Crypto loans serve as the backbone of the decentralized finance (DeFi) market. But, for those new to this sector, finding the initial capital to provide collateral for a loan can be a real challenge. Enter: crypto loans without collateral.
Uncollateralized crypto loans are viewed by many as one of DeFi’s most important missing elements. They have the potential to make crypto lending available to the vast majority of the world and bring the credit industry (worth some $11 trillion) onto the blockchain.
In this article, we’ll discuss crypto loans without collateral to help you decide whether they’re right for you.
What Are Crypto Loans Without Collateral?
As the name suggests, crypto loans without collateral are loans that don’t require the borrower to put up their cryptocurrency — or any tangible or digital asset, for that matter — as security for the lender.
We’ll explain how this works in more detail, but first, let’s look at the current state of the DeFi loan market so you can see how crypto loans without collateral compare.
The Current Collateral-Based Loan Market
Fully understanding crypto loans with collateral starts by backing up a few steps and getting to know the foundation on which they’re based: the collateral-based loan market.
To do that, we have to leave the blockchain and return to the “real world” for a moment.
In a traditional (or secured) bank loan, the borrower agrees to provide something of value to the lender as security against failure to pay off the loan.
A simple example of this is a home loan. The borrower agrees to provide the house itself as collateral to the lender. The lender then loans the borrower money (e.g., fiat currency such as dollars, pesos, or pounds) to pay for the house.
The borrower pays off that loan in installments — including interest — over a set period of time. Should the borrower fail to repay the loan, the lender takes ownership of the house (the collateral on which the loan was based).
Again, this serves as security for the lender so they have something with tangible value to fall back on in case the borrower defaults on the loan.
As with a traditional bank loan, the goal of a crypto loan is to obtain fiat currency. Unlike a traditional bank loan, a crypto loan is based on the value of the crypto that the borrower owns.
Borrowers set up an account with a DeFi exchange, such as Vauld, and then deposit their cryptocurrency in that account.
The DeFi exchange issues the loan and then holds the crypto as collateral until the borrower repays both the original loan and the interest.
Should the borrower fail to pay off the loan, the DeFi exchange assumes ownership of the cryptocurrency on deposit (just as the traditional bank would assume ownership of the house if the borrower failed to pay off their mortgage).
This ability to borrow, though, comes with caveats just as it does in a traditional bank loan. Lenders limit how much the borrower can take out in fiat currency (e.g., dollars) based on a percentage of the crypto the borrower deposits with the exchange.
The typical rate for lending averages around 50%. That means you can borrow up to 50% of the value of the total crypto (collateral) on deposit.
Another way to express this relationship is that these exchanges require you to provide collateral worth 200% of the value of the borrowed assets.
So, for example, if you wanted to borrow $10,000 in fiat currency, you would need to deposit $20,000 worth of cryptocurrency as collateral.
Where did that $20,000 number come from? Here’s a simple formula for calculating the amount of collateral you need to secure a specific loan amount at a given loan rate:
Collateral = Loan Amount / Loan Rate In Decimal Format
Collateral = $10,000 / 0.50
Collateral = $20,000
With Vauld, however, you can borrow up to 66.7% of your crypto’s value. If you wanted to borrow $10,000 in fiat currency, you would only need to deposit $15,000 worth of cryptocurrency as collateral ($10,000 / 0.667 = $15,000).
Now that you’re familiar with how collateral works in traditional and crypto loans, let’s delve a bit deeper into how crypto loans without collateral work.
How Crypto Loans Without Collateral Work
Currently, crypto loans without collateral fall into two distinct categories: semi-collateralized and uncollateralized.
While semi-collateralized loans aren’t true crypto loans without collateral, they are a move in that direction and are a way for borrowers to access more funds than their existing assets would normally cover.
In a semi-collateralized crypto loan, User A “delegates” a small amount of their crypto to User B. User B then adds those funds to their existing stock of crypto in order to cover a larger loan.
For example, User B wants to obtain a loan for $10,000. However, User B only has $15,000 worth of crypto. At the 50% collateral rate mentioned earlier, User B would need $20,000 to cover the cost of a $10,000 loan. They’re $5,000 short.
If the exchange offered semi-collateralized loans, User B could partner with User A to “borrow” $5,000 in crypto to serve as the remainder of their $20,000 collateral.
User A charges a small fee. User B gets their collateral and their loan. Everyone is happy.
Though this novel procedure makes it easier for new crypto users to get the financing they need, the loan itself is still over-collateralized (meaning it took $20,000 in crypto to get $10,000 in fiat currency).
That simple fact means that the vast majority of people can’t benefit from the blockchain. In addition, crypto that is locked up as collateral suppresses the market and keeps it from growing.
That’s where crypto loans without collateral come in.
The working theory of crypto loans without collateral (true uncollateralized loans) posits that overhauling, reducing, and all but eliminating the capital it takes to secure a loan does two very important things:
- Makes the system more accessible to new users and non-experts
- Releases a significant amount of “locked” crypto that’s being used as collateral back into the market
Such an increase in users and free capital would, theoretically, result in dramatic market growth and stability — both essential elements that the emerging cryptocurrency sector needs to mature.
True uncollateralized loans would work on the principle of approval through consensus.
Under this model, token holders (or those doing the lending) would form a sort of decentralized governance with the power to vote on the worthiness of new borrowers and loans based on factors such as:
- Loan amount
- Risk involved
- Loan conditions
- On-chain credit data
- Off-chain credit data
- Borrower’s past activity
Theoretically, then, a user would build their reputation — and their trustworthiness — by paying their loans on time and without issue. All of this data would be stored on the blockchain where lenders can access it when considering whether or not to approve a new loan.
So, for example, a new user might obtain a small unsecured loan for $1,000. They pay it off on time and then apply for a $5,000 loan. They pay that off on time and then apply for a $10,000 loan.
Those on the blockchain can see the new user build their reputation and trustworthiness. As a result, the new user’s ability to take out larger loans increases along with their approval through consensus.
In a sense, then, crypto loans without collateral depend on more than just the loan conditions or the collateral — they depend on all of what the finance world calls ‘the five Cs:
- Character (based on lending history)
- Capacity (based on debt-to-income ratio)
- Capital (that the borrower has on hand)
With all of this data available to lenders, crypto loans without collateral would be easier than ever and would improve the way the cryptocurrency market works.
Are Crypto Loans Without Collateral Viable?
The question is: Are crypto loans without collateral viable?
Of course, security isn’t an issue because everything takes place on the blockchain. But these unsecured loans are so new that no one really knows if they will work long-term. Only time will tell if this is the future of cryptocurrency lending.
Preserve Your Wealth With A Traditional Crypto Loan
While the market tests the viability of crypto loans without collateral, the best way to borrow against your blockchain assets and preserve your wealth is to partner with Vauld.
- Competitive rates
- Transparent business practices
- Regular upgrades
- The highest quality customer experience
Start borrowing and building your wealth today without risk. Sign up with Vauld and never miss out on an opportunity to do more with your crypto.