Cryptocurrency loans create new opportunities for crypto holders to access liquidity without selling their physical assets. In Australia, in particular, demand for such loans is increasing as more investors look for ways to leverage their digital assets. However, this path to financial freedom requires careful consideration of risks and other factors.
Here, we’ll discuss how to protect yourself while optimizing your crypto holdings. Understanding these important elements can mean the difference between a successful borrowing experience and experiencing potential financial setbacks.
The Risks of Crypto Lending
Unlike traditional personal loans that rely on credit checks and credit scores, crypto lending platforms use your digital assets, primarily your cryptocurrency, as collateral.
No wonder estimates from the Australian Taxation Office (ATO) show that more than 600,000 taxpayers have invested in virtual currencies by October 2023. A cryptocurrency exchange platform suggests that one in four Australians owns these digital assets. This figure supports a more recent finding indicating that more than one million taxpayers “engaged” in cryptocurrencies since 2018. (1) (2)
But like other types of lending, this method carries inherent risks. Even experienced borrowers need to remain vigilant about these potential downsides:
- Risk of extinction: Automatic liquidation may occur when the value of your collateral falls below the platform’s required threshold. If the crypto market experiences a severe downturn, the lender may sell your deposited assets for less than their value.
- Market volatility: Cryptocurrency prices can swing wildly over a period of time. A sudden drop in the value of your collateral could force you to add more to your crypto assets or face liquidation. This is a concern when you are lending against more volatile altcoins than established currencies.
- Interest rate changes: Unlike traditional banking, where rates change gradually, crypto lending platforms can quickly adjust their rates in response to market conditions. Variable loan rates, the total cost of borrowing, and your loan refinancing options may be affected as a result.
Understanding these associated risks helps you maintain a profitable borrowing position. Transacting on transparent platforms and developing risk mitigation strategies can help you manage these changes more effectively.
Choosing the Right Platform
Smart risk management starts with choosing the right crypto lending platform. Look for one that offers transparent loan data and customer support. Above all, check the lender’s internal policies and features that protect borrowers from risks.
Security and Transparency
Crypto loan platforms use smart contracts and are constantly refining their security measures to keep your collateral safe and secure. But most of them rehypothecate or reuse the lender’s collateral for further lending or investment purposes. Doing so exposes your assets to increased risk.
Vield’s Crypto loans sets itself apart by maintaining a strict policy against re-hypothecating borrowers’ assets. Led by Chief Financial Officer (CFO) Sam Teoh, who previously served as CFO of Binance Australia, Vield ensures that your crypto remains locked until you repay the loan.
Additionally, the platform allows you to trace your assets at any time—ensuring they are intact and fully accounted for. Earlier this year, the company lent AUD$10 million to 150 crypto users in Australia. (3)
Platform Features
Your chosen platform should provide intuitive access to all essential loan management tools. You should be able to access critical information such as collateral ratios, liquidation prices, and interest rates. It also helps to check the payment options of the platform. Flexible payment terms can be invaluable when managing your loan strategy.
Track Record
Beyond these basic elements, consider the crypto lender’s track record in the market. Established platforms with a history of reliable service often provide more stable and secure borrowing environments. Take the time to read user reviews, check the lender’s regulatory compliance, and verify their standing within the crypto community.
You should also pay more attention to the responsiveness and knowledge of customer support teams. Quick access to expert help can be vital during market volatility.
Look beyond attractive interest rates. The most important factor is finding a reliable crypto lender that prioritizes the security of your crypto assets and maintains transparent operations throughout the lending process. A reliable platform imposes a transparent fee structure, with all costs clearly documented and easily accessible. Before you commit to a loan, double check your payout address and verify all smart contract interactions.
Regular Monitoring
Being vigilant about your crypto loan means monitoring changes in the value of the collateral in real-time. Falling below these levels can trigger automatic liquidation of your collateral. Adopt a proactive approach by setting automatic alerts. Your chosen platform should notify you when values approach critical thresholds.
It also pays to monitor interest rate changes. Even small adjustments can significantly affect your long-term costs, especially with larger loan amounts. A good rule of thumb is to establish a routine of reviewing your loans periodically. For example, conduct a weekly review of your loan-to-value ratio and a monthly assessment of your overall loan performance.
Risk Reduction
As with crypto investing, you can diversify your collateral as much as possible. Spread your loan across different cryptocurrencies to buffer against dramatic price swings in an asset. You can combine stablecoins with major cryptocurrencies for a more balanced collateral portfolio. Aim to keep a portion of your loan amount readily accessible to adjust your collateral if market conditions deteriorate rapidly. Consider lines of credit you can tap to protect your collateral from liquidation.
Crypto regulatory policies are constantly changing around the world. These changes may affect your loan terms and collateral requirements. Your chosen platform’s operations, tax obligations, and access to lending services may also change. Stay actively informed about platform updates and changes in lending policies to adopt a healthy credit position.
Contingency Planning
In addition to mitigating risk, you should also learn how to handle unexpected market movements or technical issues. Start by establishing multiple backup funding sources. Besides keeping stable coins on various exchanges, keep fiat reserves in traditional bank accounts.
Diversify your withdrawal options by maintaining verified accounts on the platforms you use. You must link your bank accounts properly. Redundancy becomes very important when you need quick access to funds or if the withdrawal method experiences delays.
You also need to understand the platform’s liquidation process and familiarize yourself with its emergency contact protocols. Contact customer support during normal operations, keep your account documentation up to date, and maintain clear communication channels.
Final Thoughts
Choosing reliable crypto lending platforms is important. However, at the end of the day, it is your responsibility as a borrower to manage your loan effectively and protect your crypto assets. To minimize potential downsides, always stay vigilant and informed about market conditions that affect your collateral value and interest rates. Above all, develop risk mitigation and contingency plans to get the most out of your borrowed funds.
Citations
- “Address at the Australian Financial Review Crypto Summit 2023, Sydney”, Source: https://ministers.treasury.gov.au/ministers/stephen-jones-2022/speeches/address-australian-financial-review-crypto-summit- 2023 – sydney
- “What is Cryptocurrency?” Source: https://www.forbes.com/advisor/au/investing/cryptocurrency/
- “How Australians are unlocking their crypto riches”, Source: https://www.afr.com/markets/currencies/how-australians-are-unlocking-their-crypto-riches-20240422-p5flps
Also Read: What Are the Different Types of Crypto?
Disclaimer: The information provided on AlexaBlockchain is for informational purposes only and does not constitute financial advice. Cryptocurrency investments, including but not limited to ICOs, IDOs, presales, and other token offerings, involve substantial risk. You are solely responsible for conducting thorough research (DYOR) and performing due diligence before making any financial commitments. It is strongly recommended that you seek professional financial advice before making investment decisions. Read the full disclaimer here.
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