One of the recently rising activities in crypto space is lending by leveraging crypto. This is not new but has gained popularity recently. This is how it works, we give our crypto assets to a lender who then gives a portion of the total value of the assets pledged back to us in cash. We will get our crypto back once we pay up the interest and principle, similar to how bank loans work except banks usually don’t accept crypto as collateral. One might ask, ‘Why not sell the asset and use the cash instead of mortgaging it and paying up interest?‘ The reason crypto enthusiasts choose mortgage over selling is due to a different mindset of crypto enthusiasts compared to a traditional financial manager. Most crypto enthusiasts are convinced that the cryptocurrency universe will one day skyrocket, so they never want to sell their assets. However, sometimes people need fiat cash fast, leveraging crypto instead of selling it helps them keep the asset while at the same time liquidity demands can also be met.
Securing $1.2 million
Recently, a crypto lending startup called NEXO announced that it has given $1.2M loan to Brock Pierce to facilitate the purchase of an eighteenth-century church in Amsterdam. Brock Pierce was a child actor who has acted in a number of Disney films. The chapel has an image of a spirit handing a coin down to a man, this marks the commemoration of the first Dutch Royal mint. According to a report, Pierce secured the loan by leveraging only Bitcoin and no other traditional asset. In order to get the $1.2 million loan, Pierce has to pledge $3M in Bitcoin, stored in a trustless smart contract. This is the biggest of such loans involving crypto and has surely made NEXO the company which made the loan really famous.
Word of Caution
While it might seem to be the perfect solution, there are things to watch out. Cryptocurrency lenders are not subject to the same level of oversight by regulators and the chances for scam increases. One has to trust the company that is taking possession of the crypto. As of now, there are no legal means to recover the asset in the event that the lender fails to return crypto even after settling all the payments. This is especially worrisome in the case of offshore entities. Usually, the lender only gives away a maximum of 60 percent value of the cryptocurrency as loan and the rest is kept as collateral. This is done to protect the lender against volatility in the crypto market. And if the price of the asset which is pledged for the loan falls below a certain value, the lender sells part of the asset in a margin call in order to maintain the ratio of collateral to debt. This kind of defeats the purpose of the whole scheme, but at the end of the day, it is still good to have options.