How Do Crypto Loans Work?

A crypto loan allows you to borrow money while using cryptocurrency as collateral. Instead of selling your assets, you can use them as security to access cash or stablecoins. The loan terms depend on the platform you use and how much collateral you provide. With a crypto loan, you don’t need to sell your Bitcoin, Ethereum, or other assets to get liquidity, making it a popular option for people who expect the value of their holdings to increase over time.

There are two main types of crypto loans: secured and unsecured. Secured loans are more common and require that you use some of your cryptocurrency as collateral. If you default on the loan, the lender can seize your assets. Unsecured loans, which are less common, don’t require collateral but usually come with higher interest rates and stricter requirements.

When it comes to crypto loans, you’ll find two main categories: centralized and decentralized loans. Both have their own structures and risks, so it’s essential to understand the differences before deciding which one to use.

Centralized crypto loans vs DeFi crypto loans

Centralized crypto loans are provided by platforms that work similarly to traditional banks. These platforms, like BlockFi and Nexo, require you to go through KYC (Know Your Customer) verification to comply with regulations. They tend to offer more security and customer support, making them appealing to users who want a more traditional loan experience. However, with CeFi loans, your crypto is held by the platform, meaning you lose direct control of your assets while the loan is active.

On the other hand, decentralized crypto loans operate using smart contracts on blockchain platforms like Aave or Compound. With DeFi loans, there’s no central authority holding your assets. Instead, smart contracts handle the loan agreement, giving you more control over your funds. However, DeFi loans come with added risks, such as smart contract vulnerabilities, and they don’t offer the same level of regulatory protection as CeFi loans.

Borrowing against your crypto for cash can offer several advantages. One of the biggest benefits is access to liquidity without selling your crypto holdings. This means you avoid potential capital gains taxes and can hold onto your assets, hoping they increase in value over time. Cryptocurrency loans can be a smart move for investors who want to stay in the market but need cash for other purposes.

Another advantage is the speed of approval. Many crypto lending platforms approve loans quickly, sometimes within a few hours, and often don’t require credit checks. This can make crypto loans a good option for people who don’t qualify for traditional loans due to low credit scores or lack of credit history.

While crypto loans have their perks, they also come with some downsides. The biggest risk is price volatility. Cryptocurrencies are known for their wild price swings, and if the value of your collateral drops significantly, you could face a margin call. This means the lender will require you to add more collateral or risk liquidating your assets.

Another downside is that your crypto is locked up while the loan is active, meaning you can’t access it for other investments or transactions. Plus, some platforms charge high fees, including origination fees and interest rates that may add up, primarily if you don’t repay the loan quickly.

What are the risks of crypto loans?

The most significant risks include the possibility of liquidation if the value of your crypto drops, leading to a margin call. You might also face platform risk if the lender experiences financial trouble or is hacked. With DeFi loans, there’s the added risk of smart contract vulnerabilities, where a flaw in the code could lead to losses. It’s essential to weigh these risks before taking out a crypto loan.

To borrow against your crypto for cash, follow these steps:

1. Choose a lending platform: Start by selecting a platform that supports your preferred cryptocurrency and offers loan terms that suit your needs. You can choose between centralized platforms like BlockFi or decentralized platforms like Aave. For a list of platforms, visit our guide to the best crypto loans.

2. Verify your holdings and identity: Most platforms require you to verify your crypto holdings and complete identity verification for centralized platforms.

3. Set your loan terms: Choose the loan amount, loan-to-value (LTV) ratio, and repayment period that works for you.

4. Deposit collateral: Once your loan is approved, deposit your cryptocurrency. The amount you can borrow will depend on its value.

After these steps, the loan amount will be transferred to your account, and you can use it as needed.

Looking to calculate your crypto taxes? Try our free crypto tax calculator.

You can borrow against your crypto through both centralized and decentralized platforms. Centralized options include well-known companies like Nexo, Celsius, and BlockFi, where you can find regulated services with customer support. These platforms offer security but require identity verification.

Platforms like Aave and Compound are popular choices for decentralized loans. These DeFi platforms give you more privacy and control over your assets but come with added risks due to the lack of oversight. For a list of platforms, check out our guide to the best crypto loans.

If you’re unsure about locking up your crypto as collateral, there are other ways to access funds. You could consider more traditional options like personal loans from a bank or credit union, which offer stability and aren’t affected by crypto volatility. Home equity loans or refinancing your mortgage are options if you own property and need cash for a larger expense.

For smaller, quick loans, apps like CashApp may offer options. These tend to have higher interest rates than crypto loans. It’s imperative to understand the risks involved and do your own research before undertaking any activity in crypto.

Here are answers to frequently asked questions about crypto loans, how to borrow against crypto for cash, how to get a crypto loan, the cryptocurrency loan process, and Bitcoin loans.

What are crypto loans without collateral?

Crypto loans without collateral (often called uncollateralized loans or flash loans) don’t require you to pledge any assets upfront. These loans, like arbitrage trades, are usually used for specific, short-term purposes and must be repaid within the same transaction. Platforms like Aave offer flash loans, but they come with significant risks and require a solid understanding of DeFi protocols.

How are crypto loans taxed?

In most cases, taking out a crypto loan is not a taxable event. However, if your collateral is liquidated or you repay the loan with appreciated crypto, you could trigger a capital gains tax. Interest payments on the loan may also be deductible in some instances.

For more details on the tax implications of crypto loans, check out our guide to crypto loans tax.

Can I get a loan for crypto?

Yes, crypto loans allow you to use your crypto holdings as collateral for a loan.

Why do people take crypto loans?

To access liquidity without selling crypto, benefiting from potential future value increases and flexible borrowing options.

Can I withdraw crypto loan?

Yes, once secured, crypto loan funds can typically be withdrawn via bank transfers or stablecoin payouts.

Do crypto loans affect credit score?

Most crypto loans do not involve credit checks, but this may change as the market evolves.