using crypto as collateral for loans allow bullish traders to access additional funds without selling their existing crypto holdings. This provides leverage, enabling them to maintain their exposure to the potential upside of their crypto assets while also gaining access to funds for other needs.
Giving the unbanked access to credit
If you've ever tried to secure a loan from a traditional financial institution, you'll know that it can sometimes be a hassle because of the administrative steps involved. Fortunately, crypto collateralized loans can be accessed without going through the route of securing a loan with a bank, making them more accessible than traditional collateralized loans. This could be a game-changer for the estimated one-third of the world lacking access to traditional banking services.
Potential for lower interest rates and higher LTV ratios
Despite their volatility, crypto collateralized loans offer a glimpse into a lending landscape with lower interest rates and better LTV ratios compared to traditional collateralized loans. This is because cryptocurrencies can be more efficient collateral for lenders. Unlike traditional fixed assets like houses, crypto can be easily liquidated on a global market. This efficiency can translate to lower borrowing costs for users and potentially higher LTVs, meaning borrowers can access a larger portion of their crypto's value as a loan.
Risks of crypto collateral loans
Loss of collateral at a disadvantageous price
During a market downturn, the value of your crypto collateral can plummet due to significant price dips, resulting in an immediate increase in your LTV ratio passing a margin call threshold. If left unchecked, this can trigger forced liquidation by the lender to cover the loan, causing you to sell your crypto holdings at a significant loss compared to when you locked it in as collateral.
Smart contract risk
DeFi platforms that offer crypto collateralized loans rely on smart contracts. While this allows for greater automation, transparency, and potentially lower fees, these contracts are essentially lines of code which are prone to bugs and vulnerability exploits. These vulnerabilities can be exploited by malicious actors, potentially leading to the loss of your deposited crypto collateral.
Can you use Bitcoin as collateral for a house?
With the exception of the crypto mortgage services offered by Milo Credit for properties within the United States, it's generally not possible to directly use Bitcoin or other cryptocurrencies as collateral for a house from traditional lenders like banks. This is due to two reasons:
Limited crypto acceptance by traditional lenders
Banks and mortgage lenders have well-defined rules and compliance standards about what they can accept as collateral for loans. These rules tend to favor established assets with a proven track record and stable value, like houses or investment portfolios. Due to their volatility and short history, cryptocurrencies are not yet widely accepted as collateral for traditional loans like mortgages.
Valuation challenges due to crypto volatility
The value of Bitcoin and other cryptocurrencies can fluctuate significantly. This volatility makes it difficult for lenders to accurately assess the value of your crypto holdings and determine a safe loan amount. If the price of Bitcoin falls sharply after you take out a loan, the lender might not be able to recoup their losses if you default on the loan. This ultimately discourages traditional lenders from taking on this risk of volatility.
Despite these roadblocks, it seems we might have new developments down the line thanks to the approval of spot Bitcoin ETFs.
How spot Bitcoin ETFs might enable BTC-backed mortgages
With the official approval of spot Bitcoin ETFs, a revolutionary shift in the world of TradFi and crypto integration might be on the horizon. Here's how spot Bitcoin ETFs could potentially pave the way for BTC-backed mortgages:
Increased legitimacy as an asset class
Since their approval, spot Bitcoin ETFs are considered regulated investment vehicles in the world of TradFi, similar to traditional ETFs that track stocks or bonds. This regulatory oversight could increase the legitimacy of Bitcoin as an asset class in the eyes of traditional financial institutions, including mortgage lenders. With greater trust in Bitcoin's role as a potential asset class, lenders might be more open to considering it as collateral and treat it similar to how stocks and bonds are used for loan collateral, potentially offering borrowers more favorable interest rates on BTC-backed mortgages.
Standardized valuation
Spot Bitcoin ETFs trade on major stock exchanges, providing a transparent and regulated market for buying and selling these funds. This would establish a more standardized and reliable mechanism for valuing Bitcoin, addressing one of the major hurdles for traditional lenders that may get confused by the lack of a standard pricing for the digital asset powerhouse. With a clearer picture of Bitcoin's value, lenders could determine appropriate loan amounts based on BTC-backed ETF collateral.
Improved liquidity
The additional step of creating accounts on centralized exchanges or Web3 wallets for DeFi trading can be a barrier to entry for those new to the crypto space. Spot Bitcoin ETFs offer a more accessible gateway to gain exposure to Bitcoin, thereby attracting a wider range of traders. This increased participation can lead to greater liquidity in the Bitcoin market, making it easier for buyers and sellers to enter and exit. Consequently, a more liquid market could also potentially reduce volatility, ultimately making Bitcoin a more attractive collateral option for lenders as they'd be more confident in quickly selling the asset in case of a borrower's default.
Regulatory framework development
The introduction of spot Bitcoin ETFs might prompt regulatory bodies to develop a clearer framework for how cryptocurrencies can be used and measured as financial instruments. This framework could establish guidelines for how crypto assets can be valued, held securely, and used as collateral, paving the way for wider acceptance by lenders, including those in the mortgage market. On top of giving lenders more certainty and risk mitigation strategies, a clear regulatory framework could also offer borrowers increased security and consumer protection within the crypto space.
How would a spot Bitcoin ETF backed mortgage work?
Let's explore a hypothetical scenario. Imagine you own units of the iShares Bitcoin Trust spot ETF, representing the value of 5 BTC. The current total value is $350,000, assuming each Bitcoin is valued at $70,000. You're interested in purchasing a house but might not have the entire down payment readily available. Here's how a spot Bitcoin ETF-backed mortgage could potentially help you bridge that gap.
1. Choosing a lender
The first step involves researching reputable lenders offering spot Bitcoin ETF-backed mortgages. These lenders might be traditional institutions adapting to the changing landscape or new fintech players specializing in crypto-backed loans. Let's assume in this case that lenders are transitioning towards accepting crypto backed mortgages in the form of spot Bitcoin ETF shares.
2. Loan application and eligibility
Once you've chosen a lender, you'll initiate the loan application process. Similar to traditional collateralized mortgages, you'll need to provide basic financial information, income verification documents, and proof of employment. However, the crucial difference lies in using your spot Bitcoin ETF holdings as collateral.
3. LTV ratio and collateralization
The lender will determine the Loan-to-Value Ratio (LTV) applicable to your spot Bitcoin ETF. This ratio signifies the percentage of your ETF's value you can borrow against. For instance, if the LTV is 60%, and your spot Bitcoin ETF representing 5 BTC is currently worth $350,000, you could potentially qualify for a loan of up to $210,000.
Given the price fluctuations of Bitcoin, the lender will likely require you to maintain a certain minimum LTV throughout the loan term. This acts as a buffer to protect them in case of price drops. If the value of your spot Bitcoin ETF falls below the minimum LTV threshold, you might need to add additional cash or sell a portion of your ETF to maintain the required collateralization level and avoid forced liquidation of your collateral.
4. Loan approval and disbursement
Upon successful application and verification, the lender will approve your loan for the agreed-upon amount. However, instead of directly receiving cash like with a traditional mortgage, the lender might hold your spot Bitcoin ETF in a secure custody solution. They then disburse the loan amount in your chosen currency to be used towards your house's down payment.
5. Repayment and reclaiming your spot BTC ETF shares
Throughout the loan term, you'll make regular monthly repayments that include principal (the borrowed amount) and interest. Once you've fully repaid the loan with interest, the lender will return control of your spot Bitcoin ETF shares back to you.
The effect of spot Bitcoin ETFs and the future of crypto collateral loans
The introduction of spot Bitcoin ETFs likely won't lead to an immediate influx of BTC-backed mortgages. However, it signifies a crucial step towards integrating Bitcoin into the traditional financial system. As regulations evolve and market volatility is addressed, BTC-backed mortgages could become a viable option for crypto holders looking to leverage their Bitcoin holdings for real estate purchases and borrow against Bitcoin to gain access to greater liquidity and cash flow. While challenges remain and the future of Bitcoin as a legitimate asset class remains uncertain, few can deny that this innovation of making use of Bitcoin as collateral for loans holds the promise of unlocking new financial opportunities for both crypto traders and traditional institutions.
Borrowing against Bitcoin with OKX Loan
With OKX Loan, you can begin exploring crypto backed loans today. While they might not be on the scale of a crypto-backed mortgage, OKX Loan offers both flexible and fixed loans to meet your crypto borrowing needs.
With more than 100 kinds of crypto options to be used as the loan's collateral, the option to borrow more than 20 different types of crypto assets, and a borrowing limit that's determined on a case-by-case basis, you can effortlessly enjoy increased cash flow by simply pledging your crypto holdings as collateral with us.
For more information, check out our beginner's introduction to OKX Loan and the guide to applying for a Flexible Loan with us.
Final words and next steps
Crypto collateral loans ultimately offer a novel way to access cash without letting go of your crypto holdings or selling your Bitcoin. They provide quicker access to funds compared to traditional loans and can be a strategic tool for crypto traders seeking short-term cash flow options. By understanding how crypto collateral loans work and the associated risks, you can make informed decisions to leverage this financial tool and unlock the potential of your Bitcoin and overall crypto holdings.
Keen on reading more about crypto lending before taking the plunge into crypto collateral loans? Check out our guide to crypto lending and the top platforms for crypto lending.
FAQs about crypto collateral loans
What are crypto collateral loans?
Crypto collateral loans are a type of loan where you borrow money using cryptocurrency as collateral. Similar to a traditional pawn shop, you don't sell your crypto, but instead use its value to secure a loan.
What types of cryptocurrencies can I use as collateral?
The specific cryptocurrencies accepted as collateral vary depending on the lender. Popular options include Bitcoin, Ether, and stablecoins like Tether and USDC.
Why would I take a crypto collateral loan?
From gaining access to cash flow without selling your crypto to boosting short-term liquidity needs, crypto collateral loans can be a faster alternative to traditional loans for short-term cash flow needs without the need for you to sell your crypto holdings.
Is getting a crypto collateral loan easy?
Getting a crypto collateral loan can be easier than traditional loans in terms of speed and credit score requirements. However, it's not without challenges. While the application process is generally straightforward, complex factors like market volatility and maintaining a certain loan-to-value ratio can add complexity and risk.
How safe are my crypto assets when they're used as collateral?
Reputable lenders like OKX will hold your crypto in secure custody solutions. This can be verified with our Proof of Reserves that maintains a 1-to-1 reserve of all users' funds on the OKX platform.
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