Is Crypto Loan Safe?
A crypto loan is only as safe as you make it, and that goes for traditional loans as well. You need to ensure that you are not taking on too high of interest payment and that you have a steady income to pay off the loan, and ensure that your personal finances would not take a dramatic hit if your collateral were to get liquidated.
Generally speaking, as long as you follow these steps and are financially responsible, crypto loans can be as safe as traditional loans! It provides many incentives for people to get them, as holders of digital assets may not want to sell their crypto to get access to cash, which would incur capital gains taxes in many jurisdictions around the world.
How Do Crypto Loans Work?
Now, you can get cash by offering your assets as collateral. However, one of the best features of crypto loans is the rapid speed at which you can acquire what you are looking for. Banks typically draw the process out over a very long time, which causes many people to not even go for loans in the first place.
On exchanges like Binance, or any CeFi exchange, you must submit KYC (Know Your Customer) information so that they can pass this information onto your countries tax collecting agencies. However, people feel inclined to get loans on DeFi protocols because they do not need to report KYC information.
Unlike traditional loans, crypto loans do not take a look at a credit score, meaning more people have access to crypto loans than conventional loans, mainly those who have been deemed not credit worthy by banks and those who simply do not even have bank accounts. Instead, users use their own digital assets as collateral for the lender to hold until the loan has been paid off. What this does mean is that there is a liquidation risk.
Crypto loan also differs from traditional loan in the way in which loans collect interest. Traditional loans collect interest statements monthly, whereas crypto loans collect micro-interest daily or even hourly in some cases. Also, because crypto is so volatile and prone to price swings based on news and spot buys, loans are typically available for shorter time frames, such as between 7 and 180 days.
When borrowing cryptocurrencies on platforms like Binance, you must remember that there is always a liquidation risk. When you put, for say, ETH up as collateral, you are betting that the price of ETH won’t fall below a certain amount and that certain amount is determined by how much you borrow and how much collateral is put upfront.
Other outside factors when using a CeFi exchange like Binance is that the health of the company can change overnight, and your collateral and other assets may not be safe if the company went insolvent, and this is why many people have opted to put their trust in DeFi platforms like AAVE or Compound. They are betting on the code within the protocol to be strong and keep performing smart contracts.
Taxes on Crypto Loans
In terms of repaying loans, it is quite easy, and you just need to follow a set of instructions that are sent by the CeFi exchange. If you do not repay the loan, you will be taxed, as your collateral will be liquidated, which triggers the taxable event. The last way you could incur taxes on yourself is if the collateral drops below the amount in which you need the asset to stay above. However, simply using cash received from the loan is not taxable as long as the loan continues to be paid off according to schedule.
Because of this, it is important to understand tax implications if you were to default on your loan or if your collateral fell below the liquidation mark. Crypto loans can be a great way to access cash without triggering taxable events, but that is only if you repay the loan on time with the schedule and if your collateral continues to hold its value and stay above liquidation thresholds.
Crypto loans are an innovative new solution to traditional loans, but of course, they come with their unique risks, which you must understand before acquiring a loan. They allow anyone and everyone to take out loans as long as they put forth collateral, and the best thing about them is that if you default, or if you get liquidated, nothing impacts your credit score! So if you are feeling a little risk-on and need some extra cash to finance a purchase, you should consider crypto loans on both DeFi and CeFi platforms, but of course, only put up what you can afford to lose as collateral!