UNITED STATES—The main peculiarity of lending cryptocurrencies is extreme volatility of the latter, and those who take loans in cryptocurrency and expect to receive fiat money (for example, dollars) back are at great risk. And there are many things explaining this.
In this review, we will talk about what crypto lending is, how an Ethereum loan can be arranged, what the loan-to-value ratio is, and how the LTV ratio is calculated after the loan has been disbursed. So, if you want to work with cryptocurrencies, then read this post. It will answer all your questions.
Decentralized Finance
Recently, the decentralized finance (DeFi) system has become very popular; this allows people to borrow cryptocurrencies without any intermediaries. Instead, a smart contract will be used to ensure that the loan is processed correctly. This smart contract will automatically complete transactions when certain predefined conditions are met.
When lending cryptocurrency, your assets are no longer at your disposal: you send them to a smart contract. What you get into income is bonds, which prove that you are the owner of these loanable assets.
Security is, of course, a concern here. As far as the more well-known DeFi lending protocols go, their smart contracts are well-vetted and publicly available, so anyone can check them manually. While this does not rule out potential vulnerabilities, it does provide some confidence.
Unfortunately for DeFi, its smart contract operations mean it is limited to one blockchain. Therefore, the options for what kind of cryptocurrency you can borrow are usually limited. Most often, this only applies to ERC20 tokens (running on the Ethereum blockchain). However, there may be some exceptions as well.
What Is the Loan / Collateral Ratio (LTV)?
The loan-to-value ratio shows the value of assets versus the size of the loan. It is calculated using the following formula if the outstanding loan balance is $1,000 and the value of your collateral in bitcoins is $2,000, then the ratio will be $1,000 ÷ $2,000 = 50%.
To calculate the LTV ratio after loan disbursement, you need to do the following:
- (Total outstanding principal + Total outstanding interest rate) / Market value of the collateral.
If the risk ratio reaches the Poor / Critical levels, a margin call is triggered to notify that the debt needs to be rebalanced by posting collateral or payments. If your collateral falls below a certain threshold, you will receive a notification and an offer to balance the debt by posting collateral or payments. If the LTV ratio exceeds the 80% threshold, then 100% of your collateral will be liquidated.
So, Is It Useful?
Cryptocurrency loans can become a useful “taking instrument” if you use them smartly. The only thing to keep in mind is that you cannot add extra credits to your account after receiving a loan. If you want to get a larger loan, then you need to fully repay the existing loan. Repayment must be made in the same currency in which you received the loan. For example, in case you choose to receive a loan in bitcoin, then repayment should be made in bitcoin.
