The world of banking and finance is one of the oldest business models in the world, and the ability to secure lending is attributed as one of the main reasons why economies flourish in the first place. Traditionally, access to loans has remained firmly within the domains of banks and other financial institutions, who use the deposits of their customers to finance loans and mortgages to other businesses and individuals. However, blockchain has not only enabled new forms of cryptocurrencies to rival the traditional fiat currencies of central banks but also has created a new form of financing without the traditional middlemen institutions we’ve been used to.
Crypto-financing is becoming an increasingly common trend as the general public realizes how much banks and financial institutions are making off their deposits. This, coupled with increasing levels of interest in cryptocurrencies, is causing some financial pundits to expect a migration of financial services from the institutional world to the realm of crypto assets. Crypto-loans allow those who hold quantities of bitcoin (BTC), Ethereum (ETH) or other digital assets to use them as collateral for obtaining loans. This new trend promises to not only make financing a quicker, smoother process but also disrupt how the traditional lending industry operates as a whole.
Traditional Problems With Collateral
Historically, there have existed a variety of financial instruments used as types of collateral for
obtaining credit. Tangible assets, such as real estate, have and continue to serve as collateral especially in the case of homeowners. The downside of using real estate is that it is a largely illiquid market, often taking months to find a buyer for a home at market price. For this reason, liquid assets tend to be preferred in collateral agreements, and stocks have been a favorite financial instrument. As opposed to tangible assets, they do not depreciate as quickly as other collateral options, although certain stocks might be vulnerable to sudden price swings.
But what makes the traditional lending world so ripe for a blockchain-powered alternative is that acquiring credit tends to be a difficult, bureaucratic process. Trying to get a loan from a bank isn’t an easy process. Often times, lenders might be unique in the type of loans they permit i.e. Bank A might accept collateral that Bank B would not. On top of that, a plethora of paperwork will be involved as well as the requirement of having a good credit score. There is also the problem of timing, as borrowers who need a quick loan for an emergency or a time-limited situation likely won’t be able to get approval from a traditional bank for funds.
While still in its infant stages, there is an alternative to the traditional lending world…
The Benefits of Crypto-Collateral
Crypto assets are designed to be seamless, liquid, and universally accepted as a method of transactions among various exchanges. For any crypto-asset, blockchain technology allows for almost immediate verification of its authenticity, worth, and ownership. When compared to a traditional loan, for example, this process could require credit checks, tax assessments, proof of insurance, personal records, and many other documents. Now that currencies such as bitcoin have become quasi-mainstream in the markets, crypto-financing is poised to capture a big portion of the worldwide consumer loan market – estimated to be worth over 48 trillion US by the end of 2019.
One benefit to crypto-loans is that their terms tend to be different from standard loan agreements. For example, a person could use 1 BTC to collateralize a loan of $10,000, but fluctuations in the market mean its value can go up to $15,000 or more or go down in that same period. As such, crypto-loans tend to be flexible to account for this volatility. The loan rate may vary from 7% to 12% or more per annum. At the same time, many platforms different systems, with some P2P-based platforms letting the buyers and sellers come to agreements on their own. That way, it’s possible to work out custom or unique arrangements if the proper lender comes along – and with thousands of lenders on these platforms, borrowers will always have more options then the handful or so traditional banks.
Traditional loan agreements tend to involve a plethora of paperwork, authentication requests, and other verification measures that slow down the entire process. Not only does this mean that those needing a time-sensitive solution are forced into pawning off their assets at discounted prices, but it guarantees that the lending industry gets bogged down in bureaucracy with dozens of employees verifying the same information over again. Ownership of bitcoin in and of itself serves as a form of verification, allowing for rapid authorization of funding.
Cryptocurrencies function on a global scale, and unlike traditional loans, blockchain technology helps facilitate borrowing and lending on a cross-continental scale, allowing for a greater, unified market with more participants and greater liquidity. At the same time, crypto-loans allow or an unparalleled level of transparency considering the global nature of the market. Borrowers can be assured that lenders won’t secretly sell or speculate with their borrowed cryptocurrencies. Considering how volatile crypto-markets can be, a faulty speculation can lead to defaults.
There have been many companies looking to create crypto-lending solutions to everyday users, each taking a somewhat different approach in their implementation. Some of these platforms use a centralized peer-to-peer (P2P) model where the platform matches individual borrowers with lenders, with the later determining the terms of the contract. Other models use a decentralized P2P approach, where loan agreements are built on Ethereum-powered smart contracts with individuals interacting directly with each other. A third approach involves a single company or entity providing all the loans directly to borrowers, with no additional lenders on the platform – a solution that most resembles the traditional banking world.
The Major Crypto-Lending Platforms
SALT is a crypto-lending platform that differentiates itself in that borrowers are able to leverage their existing blockchain assets for funding without giving up ownership of their assets. Operating under the centralized P2P model, every crypto asset holder can lend or borrow to anyone else. What makes SALT attractive to investors is the platform offers no prepayment fees and the interest rate depends on what the involved parties both agree to. The entire process for applying for a loan is, like with other crypto-lending platforms, much simpler than their non-crypto counterparts. Specifically, users purchase ERC20 SALT tokens and then put up their own bitcoin or other tokens as collateral. Then users borrow money from the platform’s network of verified lenders, with interest rates varying between 10 to 15 percent for the most part, and monthly installment loans are available as well, although only in USD.
Instead of looking at a credit score, the history of the borrower’s cryptocurrency transactions and the value of the assets are evaluated instead. With every lending agreement secured by a smart contract, the process remains remarkably secure. The only real test a lender has to pass is the SALT Lending Suitability Test as well as a minimum investment threshold. The platform does implement a membership fee which is repayable in their SALT tokens, which can also be used to pay back any loans, among other benefits.
The problem with SALT’s lending platform is that while borrowers are guaranteed to receive their collateral back, they remain vulnerable in the event of a margin call. Should the valuation of their crypto-collateral plunge to much, algorithms will demand that you either prop up additional cryptocurrency lest you face a forced liquidation of your assets.
This platform takes a more of a laissez-faire approach in facilitating crypto-lending transactions in comparison to other lending-platforms. Borrowers and lenders use their system to connect directly where they mutually negotiate and agree to the terms of the contract. Based on Ethereum, most ERC20 tokens are permissible as collateral on loan agreements.
Unlike SALT, ETHLend isn’t restricted to US Bank account holders and doesn’t require a membership fee. As well, since the funds are held only between the lenders and the borrowers, ETHLend wouldn’t be able to liquate assets in the case of a margin call.
At the same time, the disadvantage from the ETHLend platform comes from the fact that all loans are effectively denominated in Ether, making it more difficult for someone to purchase something that wasn’t readily purchasable in cryptocurrency. This would mean having to pay fees through an exchange, such as Coinbase, in order to receive fiat.
ETHLend has also announced partnerships with other companies including Brickblock, a trading platform that connects real-world assets with cryptocurrencies for trading opportunities. In the future, it’s possible that ETHLend users will get access to new forms of collaterals and help improve liquidity on the platform.
Blockchain technology has already led to a financial revolution in terms of decentralized digital currencies and the potential they can bring if they reach a point of mainstream adoption by the general population. It’s only natural that cryptocurrencies will be used as a new form of collateral, and in turn, decentralize the entire lending industry once and for all.
Also published on Medium.