Cryptocurrency-backed loans (commonly referred to as crypto loans) have begun to change the global financial sector. For those with sufficient crypto assets, borrowing crypto against those assets held as collateral can be a seamless way to receive extra capital without selling their assets. Interest rates on crypto loans are typically more competitive than traditional loans offered by banks and other financial institutions. Since they generally don’t require credit checks, the time it takes to complete a crypto loan application and receive your funds can also be significantly faster.
However, many people ask whether getting a crypto loan without collateral is possible. The short answer is currently "not likely". Although some cryptocurrency lending platforms have started offering secured loans, taking unsecured loans is unprecedented, with a few rare exceptions.
Why Borrowers Need Collateral for Loans
As the borrower, proving that you have enough collateral to repay the loan is the most important part of the application process.
The collateral required for the loan does not have to be cash. When a borrower signs up for a mortgage to purchase a home, the borrower's home is often some kind of collateral. Likewise, if a borrower takes out a car loan, the car is usually the collateral.
With traditional loans offered by banks and other financial institutions, prospective borrowers must jump through multiple hurdles. First, the lender might reject a borrower’s loan application if they haven’t built up a credit history or their credit score is too low. Even when lenders approve a loan application, the average approval wait time is 52 days, according to a March 2021 report from Ellie Mae.
While both crypto loans and traditional loans both require collateral, crypto loans are a bit different in that the loan application approval process can be quicker and the interest rates are oftentimes more competitive. Because crypto loans generally don’t require credit checks, borrowers get loan approval and receive funds much faster than traditional loans.
Why Crypto Loans Require Over-collateralization
For crypto loans, borrowers will use cryptocurrencies such as Bitcoin and Ethereum as collateral for the loan.
Borrowers can then freely use the loan capital to purchase a home with crypto, buy a car, and more. Crypto loans help to automate the entire loan process, including loan origination and repayment.
With crypto loans, the lending platform doesn’t need to trust that borrowers will pay back their loans on time because the lending platform knows the loan is over-collateralized. An over-secured loan is a loan that requires the borrower to provide cryptocurrency collateral in advance that is worth more than the original value of the loan's assets (these values are often calculated in U.S. dollars).
This ratio, called loan of value (LTV), is different for each cryptocurrency lending platform. Borrowers receive lower interest rates with lower LTV (more collateral). For example, at the time of this writing, Abra Borrow offers LTVs ranging from 15% to 50% and ratios ranging from 0% to 9.95%.
Cryptocurrency loans require excessive collateral for a number of reasons. First, excess collateral increases the likelihood that the borrower will repay the loan. This is because the value of the collateral exceeds the value of the loan. If the borrower does not repay the loan on time, there is a risk of losing collateral on the lending platform.
Second, the price volatility of cryptocurrencies means that the collateral value can drop significantly, sometimes quickly. Requiring a larger amount of collateral helps reduce risk for lenders.