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Crypto Loans Without Collateral [Ultimate Guide 2023]

source-logo  coincodex.com 14 September 2023 15:14, UTC

The average user cannot get a crypto loan without collateral, unless we are talking about flash loans, which are very different from traditional loans. However, businesses can sometimes access crypto loans without having to provide crypto collateral (on platforms like Goldfinch, borrowers provide off-chain assets as collateral).

If you’re a normal user and not a business or institutional trading firm, you’ll have to provide collateral in order to borrow crypto. Anyone who’s offering you a no-collateral crypto loan is likely trying to scam you in some way and we suggest you avoid any such “opportunities”.

Even businesses and trading firms who want to get a crypto loan without crypto collateral usually need to go through an approval process before they can get the loan. In most cases, they still need to provide some collateral, although it doesn’t have to be in the form of cryptocurrency.

There are no crypto loans without collateral for the average user

We haven’t been able to find any platforms, centralized or decentralized, where a retail crypto investor can get a crypto loan without providing some sort of collateral. The only exception are flash loans, which we’ll touch on a little further on in the article.

Crypto lending without collateral, which is also called unsecured lending, is only done among cryptocurrency companies that have large amounts of capital. This activity is quite risky — in fact, unsecured crypto lending between cryptocurrency companies was one of the factors that contributed to the 2022 cryptocurrency market crash.

According to Reuters, now-bankrupt crypto companies such as Voyager, Three Arrows Capital, BlockFi and Celsius were among the crypto industry players that engaged in unsecured loans. However, some firms in the crypto industry still practice unsecured lending despite the turmoil in 2022. Reuters said that “most out the the 11 lenders” they interviewed in September 2022 still engaged in unsecured crypto lending.

Even though some companies still provide unsecured crypto loans, they are lending funds to other companies and institutional investors, not the average cryptocurrency user.

Flash loans — the only type of crypto loan without collateral that’s available

Thanks to smart contracts, it’s actually possible to get a crypto loan without having to provide any collateral. This can be done through flash loans, which is a type of on-chain loan in which the borrower receives cryptocurrency without having to provide collateral so long as the funds are returned within the same block. Flash loans can be accessed through certain decentralized finance (DeFi) protocols, most notably Aave.

However, flash loans have practically nothing in common with traditional loans, and using them requires in-depth knowledge of smart contract programming and how the Ethereum Virtual Machine (EVM) functions. In other words, if you’re a regular user, you won’t be able to get any benefits from flash loans.

Why is collateral required for crypto loans?

There are very good reasons why anyone who’s willing to lend you crypto will require you to provide collateral. If you fail to repay your loan, the lender will sell your collateral in order to cover their loss — this process is called liquidation.

Often, borrowers provide volatile crypto assets such as Bitcoin or Ethereum as collateral. This introduces additional risk — if the value of your collateral drops too much during the duration of the loan, you might be required to provide additional collateral to avoid liquidation.

In many cases, cryptocurrency lenders require overcollateralization. This means that the value of the collateral must be higher than the value of the funds that are being borrowed. In DeFi, you’ll most often find lending protocols that require overcollateralization, for example Aave and Maker.

One of the benefits of overcollateralization is that the lender doesn’t need to perform any background checks or assess your creditworthiness. This is why anyone who has some funds in their Ethereum wallet can go to a protocol like Aave or Maker and borrow crypto without any authorization being required.

An important concept to understand is called the LTV ratio, or loan-to-value ratio. For example, if you provide $10,000 worth of Bitcoin as collateral to borrow $5,000 worth of USDT, your LTV would be 50%. If the price of Bitcoin dropped to $7,500, your LTV would increase to 66.6%.

Typically, when you take out a crypto loan, you will have a liquidation LTV. In order to avoid your LTV reaching this level, you will be asked to repay the loan early or provide additional collateral. Crypto loans with a higher LTV generally have higher interest fees, as they are riskier for the lender.

Undercollateralized loans

In some cases, you might be able to find crypto lending services offering undercollateralized loans. In an undercollateralized loan, you can borrow assets that are worth more than the collateral you are providing.

However, undercollateralized loans have some clear downsides. First off, they tend to have much higher interest rates to protect lenders against the possibility of a default. In addition, lenders might want to perform a credit and/or background check before they agree to lend you crypto on an undercollateralized basis.

We generally recommend to avoid undercollateralized loans in crypto, unless you can ensure that you are dealing with a reputable lender and that the interest rates are not excessively high.

The bottom line

If you’re a retail crypto investor and would like to borrow some crypto, you will have to provide some collateral. Crypto lending without collateral is only done among major cryptocurrency industry players, and is a very risky activity that requires robust risk management frameworks.

In most cases, you will have to provide collateral that exceeds the value of the cryptocurrencies you are borrowing. However, the benefit of overcollateralized crypto lending is that you typically won’t need to go through credit or background checks, as the collateral you provide will be sufficient to cover any losses experienced by the lender.

If you are interested in the other side of the crypto lending equation, namely lending out your crypto to earn interest, check out our article exploring the best crypto passive income strategies.