Collateral is any asset that secures a loan. Crypto collateral refers to loans which use cryptoassets as collateral.
A collateralised loan is a type of loan where the borrower gives the lender something of value to hold for the duration of the loan as security. The lender is allowed to sell the collateral, to make good on the outstanding loan, if the borrower fails to honour the terms of the credit agreement.
Collateralized lending means the lender takes on less risk when making loans which means they can provide loans to people who normally wouldn’t be able to get one, and can do so at a lower interest rate.
Collateralized lending takes many forms. A mortgage is a type of collateralized loan. In the event the borrower doesn’t repay the mortgage according to the agreement, the lender can seize the property and sell it to repay the loan (known as foreclosure).
Crypto loans use cryptoassets as collateral. Crypto-backed lenders make loans secured by crypto. Lenders take control (but not ownership) of borrowers’ cryptoassets as security before providing them loans. When the loan is repaid in full along with any interest, the crypto lender releases the crypto collateral back to the borrower, and all ends well. If however the borrower doesn’t adhere to the terms of their agreement. For example by not repaying the loan or missing interest payments, the lender will see the crypto collateral and use the proceeds to pay back the loan on the borrowers behalf.
As lenders security is based solely on the value of the cryptocurrency they are holding as collateral, crypto-backed lenders have high standards about which cryptos they will accept as collateral. There is no point taking a crypto as security if the price could crash 90% and the lender would be left with nothing in the event they needed to sell it to make good on a customer’s loan. Different crypto lenders accept different cryptocurrencies as collateral. The rule of thumb is the higher the market cap of the cryptocurrency the more likely a lender will be to accept is as collateral.
Most crypto lenders accept the big 3 cryptocurrencies, Bitcoin, Ethereum and XRP (Ripple) as collateral. As other cryptocurrencies gain wider adoption, and are traded on more exchanges at more stable prices, they will likely also be accepted as collateral by the various crypto lenders.
As cryptoassets have volatile prices, crypto lenders will always loan you less than the amount of collateral you lodge with them. The amount they will lend compared to the amount you lodge with them is known as the loan to value (LTV). Read our primer on crypto loan to value (LTV)
Collateral is the security you give the crypto lender before getting a crypto loan.
- Collateral can be any cryptoasset a lender will accept.
- The lender controls but does not legally own the collateral.
- If you don’t adhere to the terms of your loan agreement the lender can sell the collateral to make good on your agreement.
- The lender will lend you less than the value of your collateral which is known as the loan to value (LTV).