Cryptocurrency Loans: The Good, The Bad, and The Dharma
Loans are a sensitive topic. Blockchain technology presents new ways to address loans in a potentially better light. The blockchain technology used to create crypto-backed loans can increase transparency and trust for all participants, thereby reducing some of the risks typically encountered with loans.
Cryptocurrency assets back Crypto-backed loans. To get a loan, borrowers must provide cryptocurrency as collateral. Paradoxically, the benefit of such loans is that many platforms do not require verification and credit checks.
Decentralized crypto-loan platforms such as Dharma provide an environment where different parties can agree on loans. It recently launched on Ethereum blockchain, giving users opportunities to earn interest on their cryptocurrency as lenders. Dharma gave depositors a fixed rate of return on cryptocurrencies they make available to lend. It presents a significant step forward for cryptocurrencies as a form of investment. Essentially, banking has decentralized, albeit on a small scale. Now, from the comfort of your living room, you can make a few clicks or taps and earn interest from your cryptocurrency.
There are different strategies issuing loans in cryptocurrencies. Many platforms give users several options for loan requests. Lenders may not need to fully back loans. Instead, a borrower’s loans could be backed by several lenders, allowing for a lender to invest small amounts in multiple loans. This can allow them to reduce their risks in the case that one borrower is not able to pay their loan.
In the past, borrowing against cryptocurrencies was a method of reducing taxes. Borrowing against crypto provides a way to manage tax liabilities. It provides cash while allowing an individual to postpone, realizing potential gains in the future. IRS would not deem the use of an asset (like a home) for collateral for loan as a sale of an asset. Thus, an individual may not be subject to capital gains tax. Despite the increase in the value of a home, the use of the asset for a loan is not considered a sale. Of course, you’d need to consult an accountant and legal professional first. Legislative guidance is still being developed in this respect.
Risks of Cryptocurrency Loans
Demand for lending remains relatively low. Consequently, more borrowers are needed to make lending cryptocurrencies more attractive. For now, Dharma subsidizes lenders. Borrowers only pay 2 percent while lenders earn 4 percent on ETH and 5.5 percent on Dai.
For first-timers, loans can come with high interest rates. The short terms for loans on several platforms coupled with the possible high volatility can make repayment difficult. Additionally, more platforms require verification and identification, which may be inconvenient for the privacy-conscious.
Taking legal action against a lender is next to impossible. Even if one finds a way to take said legal action, it can be incredibly difficult to carry out the action where there is very little legislative guidance. Taking legal action against platforms is also difficult. Many platforms are not located in the U.S. or even North America.