The emergence of blockchain has significantly influenced how people transact. Cryptocurrencies have become tokens that many can use to transact, invest, lend, or borrow.
Before crypto, traditional loans were the backbone of businesses and personal finance for centuries. With more people using cryptocurrencies, developers are evolving lending. They opened a path for crypto users to access crypto and Bitcoin loans. What are the differences between traditional lending options and crypto-backed loans? Let’s dive deeper into these two loan options.
Traditional Loans
Traditional lending or borrowing is a process where people can borrow money through financial institutions like credit unions, licensed lenders, and banks. It’s a time-tested system that provides loans based on the borrower’s income stability, credit history, and repayment ability.
When someone applies for a traditional loan, they undergo a lengthy evaluation process to ensure eligibility. The institution must examine the borrower’s financial status, including employment, debt obligations, and credit history.
This process assesses the risk level and interest rates that apply to the applicant’s loan. Some more common traditional forms include lines of credit, business and personal loans, and mortgages.
Due to the lengthy checking process, institutions offering traditional loans can take a few days before approval. They must follow the standardized documentation requirements, check interest rate regulations, etc.
Despite the slow processing time, traditional loans are time-tested. Established financial institutions are also under tight security measures provided by regulatory frameworks and offer legal protections to their clients.
Crypto Loans
Crypto loans offer a new approach to lending and borrowing by utilizing smart contracts and blockchain technology. Like traditional lending, it allowed people to borrow funds by submitting an asset as collateral. In this case, the collateral would be cryptocurrencies or digital assets to earn interest.
The process is usually done through decentralized platforms (DeFi), but there are also centralized crypto lending services. Borrowers can obtain crypto or fiat currency. In return, they lock their crypto assets that would act as collateral.
One of the most significant advantages of Bitcoin loans is smart contracts. It speeds up processes, allowing users to obtain a loan immediately without waiting days for verification.
On the downside, some crypto lending platforms implement over-collateralization. To cover the cryptocurrencies’ volatile nature, borrowers must provide collateral whose sum is larger than the loan value. While traditional loans rely on income verification and credit history for loan security, crypto lending leans on self-regulating systems secured by digital assets.
Traditional Vs. Crypto Loans
One of the more apparent differences between the two is transaction speed. Crypto lending thrives on blockchain technology, so crypto lending platforms can provide quick, secure transactions. They’re not obliged to provide documentation, so funds can be disbursed within minutes of approval.
On the other hand, traditional loans operate under regulated institutions. Applications must undergo comprehensive checking, which takes time to complete. Thus, borrowers won’t be able to receive their money immediately. Besides speed, there are other aspects that differentiate traditional and crypto lending.
Speed and Accessibility
Crypto lending has the advantage in terms of speed and accessibility. As crypto lending platforms are decentralized, approvals are automated. It only takes minutes to confirm borrowers’ assets and issue loans.
Investors aiming to obtain a quick loan during market fluctuation can benefit from this speed. The platform provides almost instant access to loans as long as borrowers have enough assets for the collateral. Thus, crypto users can access liquidity without selling their assets.
Conversely, traditional lending takes significantly longer to approve loan requests. Verification generally takes a few days to weeks, making it unsuitable for obtaining funds in emergencies.
Collateral and Credit Criteria
When comparing traditional and crypto lending based on their collateral, crypto loans may seem less flexible. They rely on the collateral, usually the borrower’s crypto assets. The assets’ value determines the loan value.
Meanwhile, traditional lending provides higher flexibility regarding collateral. Car loans use a vehicle for collateral, while mortgages use property. Personal loans might not use collateral, but they have higher interest rates and are stricter on credit score checking.
A strong credit score is crucial for traditional loans. It determines whether the borrower will get approval for a loan and the interest rates applied. Crypto lending disregards this factor.
Borrowers with a poor credit history might find it traditionally hard to get a loan. Yet, if they have enough crypto assets, they can still get a loan through crypto-backed lending platforms, like Figure..
Interest Rates and Fees
Interest rates for crypto lending vary depending on the type of collateral, the market conditions, and demand. Platforms can also set fixed interest rates, but they differ from platform to platform. Many crypto lending solutions offer interest-bearing accounts, which allow borrowers to get returns on their unused crypto assets.
Cryptocurrencies are known for their volatility, which can also influence loans. One downside is that crypto lending may come with high liquidation fees, especially if the value of the collateral falls below a certain threshold.
In comparison, traditional loans’ interest rates are much more stable. They’re based on Federal Reserve rates, but the applicant’s credit history may influence the numbers, too. Personal loans generally have interest rates of 5% to 35%, and the borrower’s credit history will help determine the interest rate.
One of the advantages of traditional lending is its relatively low interest rates. Because traditional loans are secured by less volatile assets, like vehicles and properties, their values will be unlikely to drop as unpredictably as cryptocurrencies’. This allows applicants to get better rates.