Cryptocurrency loans have created new opportunities for cryptocurrency holders to access liquidity without selling their physical holdings. In Australia, in particular, demand for these types of loans is increasing as more investors find ways to leverage their digital assets. However, this path to financial freedom requires careful consideration of risks and other factors.
Here, we’ll discuss how to protect yourself while optimizing your cryptocurrency holdings. Understanding these essential elements can mean the difference between a successful debt experience and experiencing potential financial setbacks.
The risks of crypto loans
Unlike traditional personal loans that rely on credit checks and scores, crypto lending platforms use your digital assets, primarily your cryptocurrency, as collateral.
Not surprisingly, Australian Tax Office (ATO) estimates reveal that more than 600,000 taxpayers have invested in virtual currencies as of October 2023. One cryptocurrency exchange suggests one in four Australians own these digital assets . This figure supports a more recent finding that more than one million taxpayers have “engaged” with cryptocurrencies since 2018. (1) (2)
But like other types of loans, this approach carries inherent risks. Even experienced borrowers should be aware of these potential disadvantages:
- Liquidation risk: Automatic liquidation may occur when the value of your collateral falls below the threshold required by the platform. If the cryptocurrency market experiences a sharp decline, the lender could sell its deposited assets for less than their value.
- Market volatility: Cryptocurrency prices can vary dramatically in a matter of hours. A sudden drop in the value of your collateral could force you to add more crypto assets or face liquidation. This becomes concerning when lending against more volatile altcoins rather than established currencies.
- Interest rate fluctuations: Unlike traditional banking, where rates change gradually, crypto lending platforms can adjust their rates quickly in response to market conditions. As a result, variable rate loans, the overall cost of the loan, and your loan refinancing options may be affected.
Understanding these associated risks will help you maintain a profitable debt position. Transacting with transparent platforms and developing risk mitigation strategies can help you manage these changes more effectively.
Choose the right platform
Smart risk management starts with choosing the right crypto lending platform. Look for one that offers transparent loan data and customer support. More importantly, evaluate the lender’s internal policies and features that protect borrowers from risks.
Security and Transparency
Crypto lending platforms use smart contracts and constantly refine their security measures to keep your collateral safe. But most of them remortgage or reuse the lender’s collateral for additional lending or investment purposes. Doing so exposes your assets to greater risk.
Vield Crypto Loans It is distinguished by maintaining a strict policy against remortgaging borrowers’ assets. Under the leadership of Chief Financial Officer (CFO) Sam Teoh, who previously served as Binance Australia’s CFO, Vield ensures that your crypto remains locked until you can repay the loan.
Additionally, the platform allows you to track your assets at any time, ensuring that they are intact and fully accounted for. Earlier this year, the company lent 10 million Australian dollars to 150 cryptocurrency users in Australia. (3)
Platform Features
The platform you choose should provide intuitive access to all essential loan management tools. You should be able to access critical information such as collateral ratios, liquidation prices, and interest rates. It also helps evaluate the platform’s payment options. Flexible repayment terms can be invaluable when managing your lending strategy.
Record
Beyond these fundamentals, consider the cryptocurrency lender’s track record in the market. Established platforms with a track record of reliable service often provide more stable and secure borrowing environments. Take the time to read user reviews, examine the lender’s regulatory compliance, and check its standing within the crypto community.
You should also pay special attention to the responsiveness and knowledge of customer service teams. Quick access to expert assistance can be crucial during market volatility.
Look beyond the attractive interest rates. The most important factor is finding a trustworthy crypto lender that prioritizes the security of your crypto assets and maintains transparent operations throughout the lending process. A reliable platform enforces a transparent fee structure, with all costs clearly documented and easily accessible. Before committing to a loan, verify your payment address and verify all smart contract interactions.
Regular monitoring
Keeping an eye on your crypto loan means tracking collateral value fluctuations in real time. Falling below these levels could trigger automatic liquidation of your collateral. Take a proactive approach by setting up automatic alerts. Your chosen platform should notify you when values approach critical thresholds.
It is also worth monitoring changes in interest rates. Even small adjustments can significantly affect your long-term costs, especially when it comes to larger loan amounts. A good rule of thumb is to establish a routine to review your loans periodically. For example, conduct weekly reviews of your loan-to-value ratio and monthly evaluations of your overall loan performance.
Risk mitigation
Just like investing in cryptocurrencies, you can diversify your collateral wherever possible. Spread your loan across different cryptocurrencies to protect against dramatic price swings in a single asset. You can combine stablecoins with major cryptocurrencies for a more balanced collateral portfolio. Try to keep a portion of your loan’s value easily accessible to adjust your collateral if market conditions deteriorate quickly. Consider lines of credit that you can tap to protect your collateral from liquidation.
Cryptocurrency regulatory policies continue to evolve around the world. These revisions may affect your loan terms and collateral requirements. The operations, tax obligations and access to lending services of the chosen platform may also change. Actively stay informed about platform updates and credit policy changes to adopt a healthy credit position.
Contingency planning
In addition to mitigating risks, you must also know how to handle unexpected market movements or technical problems. Start by establishing multiple backup funding sources. In addition to holding stablecoins on different exchanges, hold fiat reserves in traditional bank accounts.
Diversify your withdrawal options by maintaining verified accounts on the platforms you use. You must link your bank accounts correctly. Redundancy becomes invaluable when you need quick access to funds or if the withdrawal method experiences delays.
It is also necessary to understand the platform’s liquidation process and familiarize yourself with its emergency contact protocols. Collaborate with customer service during normal operations, keep your account documentation up to date, and maintain clear communication channels.
Final thoughts
Choosing reliable crypto lending platforms is crucial. However, at the end of the day, it is your responsibility as a borrower to manage your loan effectively and protect your crypto assets. To minimize potential downsides, always remain vigilant and informed about market conditions that affect the value of your collateral and interest rates. Most importantly, develop contingency and risk mitigation plans to get the most out of borrowed funds.
Quotes
- “Speech at the Australian Financial Review Crypto Summit 2023, Sydney”, Source: https://ministers.treasury.gov.au/ministers/stephen-jones-2022/speeches/address-australian-financial-review-crypto-summit-2023-sydney
- “What is cryptocurrency?” Fountain: https://www.forbes.com/advisor/au/investing/cryptocurrency/
- “How Australians are unlocking their crypto riches”, Source: https://www.afr.com/markets/currencies/how-australians-are-unlocking-their-crypto-riches-20240422-p5flps
Also read: What are the different types of cryptocurrencies?
Disclaimer: The information provided on AlexaBlockchain is for informational purposes only and does not constitute financial advice. Investments in cryptocurrency, including but not limited to ICOs, IDOs, presales and other token offerings, involve significant risk. You are solely responsible for conducting a thorough investigation (DYOR) and exercising due diligence before making any financial commitment. It is strongly recommended that you seek professional financial advice before making investment decisions. Read the full disclaimer here.
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