by Jake Wengroff
As the use of bitcoin and cryptocurrency proliferates beyond speculators and industry insiders, many are wondering: Can crypto be used as collateral for a loan?
More specifically, the question revolves around whether cryptocurrency can be used as collateral for a more traditional loan denominated in U.S. dollars or another fiat currency. Given the volatile nature of bitcoin and other cryptocurrencies, the answer would likely be “No.”
However, given the rising popularity of crypto and its spread through all areas of the financial services industry, crypto can be used as collateral for a traditional loan — if you know where to look.
The Best Collateral Asset
According to Arcane Research, bitcoin’s unique combination of properties, unlike those of any other asset class, makes it the perfect collateral asset for a number of reasons, including the following:
- It is an asset without both counterparty risk and credit risk.
- It is available for trading 24/7, 365 days a year, all over the world.
- It is portable.
“Bitcoin can be transferred around the world, instantly, at almost no cost, any time of the day, and any day of the year, and with full finality,” according to the Banking on Bitcoin report published by Arcane Research. “No other assets can match these properties today, making bitcoin the perfect collateral asset for the future.”
Limited to Certain Banks
While the price volatility and risk of loss might be deterring larger, money-center banks from permitting crypto to be used as collateral against a loan, a number of startups are taking the opposite approach. The upside of crypto has encouraged startups like Salt Lending and CoinLoan to offer loans to borrowers who wish to use their crypto assets as collateral.
However, this is not without its limitations and risks, according to Investopedia. While many of these startup lenders do not require a credit check or much paperwork, the cost of capital is high. For example, a $100,000 cash loan would require $200,000 of bitcoin holdings as collateral and an interest rate of 12 percent to 20 percent at Salt Lending.
Typically, unsecured loans for a similar amount from a larger financial institution like Wells Fargo have interest rates of between 7 percent and 20 percent. If the prices of bitcoin and other cryptocurrencies drop significantly, it is not clear whether these startup lenders will be able to offer loans backed by cryptocurrency.
Proof of Title to Drive Crypto as Collateral for a Loan
Lenders might be deterred from collateralizing loans based on crypto assets because of the risk of loss or theft.
However, if financial institutions could research and verify the title for the crypto, as they do for other asset types borrowers use as collateral (e.g. real estate, cash and brokerage accounts), then loans with crypto as collateral could gain traction in the industry and potentially increase the underwriting volume in the banking industry.
The blockchain cannot be hacked. Rather, it’s the wallets or exchanges holding the crypto on behalf of investors that can be. If a bitcoin private key is lost or stolen, it is extremely difficult to demonstrate proof of ownership. Because bitcoin and cryptocurrencies are bearer assets, whoever holds the private key to a crypto asset is considered the owner.
As such, the cryptocurrency industry is in need of infrastructure to verify the rightful ownership of cryptographic assets. It’s reasonable to surmise that proof of ownership that cannot be misused or compromised might provide lenders with the trust needed in order to collateralize loans.
As a way to add an additional layer of protection and record-keeping for cryptocurrency assets, TransitNet is currently developing the industry’s first offchain title registry of record for digital wallets.
Jake Wengroff writes about technology and financial services. A former technology reporter for CBS Radio, Jake covers such topics as security, mobility, e-commerce, and IoT.
Arcane Research – Banking on Bitcoin: The State of Bitcoin as Collateral
Investopedia – Now You Can Use Bitcoin As Collateral For Loans