Can Bitcoin Be Used as Collateral for Loans?

The use of Bitcoin as a means of collateral for obtaining loans is a practice that is starting to gain some momentum. From time immemorial, several forms of financial market instruments have been used as collateral in obtaining credit facilities. Traditionally, stocks have been used as a means of collateralizing loans. This is because stocks generally have a good exchange value, do not depreciate very rapidly and are quite liquid. Stocks are not the only financial market instruments used as collateral. Governments also borrow money and use the central banks as the guaranteeing party for the bonds that are issued. People have also used their gold assets as collateral for obtaining loans. Anytime a piece of gold jewelry is deposited with the goldsmith or pawn shop owner for cash, the gold has been used as collateral to obtain the cash from the pawn shop. In case of default, the pawn shop can recover their cash and fees by selling off the gold holdings.

Lately, Bitcoin and a few cryptocurrencies have become the next big thing in terms of acting as collateral for loans. Bitcoin started the year at $820 and ended it at just under $16,000, making it one of the highest grossing financial assets of 2017. This extreme price rise has also made it one of the most sought-after cryptocurrencies. People are setting up huge mining rigs for it, hackers are plowing exchanges for it, and there is even evidence that cash-strapped countries who are under international financial sanctions are either doing business with Bitcoin or are stealing it outright from exchanges.

Why Do Cryptoassets Make Good Collaterals for Loans?

Anyone who has ever taken out a loan from the bank will easily tell you that it is not an easy process. One of the most problematic conditions that are placed by lenders on borrowers is coming up with an acceptable form of collateral that can be used as a loan. Sometimes, what can serve as collateral for one lender may not be deemed suitable collateral by another lender. Then there is the issue of credit scoring as well as the heaps of paperwork that need to be filled. Furthermore, the process of transferring the collateral to the lending institution and getting the cash needed takes a lot of time. When loans are being taken for personal expenses, they are usually to meet immediate or time-limited situations, so time is a premium here.

This is where cryptocurrency assets come in as useful collateral. They have been created to be seamless. They are liquid, universally acceptable and can be bought or sold by anyone in any part of the world. A lender who accepts cryptocurrencies as collateral will not have any issues with monetizing this collateral in case of loan defaults. Another advantage is that it takes far less time to process such loans than it would take with a traditional lending institution.

Bitcoin as a Good Collateral for a Loan

So what is all this new fuss about Bitcoin and other cryptocurrencies now being used as collateral for personal loans? Well, some startup lenders have come up with the idea of lending cash in the form of a personal loan and collecting the borrower’s Bitcoin as a form of collateral for this transaction. A Bloomberg report in December 2017 has indicated that a few startup lending companies have started to use Bitcoin as collaterals in this manner. CoinLoan, EthLend, Nebeus and Salt Lending are just examples of a few companies that have emerged to offer this service.

Lending Models Using Cryptocurrency Collateral

CoinLoan provides fiat currency loans using a peer-to-peer model for holders of Bitcoin. CoinLoan charges a fee for this service and also hopes to use its business model to provide utility to any cryptocurrencies within its online platform. In other words, CoinLoan hopes that this service will provide an alternative use to cryptocurrencies aside the buying and selling which goes on in exchanges at the moment.

Nebeus is a startup based in London which has actively started bringing together third-party lenders with holders of Ether and Bitcoin who seek loans. The company’s Managing Director, Konstantin Zaripov intimated that its first day of operation saw the provision of almost 100 of such loans.

Salt Lending allows the use of its unique SALT tokens to payback interests on cryptocurrency-collateralized loans. David Lechner, Salt’s Chief Financial Officer has indicated that the company intends to help mainstream banks provide such services, with SALT acting as an intermediary.

Benefits of Using Bitcoin as Collateral

Nobody really knows how high Bitcoin will go in 2018 or beyond. One thing is for sure: not many who own Bitcoin and other useful cryptoassets are ready to sell them. Those who own Bitcoin but need money to do a few things can presently only sell them. Once sold, those holdings are gone and cannot be used to capture any possible future price increases. Most savvy investors do not sell their assets, but rather use them to source for loans. This is what is happening here. Bitcoin holders would definitely want to cash in on this. So by being able to use their holdings to attract financing without having to sell, people can still have access to the cash that they need to finance their loan needs.

For those who will provide lending services while accepting crypto coins as collateral, this is another business opportunity which has spun off from the cryptocurrency disruption. This has the potential to challenge traditional lending institutions as far as personal lending is concerned.

Disadvantages of Using Bitcoin as Collateral

The greatest disadvantage of using Bitcoin and other cryptocurrencies as collateral is the fact that prices can take wild swings on a daily basis. It is possible for the value of collateralized Bitcoin to fall rapidly and heavily, even in one day. There are several examples to prove this. In September 2017, the decision of the Chinese government to ban ICOs and Bitcoin exchanges caused prices of Bitcoin to drop by 50% in one day.

Similar falls were recorded in December 2017, when Bitcoin prices fell from just under $19,800 on the 16^th to just above $10,600 on the 22^nd. Such instability in price will add to the risk profile of using Bitcoin as collateral. Lenders may, therefore, be forced to demand much higher deposits of Bitcoin for the loan amounts or may charge very high interest rates.

Conclusion

Other cryptocurrencies with more stable pricing and greater value (e.g. Ethereum or Ripple) may be used as substitutes if Bitcoin proves too unsteady to be used as an effective collateral. But what is of greatest importance at the moment is that Bitcoin and other cryptocurrencies will definitely assume greater importance as collaterals for loans as we hit 2018.