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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.
This discussion will concentrate on custodial crypto loans, but in case you are interested in learning about options from public blockchains, defirate.com provides strong resources and guides to crypto loans in the decentralized space. As previously mentioned, BlockFi, Celsius, and Nexo are three of the main current options to obtain a crypto-backed loan. As its name states, people can access a loan when using cryptocurrencies as collateral. This is a brilliant option for crypto holders that wish to create liquidity from their crypto holdings without selling these assets. These three institutions, as is the base case with traditional securities collateralized loan providers, force their crypto loan clients to hold the collateral in their platform. One of the main benefits across all three platforms is the ease of transaction, as participants who hold crypto assets in the respective exchange can apply for the loan and get instant approval.
Conveniently, for many early players in the credit rating game, these platforms do not run credit scores but rather use the historical financial statistical profile of the cryptocurrencies that are allowed as collateral, as well as the LTV levels to determine the lending interest rates. Moreover, all three providers offer the options of obtaining the loan in fiat currencies, which can then be wired to another financial institution, or if desired, in stable coins or other cryptocurrencies. All three institutions are also known for disbursing the loan funds in less than two days, which makes this transaction extremely efficient and convenient.
Crypto-backed loans make a lot of sense as an emergency fund, a diversification play when not wanting to sell the crypto assets or as a straight up leverage play in the crypto space. Some opportunistic and risky crypto investors have even implemented arbitrage plays, where they obtain a loan and then stake the newly obtained funds in a crypto play that covers the lending interest rates.
The provisions of the crypto loans from each of these players have changed over time, but the tendency is for all exchanges to adopt and offer as flexible terms as possible. There are no origination fees, no prepayment fees, and different LTV levels, plus all three platforms allow for monthly automatic or manual interest payments from either the crypto assets held in the custodian platform where the loan is obtained or from outside connected fiat currency accounts. BlockFi is the least flexible platform, only allowing Bitcoin, Ethereum, Litecoin, and PAXG as the crypto loan collateral assets and requiring a minimum $10k loan size. Celsius and Nexo allow for USD loans as small as $1,000 and $50 respectively, and both have over 39 different cryptocurrencies available for collateral. Nexo is the most flexible exchange, allowing for loans without a fixed term and an option also provided by BlockFi, whereas Celsius currently offers $6 million to $60 million loans. Another common and very important feature across all platforms is that crypto assets used as collateral are not allowed to be used for staking purposes, preventing the tempting but potentially very dangerous double dipping.
The DEFI industry has evolved very quickly in the space of crypto-backed loans, and of course centralized exchanges are fiercely competing for customers by allowing more flexible loan structures and even offering opportunities to bring lending rates down to close to 0%. Nexo currently offers 0% lending rates for crypto loans if the customer holds more than 10% of their crypto portfolio in the exchange’s crypto coin, NEXO. This is a brilliant scheme to drive demand to the NEXO coin. Another very new vertical in the crypto loan space is the use of NFTs as collateral. NFT loans as of June 2022 have been primarily available on decentralized DEFI platforms, which use smart contracts to facilitate the loan agreements and obligations, yet we are starting to see some small, centralized platforms offer the service. However, it would not be surprising to see some of the big, centralized exchange platforms such as BlockFi make partnerships with large NFT platforms soon and offer some NFT loan options.
As with any collateralized loan and leverage play, participants must pay attention to detail and study all potential fees associated with creating, servicing, and closing the loan.
Juan Pablo Villamarin, CFA, CAIA, is a senior investment analyst at Intercontinental Wealth Advisors, a global wealth management firm founded in 1981 and based in San Antonio, Texas.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
