What Is Crypto Lending, and How Do Crypto-Backed Loans Work? 

Crypto lending is a way to turn your cryptocurrency into cash without selling your investment. It’s a newer and niche lending option that isn’t without risk. However, if you own cryptocurrency, it might be worth considering.

Keep reading to learn more about crypto lending and whether a crypto-backed loan is right for you.

Table of Contents

1. What is crypto lending?
2. How it works
3. Pros and cons
4. Should I get a crypto-backed loan?
5. How to choose a platform
6. Alternatives

What is crypto lending?

Crypto-backed loans are a relatively new option for cryptocurrency owners. While some early iterations of crypto lending can be found as far back as 2013, it’s only within the past five years or so that these loans have become widely available.

With crypto lending, you use your cryptocurrency as collateral for a loan. That loan could be paid out in cash or another cryptocurrency, such as a stablecoin. Crypto-backed loans are most readily available to owners of larger cryptocurrencies, like the following:

• Bitcoin
• Ethereum
• Solana

Crypto lending can be a good option for those who want to use the value of their cryptocurrency without selling it.

It comes with caveats, though. Notably, you may only be able to borrow 50% or less of your cryptocurrency’s value. There is also a risk of margin calls or liquidation if the crypto market should falter.

How does crypto lending work?

The process of crypto borrowing and lending can depend on the platform you use, but here’s a general overview.

1. Choose a crypto lending platform

First, you’ll need to decide where to get crypto loans. Your options fall into two main categories:

• Centralized crypto lenders, known as CeFi, operate similarly to a bank in that they hold your cryptocurrency and act as an intermediary for borrowers and lenders.
• Decentralized lending crypto platforms, known as DeFi, facilitate loans on the blockchain. Rather than a centralized institution holding the cryptocurrency, collateral may be placed in a decentralized custody wallet.

Centralized crypto lenders typically have easy-to-use platforms and customer service options.

However, a few large CeFi lenders went bankrupt in 2022, and because of that, some people prefer the transparency of DeFi lending even though the process can be more complex.

2. Deposit your crypto

Once you have selected a platform, you’ll need to deposit the cryptocurrency you plan to use as collateral.

Most platforms will only allow you to borrow up to a certain percentage of your crypto’s value. This is known as the loan-to-value ratio, or LTV.

3. Apply for the loan

To borrow crypto or cash based on your own cryptocurrency holdings, you’ll need to submit an application. Some lenders will conduct a soft credit pull to check on the health of your overall finances, but these applications generally don’t have the same underwriting requirements as a regular personal loan.

4. Receive proceeds

After your application is reviewed and approved, you will receive your loan proceeds. They may be issued as cash or a cryptocurrency, such as a stablecoin. Depending on the service used, you could have your money in hours.

5. Repay loan

You may be able to make payments throughout the loan term, but many major crypto lenders don’t require that. Instead, the entire loan principal plus interest must be paid at the end of the loan term.  

6. Collect collateral

After the loan principal and interest are paid, your collateral will be unlocked. You can then move your cryptocurrency off the lending platform or out of the custodial wallet.

Pros and cons

There are benefits to crypto lending, but there are also some significant drawbacks. Here’s a look at the pros and cons.

Pros

• Tap into the value of your cryptocurrency without selling it.

• Generally available to anyone, regardless of credit score.

• Loans can be funded in hours.

• No payments may be required during the loan term.

Cons

• Long loan terms typically not available.

• Volatility in the crypto market could result in margin calls or liquidation.

• Lenders often charge origination fees.

• Can only borrow a percentage of the cryptocurrency deposited as collateral.

Should I get a crypto-backed loan?

So should you get a crypto loan? That depends on your individual needs and whether you already own cryptocurrency.

Crypto lending may be right for you if:

• You already use cryptocurrency.
• You are comfortable with the risk posed by alternative investments.
• You understand how the lending process works.

Crypto lending may not be a good fit for you if:

• You are a conservative investor.
• You aren’t sure whether you’ll be able to pay off the entire loan at the end of the term.
• You have good to excellent credit.

If you aren’t comfortable with alternative investments, we certainly don’t recommend that you buy cryptocurrency just to get a crypto-backed loan. Cryptocurrencies can be subject to wide swings in value and aren’t for the faint of heart.

What’s more, if you have good credit, you may find traditional personal loans from companies like Upstart, Credible and Upgrade may have lower fees, better interest rates and more predictability than crypto lending.

How to choose a crypto lending platform

Figure, Ledn, Aave, and Morpho are a few of the crypto lending platforms and protocols available. Some platforms will allow you to lend crypto as well as borrow crypto.

It’s hard to say which is the best crypto lending platform since everyone’s lending needs are different. Here are some things to consider as you review your options.

• CeFi vs. DeFi
• Types of crypto supported
• How loan is paid out (i.e., fiat vs. stablecoin)
• Interest rate
• Repayment terms
• Loan-to-value ratio

Given volatility in the crypto market, pay particular attention to that last bullet and learn what, if any, liquidation protection a platform might offer in case the value of your collateral falls below the required LTV.

Alternatives to crypto lending

Crypto lending is a niche financial product that comes with risk and complexity. If you’re still unclear on how crypto loans work, that could be a sign to look for an alternative if you need cash.

Consider one of these options instead:

1. Sell your cryptocurrency rather than borrow against it.
2. Take out a personal loan.
3. Tap into your home equity.

If the value of cryptocurrency should plummet, you could find yourself scrambling to make a large payment on a crypto loan. The above options involve less risk and can still provide you with the money you need.  

Check out our picks for the best personal loans and compare their terms to those available from crypto lenders.