Borrowing Against Crypto Is Growing – Is it Safe?
More and more borrowers are turning to cryptocurrency to buy homes, cars and sometimes even more crypto. Startup nonbank lenders and automated, blockchain-based platforms take deposits in the form of cryptocurrency. These deposits earn higher interest rates, reports The Wall Street Journal, and are used to fund loans to borrowers who use crypto to back the loan. Borrowers can take out cash or stablecoins, depending on the lender.
Crypto banking is growing. One group of crypto lenders has $25 billion in outstanding loans to individuals and institutional clients, up from $1.4 billion just one year ago, according to the crypto research firm Messari.
Cryptocurrency lenders take a similar approach as traditional banks, The New York Times noted. Deposits are pooled to offer loans and give interest to depositors. However, banks are required by law to have reserves to make sure that if some loans go bad, customers are still able to withdraw funds. Crypto lenders are not held to this same standard. Additionally, because transactions are backed by digital assets, crypto loans generally involve no credit checks.
People are using crypto-backed loans to benefit from rising prices without reducing the size of their bets, according to WSJ. However, there are risks.
Crypto loans are normally for a percentage of pledged holdings. If the value of the collateral takes a hit, the lender can issue a margin call and seize it all. If the lender should go out of business or fall victim to a cyberattack, federal insurance isn’t there to act as a safety net for depositors.+
These very real risks have drawn the attention of regulators, noted WSJ. The Securities and Exchange Commission is investigating Coinbase, a crypto exchange platform, over a lending program the company plans to market. According to a separate WSJ report, the SEC stated the activity would make up a type of investment that needs to be registered with the government under investor-protection laws.
Many crypto developers are pushing back, saying that SEC oversight doesn’t fit their technology and trading programs.
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