Crypto Loans and How They Work
Crypto loans are a form of financial service that utilizes blockchain technology to facilitate the lending and borrowing of digital assets. Crypto loans allow borrowers to access funds without the need for a traditional financial intermediary. Loans are typically originated on decentralized applications (dApps) on a blockchain network where borrowers and lenders can securely and transparently negotiate loan terms and conditions.
Unlike traditional lending models, crypto loans are borderless and do not require credit checks. Anyone with a crypto wallet can instantly utilize these protocols and gain access to financial services. Crypto loans allow for more flexibility in terms of repayment schedules and loan amounts.
Why Crypto Loans Require Collateral
In most cases, the loan is collateralized by cryptocurrency or other digital assets, allowing the lender to recoup their funds in case the borrower defaults on their loan payments. The loan terms are also often programmed into the dApp, meaning that the borrower can rest assured that all of the terms and conditions of their loan will be honored.
Most protocols opt for an over-collateralization schema to ensure safety. The crypto being used as collateral is a form of security for the loan, ensuring the lender will be repaid in the event that the borrower defaults on the loan. This involves setting a Loan-to-Value (LTV) ratio, which requires that the borrower provide more collateral than is necessary to cover the loan amount. This is important for both the borrower’s position and the safety of the overall protocol, as it helps to protect the lender from losses if the borrower defaults on their loan. Over-collateralization also helps to reduce the impact of market volatility, as a higher LTV ratio can lead to a larger potential loss for the lender if the value of the collateral decreases during the loan period.
The Risks Involved
As is the case with every lending and borrowing protocol utilizing smart contracts, they can also face some security issues. In the event of some smart contract vulnerability, the user’s funds might be at risk.
This risk can be mitigated by smart contract audits. A smart contract audit is a process by which a smart contract is reviewed by a professional audit team. The audit team will review the code of the contract, the security of the contract, and the functionality of the contract to ensure that it is secure, reliable, and functioning as intended. The audit team will then provide a report on their findings and make recommendations for any improvements that should be made. This is an important step in ensuring the security of a smart contract. Through the audit, any vulnerabilities in the code can be identified and addressed before the contract is deployed. This helps reduce the risk of stolen or lost funds due to a smart contract vulnerability.
To learn more about protecting your crypto when interacting with dApps, click here.
How Crypto Loans Without Collateral Work
Crypto loans without collateral is a form of financing that allows users to access capital without providing traditional collateral forms such as property or capital assets.
One of the ways these types of loans can be secured is by using a standby letter of credit (SBLC), which is a promise from an institution to pay back the loan in the event of a loan default from the user. These loans are usually only available to whitelisted institutional players, meaning that only those approved by the lender can access these types of loans.
Non-whitelisted users are still able to participate in these protocols by lending out their excess stablecoins (USDC, DAI) for these players to utilize.
Platforms That Offer Non-Collateralized Crypto Loans
Below are some protocols offering non-collateralized loans and how they facilitate them
Centrifuge
Tinlake is a platform that allows investors to provide funding for assets locked in liquidity pools, which can then be borrowed by asset originators. These assets can come from various sources, such as fix and flip real estate loans, short-term cash advances, working capital, advance inventory purchases, or advance payments for artists and media companies. Investors can choose either the DROP token, which represents a lower-risk senior tranche with a fixed but lower yield, or the TIN token, which represents a riskier junior tranche with a higher but variable yield. The platform has several advantages for asset originators, such as faster access to capital, lower-cost financing, and more accessibility to small and medium-sized businesses.
Ondo Finance
Ondo Finance is an open, permissionless, decentralized investment bank that provides services and connects various stakeholders in the DeFi ecosystem to fully on-chain services. Ondo bundles and unbundles financial products from many protocols and repackages them into exposures that fit the needs of different investors, increasing the diversity of capital supply for DeFi. Ondo acts much like a traditional investment bank, but with the use of open-source code, the need for back office staff and intermediaries is eliminated, allowing for it to be accessible to everyone with no investment minimums. Governed as a DAO, it also incentivizes anyone to create products or services and be rewarded. Ondo has completed three audits and is highly experimental software, yet it provides liquidity providers with both fixed and variable tranches, allowing for a better balance of risk and rewards.
Goldfinch Finance
Goldfinch (GFI) is a DeFi protocol that provides users with access to cryptocurrency loans without the need for collateral. It has been immensely popular, with over 100m USD in active loans since its launch, and is now expanding financial access to thousands of individuals in emerging markets. The protocol operates as pure code, eliminating the need for gatekeepers and middlemen and reducing the delays associated with loan processing. GFI is the protocol’s main utility and community governance token and is used for staking, voting, rewards, grants, and incentives. Stablecoins like USDC are used for investment and loans.
Atlendis
Atlendis is a decentralized non-custodial DeFi lending protocol that allows liquidity providers to lend digital assets to allow-listed counterparties. It enables borrowers to borrow without posting any collateral upfront and lenders to receive a yield determined by the market’s supply/demand dynamics. This unsecured nature of the loan exposes the lender to credit risk but is beneficial to borrowers as it allows for greater capital efficiency and flexibility. Atlendis targets entities with regular and short-term liquidity needs, allowing them to borrow up to a preset limit without collateral. The borrowing rates are discovered via a limit order book specific to each pool, and the protocol is composed of a set of fully autonomous smart contracts that reside on the Ethereum network.
In Conclusion…
Crypto Loans provide a unique way to access capital using cryptocurrency, either with or without collateral. Collateralized loans are more secure for the lender, while non-collateralized loans are beneficial to borrowers due to their greater capital efficiency and flexibility.
Always be sure to do your own research before choosing a lending and borrowing protocol to work with!
Disclaimer
The information provided in this marketing material is for educational and informational purposes only and should not be construed as financial or investment advice. Cryptocurrencies are highly volatile and speculative assets that can experience significant price fluctuations. Past performance is not indicative of future results. Any forward-looking statements reflect MELD’s views at the time such statements were made with respect to future events and are not a guarantee of future performance or developments. You are strongly cautioned that reliance on any forward-looking statements involves known and unknown risks and uncertainties. You should conduct your own research and consult with a financial advisor before making any investment decisions. The issuer of this marketing material assumes no liability for any financial losses or damages resulting from your reliance on the information provided herein.
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