Bitcoin and other cryptocurrencies are primarily a speculative instrument, and if you own bitcoin, there is little reason to sell it or exchange it for goods and services as long as its value continues to increase. Bitcoin lending provides a way to put your satoshis to work without having to exit your investment position by selling your bitcoin. As a borrower, bitcoin loans help you get your hands on an asset which is currently highly liquid and can easily be converted to cash. However, before you invest in bitcoin loans it is important that you understand that this kind of investment bears a high level of risk.
How do bitcoin loans work?
In principle, bitcoin loans work just like any other loans. A lender loans their bitcoin to a borrower. The borrower then repays the loan with interest. Bitcoin loans can be transacted as private loans directly between any two parties which have bitcoin wallets. However, it can be difficult for individuals to connect with other individuals whom they can trust and who are willing to lend or borrow from them in bitcoin. This has led a to the appearance of a number of online bitcoin lending platforms have sprung up to broker loans between lenders and borrowers, making it easier to lend or borrow bitcoin and earn interest.
The majority of online bitcoin lenders are peer to peer loan platforms, meaning the bitcoin is lent out by private bitcoin owners directly to borrowers rather than by an institutional lender. Borrowers may state how much they are willing to pay in interest, or the interest due may be determined by the platform based on their creditworthiness. Investors can pick the loans which they are willing to finance. Some platforms also allow lenders to state how much bitcoin they are willing to lend and at which interest rate. Borrowers can then apply for the loan that suits them best, and lenders can choose whether to provide the loan or not.
What loan models are available?
Borrowers can normally choose between loans denominated b much they are willing to pay in interest, or the interest due may be determined by the platform based on their creditworthiness. Investors can pick the loans which they are willing to finance. Some platforms also allow lenders to state how much bitcoin they are willing to lend and at which interest rate. Borrowers can then apply for the loan that suits them best, and lenders can choose whether to provide the loan or not.
What loan models are available?
Borrowers can normally choose between loans denominated by bitcoin and loans denominated by a major currency (euros or U.S. dollars, for example).
If a loan is denominated by bitcoin, then the borrower must repay the exact amount of bitcoin which they borrow, plus interest. For example, if you by bitcoin and loans denominated by a major currency (euros or U.S. dollars, for example).
If a loan is denominated by bitcoin, then the borrower must repay the exact amount of bitcoin which they borrow, plus interest. For example, if you borrow 1 bitcoin for 2 years at 8% interest per annum, then you must repay 1 bitcoin plus 0.16 bitcoins as interest across the loan term. This model works well if you actually earn or mine bitcoin because you can calculate exactly how much the loan will cost.
If a loan is denominated by a fiat currency, then the borrower must repay bitcoin up to the predetermined amount of fiat currency. For example, if you borrow 1000 U.S. dollars worth of bitcoin for 2 years at 8% nominal interest per annum, then you must repay 1000 U.S. dollars worth of bitcoin plus 160 dollars worth of bitcoin in interest across the loan term. This model works well for if you earn fiat currency because you can calculate exactly how much the loan will cost. However, bitcoin loans offer no added value compared to standard peer to peer loans when used in this way. A more notable use of this bitcoin loan type is as an investment vehicle through which investors can long sell bitcoin by holding the borrowed bitcoin and, when its price increases, repaying the agreed on amount and selling the difference.
Possible uses of bitcoin loans
As an investor, the biggest benefit for lenders is being able to lend out your bitcoins and earn interest without having to sell them. This lets you keep your bitcoin to profit from both capital gains in its value, while simultaneously benefiting by earning interest on the bitcoin you lend out.
As a borrower, the biggest benefit of bitcoin loans is that they allow you to get your hands on bitcoin which you can then invest in services which require payment in bitcoin, such as shares of bitcoin mining centers or purchases of tokens during ICOs. They also benefit a broader base of borrowers in that they service borrowers who do not have bank accounts.
Bitcoin loans denominated by fiat currencies allow investors to speculate on hikes in the price of bitcoin because if the value of bitcoin grows over the loan term, they can sell the borrowed bitcoin, repay the agreed on amount of fiat currency plus interest and pocket the difference. They also allow investors to make short bitcoin investment by selling borrowed bitcoin and then repurchasing and repaying bitcoin loans if and when the price falls, pocketing the difference. These highly speculative activities require a high risk tolerance and risk capacity.
Risks of bitcoin loans for borrowers
If you are one of the few individuals who actually earn bitcoin and make relevant purchases or investments using bitcoin, then the volatility of bitcoin will not likely matter much to you. Regardless of how the value of bitcoin changes in relation to fiat currencies, you will not likely notice as long as you borrow, spend, earn and repay bitcoin.
When loans are denominated by bitcoin but converted into standard currencies and vice versa, on the other hand, the volatility of the price of bitcoin represents a hazard. If borrowers earn standard currencies and need to buy bitcoin specifically to repay their loan, a hike in the price of bitcoin can greatly increase the cost of their loans. By the same token, a drop in bitcoin prices could reduce the cost of loans. In every case, obtaining bitcoin which must then be sold to obtain fiat currency and buying bitcoin to repay loans involves additional costs (including spread or commission charged by bitcoin marketplaces). Selling and buying bitcoin also requires time and effort.
Risks of bitcoin loans for lenders
There are a number of different risks associated with lending out bitcoin. These include:
1. Lack of regulation
When you lend Swiss francs to Swiss borrowers through Swiss peer to peer lending platforms, legally binding private loan contracts are created which give you the right to file debt collection charges against delinquent borrowers. The regulatory landscape surrounding digital assets like bitcoin, the development of which is in a constant state of flux, is sketchy. This can complicate debt collection when borrower default on loans.
2. Dealing with international borrowers
A large part of the value of Bitcoin loans is that they can be transacted between lenders and borrowers in many different countries without paying high transfer and currency exchange fees. However, lending money to borrowers living outside of Switzerland is a risky business for Swiss lenders.
It may be nearly impossible to accurately determine the creditworthiness of lenders because the ZEK and municipal debt collection offices only track the credit behavior of residents of Switzerland. Similar credit bureaus do not exist in many countries. Some bitcoin lending platforms rely on pure trust alone, while others use reputation models by which borrowers are rated based on the way in which they go about repaying loans provided by the same platform.
The relative anonymity of the internet and bitcoin in particular leaves a lot of room for abuse. It can be difficult or impossible for platforms or lenders to take debt collection measures against delinquent borrowers who are not resident in the same country. Reputable bitcoin lending platforms generally partner with debt collection agencies to collect debt internationally. However, investors should always consider dividing their investment capital between a large number of loans to balance the risk of default. Some bitcoin loan platforms provide an option by which you can have your capital automatically invested in a large number of different loans, spreading out the risk.
Some platforms use a secured loan model by which bitcoin loans are secured by fiat money or cryptocurrency which is deposited as collateral. This model provides some security for lenders as they can keep the collateral should the borrower default on their loan. However, the value of the collateral may not consistently secure the loan if the price of bitcoin increases over the loan term. Swiss investors who want to engage in peer to peer lending but want greater legal security should consider Swiss peer to peer lending platforms as a safer alternative to bitcoin lending.
3. Bitcoin price volatility
When bitcoin loans are denominated by fiat currency, investors bear the risk of possible bitcoin price fluctuations. For example, if a borrower is required to repay 1000 U.S. dollars worth of bitcoin and the value of the bitcoin lent out by the lender doubles over the loan term, the borrower would only repay 1000 dollars worth of bitcoin and the lender would lose half of their investment. Unless you expect the value of bitcoin to drop and want to go short on a bitcoin investment, you should consider investing in bitcoin denominated loans only. Doing this ensures that you get back the same amount of bitcoin which you lent out, plus interest.
4. Risk of digital theft.
Many bitcoin loan platforms may require you to hold bitcoin in a wallet provided by them, at least temporarily. Like all online bitcoin wallets, those operated by bitcoin loan platforms are at risk of hacking attacks.
5. Risk of platform failure.
Due to the international nature of bitcoin loans and the absence of legislation, bitcoin lenders are highly dependent on platforms to transact bitcoin loans and collect loan repayments. However, bitcoin loan platforms are currently small and relatively weak financially. They are also exposed to volatility in bitcoin price rates. If a platform were to fail, lenders may find it difficult or impossible to collect debts in the absence of the platform. Borrowers may find it difficult to repay their debt – particularly when loans are crowdfunded by multiple investors – which may damage their credit if investors instigate debt collection procedures.
Costs of bitcoin loans
Bitcoin lending platforms charge fees to borrowers and/or lenders for their brokerage services. These may be charged to borrowers as a markup on their loan repayments, as is the case with German bitcoin loan platform Bitbond which charges bitcoin borrowers an ongoing fee as a 1% markup on loan repayments. Some platforms charge a one-time brokerage fee at the start of the loan term and this fee is normally deducted from the loan itself before it is paid out to the borrower. Bitcoin loan platform TCJam, for example, charges a one-time fee of between 1% and 5%, depending on borrowers’ creditworthiness. Bitbond charges a one-time fee of between 1% and 2.5% of each issued loan (based on the loan term) in addition to the 1% recurring fee.
Incidental costs include late payment reminder fees, late payment penalty interest, bitcoin transfer fees (charged by bitcoin miners to transfer bitcoin between wallets), and bid/ask spreads or brokerage fees when you sell bitcoin to get money or change money back into bitcoin to repay your loan. UK-based bitcoin loan platform Nebeus, for example, charges a brokerage fee equal to 3.9% of each transaction to buy bitcoin on your behalf, but does not charge a fee to sell bitcoin.
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