Borrowing Using Digital Assets
Tags: Cryptocurrency, Quantum Computing, Digital Asset Management, Cryptocurrency Investment, Crypto

Many have found themselves in a situation where they’re in dire need of money that they know they will be able to pay back at a future date, but would rather not sell anything of value that they own. Borrowing money seems like the perfect solution: you have the funds you need now, you’ll pay them back later (with interest, most likely), and you don’t have to sell anything — only maybe promise the lender that they can have it in case you’re unable to pay them back. Cryptocurrencies can also be one of the things you borrow against. Read on to learn more about using cryptocurrencies as collateral.

Understanding Loans

While there are many types of loans, they have a basic definition in common: a certain sum of money is given to the borrower from the lender, with the promise of repaying them at a later date. The lender may also choose to add a certain percentage of interest on the sum being paid back, as a payback for the inconvenience of the loan and any other charges incurred in the meantime.

However, the lender does not necessarily know that they will get their money back, so they’re risking losing everything if they just give the money away. This is where collateral comes in: defined as an asset that is used as a security for a loan, it is promised to the lender in the case the borrower is unable to fully repay their debt. In this case, the lender will seize the asset and sell it to recoup at least some of their losses. In case the borrower pays back their debt in full, they receive their collateral back. In many cases, not using collateral incurs much higher interest rates than usual.

Cryptocurrency Use Case: Collateral

Since cryptocurrencies are rarely used as collateral (due to a number of reasons that we will consider shortly), they are often considered underutilized as a legitimate financial instrument. However, this is rapidly changing: since many cryptocurrencies already have a set price on the market (even if it’s volatile), many are deflationary, and the best-known coins have enough trading volume that liquidity is not an issue, there is no reason for a lender to not accept cryptocurrencies as collateral.

Additionally, this gives a new use case to cryptocurrencies. Owners can rest easy knowing they can borrow fiat money against it without the need to sell their crypto outright, while lenders are incentivized by the possibility of rising prices, with which they would not only recoup their losses, but also potentially make a profit. Losses are also a possibility, but this is a risk that lenders accepting crypto are willing to take.

The profiting potential is another factor for the borrower as well. For example, imagine it is August 2017 and you just had to sell your Bitcoin because you needed money for rent. Had you been able to take out a loan with Bitcoin as the collateral, you might have received it back just in time to profit from the all-time high in December of that same year, possibly even using that to offset the interest rates you had to pay on your loan. This makes the borrower’s reluctance to part with their collateral much easier to understand.

Smart Contracts for Smart Security

An ever-present concern, especially when it comes to loans in an unregulated space, is the security of both parties. It is in the borrower’s interest to not be taken advantage of while repaying their debt, while the lender wants to receive their money back with minimal issues. In financial institutions, this is solved through legal documents like contracts. But in the case of cryptocurrencies, the most logical solution is also much more elegant: smart contracts.

Smart contracts offer several advantages compared to their older, more established cousins. Perhaps most importantly, they’re trustless: both parties can review the terms and there is no need for a middleman as the contract itself handles the collateral. The lack of a third party also eliminates the need for fees. The concept is simple: a smart contract with a timelock takes the collateral and effectively locks it away during a period that was previously agreed upon, during which the borrower has to repay the lender. Once this time runs out, the contract checks the situation: if the borrower has cleared their debt, it gives them their collateral back — otherwise, it sends it to the lender.

While the theory behind this is simple enough, the question of how to get a secure loan online remains for many users. However, there is only one sure answer: do your research and only use a platform you fully trust to get in touch with the other party and use their smart contracts. Be aware of the risks you take when borrowing or lending, and always make sure you read the fine print.