How Crypto-Backed Loans Work
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
The ecosystem of crypto finance continues to bewilder participants with its innovative services. One of the latest arms of the decentralized finance (DEFI) and centralized crypto blockchain financial firms is crypto-backed loans. The concept of using liquid investment vehicles as collateral for a loan is not new to investment practitioners who have embraced margin and collateralized account loans. It is therefore not a surprise that the DEFI platforms and crypto platforms would find a way to provide this service to their loyal clients.
The structure of these crypto-backed loans, which is similar to traditional financial intermediaries, is not standard across all institutions. It is common to see very different terms from different providers. Three of the main crypto loan centralized exchanges, BlockFi, Celsius, and Nexo, offer different loan options that vary in term, collateral cryptocurrency options, loan-to-value (LTV) amounts, and payment options. Before delving into some of the differences across platforms, let’s review the basic distinction between centralized and DEFI institutions and highlight the similarities between the crypto loan offerings from the main centralized loan providers.
People and institutions can access a crypto wallet either by going directly through a public DEFI blockchain such as Metamask, Ledger Nano, and Trezor, or through a private exchange or institution such as Coinbase, BlockFi, Binance, or FTX. A public blockchain wallet is essentially a non-custodial platform where participants can open a wallet to hold and transact different cryptocurrencies. Non-custodial platforms allow users to be in control of their private keys, which in turn comes with the full responsibility of the security provision of that key. However, some of the less tech-savvy crypto participants have chosen to participate through centralized institutions or custodial wallets, where the provider or exchange is responsible for the security access of the private keys and now must abide by know your customer (KYC) regulatory provisions. Leaving aside the debate on whether public blockchains are superior to private custodial institutions, to the benefit of participants, the crypto industry has seen the spur of crypto loans in both types of ecosystems.