Why Borrow Cryptocurrencies against Your Collateral?
Crypto lending has seen significant traction in the last couple of years with institutional investors showing interest in lending their idle lying assets to earn interest on them. Many new contenders are jumping on to the crypto lending bandwagon to challenge the legacy players with lucrative features such as easy credit, versatile forms of collateral, and lucrative interest rates.
Besides crypto lending, many players in the space are now working towards providing crypto borrowing services against some form of collateral. This article takes a deep dive into such services helping the reader understand why people borrow crypto against their collateral and not just buy it right away!
The rise of crypto financial services (Crypto Lending and Crypto Borrowing)
The technological advancements in the FinTech space have given birth to diverse business models in the finance ecosystem. P2P crypto debt market place is one of them. Today, it is possible to lend and borrow any cryptocurrency by pledging some sort of collateral depending on the platform you choose to borrow.
Decentralized finance (De-Fi), has made borrowing and lending of digital assets easily available for a bigger audience. Anyone can borrow assets from anywhere without even needing a good credit score like in the traditional banking system. They, however, need to lock in some sort of collateral depending on the platform they are using.
Why borrow cryptocurrency at all?
1. Loss-control due to price volatility
The potential rise in cryptocurrencies’ prices, along with the prediction of their sustained rise, has made the selling of digital coins or using them to buy sandwiches less appealing. Holding is the best option at present. And Defi platforms such as Nuo Network, enable holders to borrow digital assets for their everyday use, without relinquishing ownership of their cryptocurrencies.
The question that still remains is, how do investors make their cryptocurrencies usable and applicable without selling them or using them to buy something?
Well, they can pledge them as collateral to secure loans. They can use digital assets secured as loans for their daily needs.
By borrowing funds, crypto investors not only contain the risk exposure on their assets but also obtain funds to use without selling their holdings.
Nuo offers loans on higher-value collateral (over-collateralization). It reduces the risk of borrowing as well as borrowers can borrow at a lower interest rate. Moreover, collateral also ensures full repayment in time. In case there is a delay in repayment, a part of the borrower’s collateral is sold to make a payment.
2. Crypto Hedging (Short selling)
There are several ways by which investors can mitigate risks associated with market volatility, and maximize their profits and minimize loss. One such way is crypto hedging, which helps reduce the potential for loss. It involves taking an offsetting position on digital assets. And, through short selling, one of the hedging strategies, investors can maintain ownership over their digital coins as well as earn some profits.
Short selling is the practice of borrowing digital assets and selling them, anticipating that their value will decline. By signing up with a DeFi platform, crypto investors can indulge in profitable short selling. When it is expected that the value of digital coins could tank, they can directly borrow digital assets from lenders and then sell them. And, later, buy them back at a lower price and keep the difference as gain.
For investors with limited crypto assets, margin trading option is available on the DeFi platform such as Nuo Network. It allows borrowers to make use of up to 3x leverage. Following the creation of the margin trade, a contract originates a loan backed by collateral. Investors can short sell loaned digital assets.
In a nutshell, Long selling is the opposite of short selling. When investors decide to go long, they buy digital assets in the hope that their value will increase. They expect to benefit significantly when the market jumps. Unlike the investors who go short, the investors who go long own the cryptocurrencies that they buy. And, the profit potential for them is unlimited as the crypto market can rise spectacularly.
Investors can lend the cryptocurrencies that they hold to the borrowers, instead of storing them in the wallets and wait for the market to see the upward trajectory. By lending their cryptocurrencies via a DeFi platform, they can earn regular interest payments.
How does it work?
Trust is crucial when two users, unknown to each other, are part of a transaction process. It makes one participant believe that the other participant would fulfill his part of the deal. The lender has to trust that the borrower would repay the loan.
DeFi protocols, however, have eliminated the trust factor and adopted the model of trustlessness. Now, how do they make lenders trust the system and believe that they would get back their loaned amount? Because of the collateral, lenders can trust the system and lend without fearing a loss.
And borrowers:
- Can assure the lenders that they won’t lose the loaned digital assets.
- Don’t have to prove solvency, the ability to meet long-term debts and other financial obligations.
- Can get a higher loan amount at a lower interest rate than the unsecured loans.
- Don’t have to worry about their inability to repay loans, and the consequences as a result of that.
Usually, the loaned amount is less than the value of the pledged digital assets as collateral. It is to improve their chances of getting their loaned amount back in case the cryptocurrencies lose value. And, borrowers get back their collateral once they repay the loan within the set duration.
It is being said that by offering loans against collateral, DeFi platforms such as Nuo can help fuel the growth of a much broader cryptocurrency economy which could potentially lead to quicker mainstream adoption of digital currencies.
Importance of decentralization in Lending Platforms
DeFi protocols are enabling cryptocurrency holders to realize the functionality and usability of their digital currencies, without renouncing their ownership over them. Every crypto holder, irrespective of his/her location, can borrow digital assets against the collateral thanks to DeFi platforms.
Decentralization enables the lending and borrowing of digital assets without the interference of the intermediaries. Every transaction is recorded in a distributed ledger, which a user can access to check and confirm the transaction. It ensures greater transparency, accountability and security. Also, it is not the system but the users who are the sole custodian of their funds.
Institutions and retail investors can leverage DeFi platforms to put their cryptocurrencies to work. Here is the difference between DeFi protocol and the traditional financial system.
Transaction Currency:
- DeFi: Cryptocurrencies/digital tokens
- Traditional System: Fiat currency
Lending/Borrowing:
- DeFi: Tokenized P2P debt
- Traditional System: Via banks
Collateral:
- DeFi: Digital assets
- Traditional System: Property on paper such as house and car
Transparency:
- DeFi is more transparent than the traditional system
Why Borrow from De-Fi Platforms?
Minimizes Risks for Borrowers
Borrowers don’t have to worry about the consequences in case they fail to repay the loan on the scheduled date. Defaulting on the loan will not damage their credit report. Also, as banks have no role to play, they cannot close checking accounts or block a borrower from applying for a loan again in the near future.
No counterparty risks
It is less likely that one of the participants [the borrower] involved in the transaction might default on the obligations.
Loans Available to a Larger Pool of People
Nuo Network leverages decentralized ledger technology to offer lending services. It makes lending open to a large pool of people, even those who are not part of the traditional banking or financial systems. Unlike the centralized financial services, the loan is available to the borrowers irrespective of their credit score or bank account’s financial health. No one is denied a loan because of poor credit score.
No Censorship
Nuo Network has the role for intermediaries to almost negligible level; therefore borrowers need not fear any kind of censorship. Financial intermediaries cannot shut down an individual’s DeFi account or block his/her transactions.
Global Access
Not everyone is eligible to get a loan from traditional financial services. Some cannot apply for it because of their geographical location. Nuo Network allows everyone to access the lending/borrowing service. The geographical location of a potential user does not matter at all. Anyone can borrow crypto assets from any part of the world.
Control in the hands of the Lender and Borrower
Nuo Network is one of a kind non-custodial platform, which essentially means borrowers and lenders have complete control over their digital assets and Nuo doesn’t have any custody of users funds.
Greater Transparency
Borrowing and lending happen between two users. There are no middlemen to approve a loan or facilitate the transfer of digital assets. This makes the process more transparent for users.
Flexible Repayments
The borrower is free to repay and withdraw anytime.
Instant Transaction Process
The transfer of a borrowed asset to a borrower’s wallet does not take too long. It is almost an instant process as there is no paperwork.
How to Borrow cryptocurrency against Collateral?
One of the most used platforms in De-Fi space that allows borrowing one type of ERC-20 token by lending any of the other ERC-20 tokens is Nuo Network where borrowers can get funds instantly. However, the loan on this protocol is over-collateralized. A borrower needs at least 1.3x of the loan amount as collateral. For example: if an ETH loan is backed by ZRK tokens, the borrower has to give $180 in collateral to get a loan of $120 in ETH.
The best part about using Nuo is that the user can put in any of the ERC-20 tokens as collateral and borrow any of the available assets from the below image.
The whole process is transparent as users can verify the transactions on-chain. Based on their loan request, borrowers are lent debt reserves that consist of ETH or ERC20 tokens. Once the loan is funded, it gets transferred to the borrowers’ Nuo accounts. And the collateral is returned to them when the loan amount is paid.
In case of default, the collateral is used to repay the borrowed digital assets. However, the entire 1.3x collateral is not used up as loan repayment. The actual loan amount plus the interest are deducted and the remaining collateral amount is transferred to the borrowers’ accounts.
For example: in case of a default, for a $100 ETH loan backed by $150 OMG collateral at 2 percent premium, $102 worth OMG would be used to repay the loan, and the remaining OMG worth $48 would be transferred to the borrowers’ trading account.
To Sum it up
DeFi platforms like Nuo Network too works on trustlessness. It is a model that believes that trust is not needed to safely interact and transact.
Nuo Network is a permissionless, peer-to-peer system that directly connects lenders and borrowers through their smart contracts. The system designed by Nuo lets users borrow both short-term and long-term loans flexibly along with allowing borrowers to borrow at their preferred interest rate and tenure.
Disclaimer: This is not financial advice. Opinions, statements, estimates, and projections in this message or other media are solely those of the individual author(s). The content in this article is not sponsored by anyone and the views mentioned in this are solely of the writers.
