An exciting advancement in the cryptocurrency industry will allow consumers to leverage their crypto holdings as collateral for formal currency loans. Crypto-backed lending institutions, such as BlockFi and Unchained Capital, now offer collateralized loans using Bitcoin, Ether, and Litecoin.
You may wonder exactly how crypto-secured lending works. With traditional collateralized loans, the borrower stakes an asset and receives money in return. Similarly, crypto-collateralized loans require the borrower to offer cryptocurrency as collateral in exchange for another asset. These lending institutions often require the loan to be over-collateralized to offset the volatile nature of cryptocurrencies.
The main benefit for consumers is that they aren’t required to sell any of their crypto assets in order to receive funding. By taking out a crypto-backed loan, the consumer is able to keep the upside potential of their crypto while it’s held as collateral on the loan.
When taking out a crypto-backed loan, consumers send their crypto to a unique secure wallet address that is generated specifically for them. The lending institution is responsible for securely storing the consumer’s crypto assets at this unique wallet address.
Some lending institutions store consumers’ digital assets in dedicated addresses from their multisignature cold storage wallet. Other institutions opt to utilize third-party trust companies to store the crypto assets in a cold storage system. This type of offline storage is only accessible in a secure, access-controlled facility that is protected from cyberattacks.
When utilizing third parties for storing consumers’ digital assets, it is important to verify that the trust company complies with capital reserve requirements as well as banking compliance standards. Due to the digital nature of cryptocurrencies, it is also important to verify that the third-party trust company has digital asset insurance coverage and is SOC 2 Type 1 security compliant on its exchange and custodian platform.
Throughout the duration of the loan, the crypto assets will not be accessible by the borrower. Once the loan has been paid in full, the crypto assets and any gains from the price appreciation that occurred during the term of the loan will be passed back to the borrower.
