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Collateralized Loans In DeFi

All You Need To Know About Collateralized Loans In DeFi

Hodling is the favorite activity of the long term crypto investors. However, keeping your assets in the crypto wallets for many years can have negative effects as well. Firstly, unless their value rises, you do not receive any profits. Secondly, it restricts the market liquidity and hence affects its growth. Fortunately, that problem can be solved with the help of collateralized loans in DeFi. 

This short guide on digital currency blending discusses how collateralized loans operate in decentralized finance. So here DeFi loans explained. 

What Are Collateralized Loans?

As with most types of loans, collateralized loans in DeFi need a lender and a borrower. The borrower offers digital currency like Ethereum or Bitcoin as collateral in return for fiat. On the contrary, the lender holds the collateralized crypto until the loan is repaid by the borrower. If that does not occur, the lender gets complete possession of the securities. 

These DeFi (decentralized finance) operations take place on a lending platform or on a lending pool. This service links the borrowers and lenders. In general, it creates a safe environment with a specific rate of interest on loans. Also, it holds the security and releases it only after the borrower has successfully paid the complete amount. 

Some best DeFi lending platforms 2022 enable users to use fiat currencies as collateral to get crypto assets. Nevertheless, all crypto lending platforms arrive in two forms:

  • Automated Lending Service: These platforms offer investors dividends when they deposit assets in their crypto wallets
  • Manual Lending Platforms: These services ask investors to stake a specific amount of cryptocurrency manually to develop interest. Some of the most famous platforms providing collateralized loans are Uniswap, Compound, Aave, Celsius, MakerDAO, YouHodler, and BlockFi.

Used Cases Of Collateralized Loans In DeFi

The crypto lending market provides several use cases, which illustrates its rapidly evolving popularity. For example, investors can use it for:

Non-Taxable Liquidity

Those who like to “hodl” their crypto assets can earn profit without selling them. For example, they can avail their holdings as collateral to get loans in fiat currency and ignore taxes on profits.

Arbitrage Trading

Some crypto lending channels offer arbitrage trading services. Simply stated, an investor can borrow an asset from any platform and lend the asset to another.

Margin Trading

Investors can avail crypto collateralized loans to purchase more collateral. This way, they can provide even higher securities to avail more prominent funds.

Flash Loans

Users can borrow crypto to implement an application and pay back the loan almost immediately when the transaction completes.

Advantages Of Collateralized Loans In DeFi

Collateralized loans in DeFi have unique characteristics that allow them to offer investors with highly lucrative advantages, like

Low-interest rates

Most platforms provide crypto loans with rates of interest as low as 10 percent, relatively inexpensive for most of the borrowers. Those searching for an alternative to personal loans from banks can choose a collateralized loan in crypto.

Asset value dictates the amount of loan 

Most crypto lending services enable borrowers to avail loans as high as 90 percent of their portfolio. However, this varies on the value of the asset they want to loan.

A versatile offer of loan currencies

Unlike traditional loans, decentralized finance lending offers borrowers with endless currencies of choice. Simply put, they can offer loans to almost any asset they require instead of just USD like most banking services providers.

No credit check

Most crypto lending channels do not operate an extensive check on their users. This implies that borrowers can avail loans much faster and with less hassle in comparison to fiat loans from banks. Also, individuals with bad credit or no credit history do not require significant collateral to get a loan.

Fast access to funds

Most lending avenues have enough assets to cover the requests for loans with substantial collateral. This way, borrowers can receive their loans in just a few hours.

A passive income opportunity

Collateralized loans in DeFi allow users to lend their virtual assets to borrowers. All they have to do is put crypto into the lending firms to earn interest. While the profit is not great, it is still a decent form of a passive income. For example, some of these services provide an APY as high as 10 percent in return for offering liquidity.

Disadvantages Of Collateralized Loans In DeFi

As good as collateralized loans in DeFi may seem, they are not ideal. On the contrary, digital currency lending with collateral arrives with several risks, like:

Margin calls

The fear of the crypto borrower’s worst is the value of their collateral decreasing below a specific level. At that point, the lender spontaneously needs them to raise their holdings. Otherwise, the loan would turn null, and the borrower could lose all the collateral. Furthermore, the lender may even sell the collateral of the borrower to cut the loan-to-value ratio. Margin calls are most likely to occur in periods of high fluctuations.

No Insurance

Most DeFi lending platforms do not offer insurance. This implies that if they fail or default, borrowers lose all their collateral, and lenders lose their funds. In general, most traditional banks offer insurance, and their clients can recover all their assets.

Conclusion

Crypto liquidations take place in seconds, which is why digital currencies create the ideal collateral. Collateralized loans in DeFi portray an inexpensive and quick way of availing new funds without a credit check. Also, they allow investors to capitalize on their holdings without needing to sell them. But you will not get a DeFi loan without collateral. 

Most people can avail their crypto assets as collateral to increase their portfolios, whether as borrowers or lenders. However, this practice does not arrive without risks. Before finding out more about margin calls and short terms for repayment, many newbies lose their assets. So, you should always do your due diligence and research before associating in collateralized crypto lending.

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