Since then, things have changed drastically. Cryptocurrencies have seen an unprecedented surge in the traction with retail giants like Starbucks, Shopify, McDonalds etc from diverse verticals have started accepting crypto payments.
Cryptocurrencies have made their way into the financial system and the number of use cases for crypto is only bulging with time. Among them is crypto-backed loans where users can leverage their crypto as collateral to raise funds.
The FinTech ecosystem is looking for every opportunity to explore the high value of digital currencies that actually paved the way for Crypto lending and the use of digital currencies as collateral.
Taking a Crypto loan may be one of the wisest decisions for individuals and institutions that are contemplating fund-raising options for their blockchain or crypto-based projects. The best part about crypto loans is that the user need not worry about credit score or even go through a lot of hassle and paperwork to get the loan approved. In crypto space, one can actually get the loan in just minutes.
However, if the user is going for an overcollateralized loan, then the borrower has to pledge his crypto assets(any of the assets that the user owns) as collateral and take a loan in any of the other assets that the user needs. The case of an anonymous Georgia-based app developer who took a Cryptocurrency loan highlights this. He took a loan of $450,000 that attracted 18% interest. As collateral, he put in $783,000 worth of Bitcoin. He was able to attend to some pressing needs with the loan.
However, when Bitcoin depreciated, the value of his collateral dropped drastically by almost 50%. This triggered a margin call from the lender. He had two options: increase his collateral or have his Bitcoin liquidated.
This raises a salient question: “How do you determine the most appropriate collateral for a crypto loan?”
You can choose the best collateral for your cryptocurrency loan if you have a deep knowledge of the factors that borrowers consider before accepting a coin as collateral.
A step by step guide to choosing the collateral for a crypto loan
Take a look at some of these factors:
Trading Volume of the Collateral
Crypto lenders factor in the volume of a coin before deciding whether it is acceptable or not as collateral for a crypto loan. This is a very prominent metric that summarizes the amount of that specific digital currency that was traded over a 24-hour timeframe.. Most lenders consider this factor for a coin over a period.
A breakdown of the coin’s performance for the period under consideration helps them to ascertain the acceptability status of the digital currency. Their observations will give them a clue into the coin’s value and its performance in the Cryptocurrency market. A crypto lender may use the information to predict the coin’s future.
This is because they can deduce the number of investors that transact with the coin over the given timeframe. A coin with an impressive trading volume is considered as good collateral. Lenders won’t hesitate to include such digital currency in their list of accepted collateral.
Lenders also consider the trading exchange where the digital currency is listed. It is generally believed that a coin listed on the best and major exchanges has better chances of appreciating than others listed on relatively unknown exchanges. The popularity of the exchange may rub off on the coin.
It is a well-known fact that only a handful of new digital tokens that emerged in 2017 got the desired recognition. The reason for the failure of the majority of the tokens is not far-fetched; they were never listed on the top cryptocurrency exchanges. That had a huge negative impact on their general public perception and acceptance of crypto.
This explains the rationale behind crypto lenders’ insistence on accepting only high performing crypto coins that are listed on reputable exchanges for collateral. They don’t want to take a risk with a digital currency that may depreciate badly but one with the potential for appreciation.
It is a win-win situation for both the lender and the borrower. While the lending exchange has better chances of getting their loans back, the lender is spared the stress of going through the harrowing experience of margin calls.
Furthermore, there is a perfect connection between a cryptocurrency’s listing exchanges and its success. This is quite understandable if you study the trend. Listing a cryptocurrency on popular exchanges is a surefire way for the digital asset to enjoy industry approval.
Such digital assets attract potential investors who are interested in cryptocurrencies that are more likely to perform well in the market. This will eventually boost the token’s value as the acceptance and huge interest from potential investors will have a positive impact on the coin.
Continuity of Liquidity
How liquid is the collateral? Liquidity in Cryptocurrency refers to the ease of converting a digital coin to cash or other cryptocurrencies. Lenders are interested in knowing a digital currency’s liquidity status during the loan period before accepting it as collateral. No lending platform wants to be left with a digital currency that has little or no value after granting a loan request.
Thus, a cryptocurrency with high liquidity is an assurance that lenders can always recover their loan and interest by selling the collateral or converting it to any digital currency of their choice if the borrower defaults or for any other important reason.
High liquidity offers several benefits. Price stability is one of the biggest upsides of a highly liquid digital currency. Lenders won’t lose sleep over the possibility of the coin experiencing large swings that characterize most coins.
Quick transaction speed is another benefit inherent in high-liquidity digital currencies. It is easier and more convenient to sell or buy such cryptocurrencies.
Acceptance and trading volume are two of the major factors that determine a coin’s liquidity. It is not surprising that they make the list of factors considered by lenders before accepting a cryptocurrency as collateral.
The Underlying Project Behind the Token
The underlying project behind a token also plays a crucial role in determining whether it will pass as collateral for a crypto loan or not. Since a token represents a digital currency, a token built on a viable project has a better performance potential in the market.
Lenders are more inclined to buy into a coin that offers them great assurance of recouping their investment, not collateral that can hurt their investment.
Let’s take a look at some high-flying digital currencies to help us establish a connection between a cryptocurrency and the impact of the project behind it.
Let’s take a look at Ethereum. This is a very popular digital currency whose popularity is arguably second to Bitcoin’s. With a market cap of over $18 billion and a token value of over $168 as of the time of writing, it boasts of the second-largest market cap in the Cryptocurrency industry, according to the popular Cryptocurrency-related information platform, CoinMarketCap. What’s the secret behind its popularity?
Ethereum has a wide range of applications. It is the building block for Decentralized Applications (dApps) and Smart Contracts. While the latter has a wide range of applications that covers stock trading, real estate, insurance policies, and what have you, the former powers social media and content distribution, decentralized exchanges, supply chain management, automated payments, and voting, among others.
The wide applications are behind the currency’s high-flying reputation and acceptability.
The volatility of a cryptocurrency is the digital currency’s price range over a period of time. If the coin’s value is relatively stable within the given time, it is said to have low volatility.
Why is this factor of great importance to lenders?
The higher the volatility, the less reliable the coin is. A high volatile digital currency moves erratically and is generally unpredictable. Without volatility, though lenders can reasonably predict the coin’s value and movement. Thus, they are more likely to trust such coin as collateral than one whose nature is highly unpredictable.
Therefore, when choosing the right collateral for a crypto loan, consider the coin’s volatility. It is a major factor that may determine its acceptability or rejection.
While selecting the most appropriate collateral may be challenging given the several factors that are put into consideration, Nuo Network, a decentralized exchange, spares you that stress.
The decentralized exchange makes a list of acceptable collateral coins available for potential borrowers on its website.
Nuo offers both long-term and short-term loan lending services and accepts an impressive number of digital currencies as collateral. It lists all the acceptable collateral coins on its website for potential investors to see at a glance. A visit to the exchange is a good way to start your crypto lending journey.
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Disclaimer: This is not financial advice. Opinions, statements, estimates, and projections in this message or other media are solely those of the individual author(s).