Last updated on September 24th, 2023 at 04:51 pm
Providing borrowers with access to funds is the main purpose of crypto loans and traditional loans, but they differ in terms of collateral, interest rates, credit checks, loan terms, access and approval.
Table of Contents
This article explores crypto lending vs traditional banking lending, looking at what sets them apart such as:
- Market accessibility
- Collateral requirements
- Interest rates
- Loan use
- Currency stability
- Loan duration
- Credit checks
- Regulatory Environment
What Are Crypto Loans?
Crypto loans are a newer financial instrument whereby a lender provides funds such as Bitcoin (BTC), Ethereum (ETH), stablecoin or other forms of cryptos to a borrower under specific terms through the use of blockchain technology.
The loans are usually in stablecoin so as to minimize losses – as a result of volatility -relative to a specific asset. Crypto lending borrows its model from traditional lending.
Crypto lending platforms include YouHodler, Aave, Binance Loan, CoinLoan, compound DeFi lending protocol, CoinRabbit, SpectroCoin, Crypto.com, and Nexo.
Don’t forget that using cryptocurrencies as a means of exchange carries some risks, especially its volatile nature. So, have a financial backup when dealing in crypto.
What Are Traditional Loans?
A traditional loan is a form of credit that financial institutions provide, which involves the lender (a bank) and the borrower. The lender provides money to the borrower under agreed-upon terms.
Traditional loans have been around before the advent of crypto lending. Collateral such as a house or a car is an asset that the borrower pledges to secure the loan. If the borrower fails to repay, the lender can seize the collateral to recoup their losses.
Distinctions Between Crypto Loans and Traditional Loans
Accessibility to traditional loans is usually tied to geographic location, credit history, and sometimes, an individual’s socioeconomic status.
A bank in the United States may not grant a loan request of an Australian resident because of many factors and possible differences in terms and conditions. Lenders such as banks and credit unions usually need extensive documentation to process the loan.
The power of decentralization in cryptocurrency comes into play in crypto lending, which makes it possible for users of crypto-backed platforms to access loans regardless of geographical location and with minimum documentation.
Crypto loans are available on various decentralized finance (DeFi) platforms and centralized crypto lending platforms.
The value of the collateral may be subject to high volatility in crypto loans, but in traditional loans, collateral such as real estate usually has stable values or could appreciate over time.
For traditional loans, physical assets such as real estate, cars, or a house are needed as collateral. The value of the assets must be equal or exceed the value of the loan.
In contrast, digital assets such as Bitcoin, Ethereum and other cryptocurrencies serve as collateral in crypto loans.
In traditional lending, interest rates vary based on factors such as loan amount, term length, and the borrower’s credit score.
Whereas crypto lending often provides competitive interest rates for issuance. For instance, the interest rate on Aave can go as high as 18% (for advanced users, anyway); but on the next interest can go as high as 11%.
So, there is usually competitive rates among the crypto lending platforms. Most times, the rates reflect the volatile nature of the crypto market.
The duration for traditional loans can range from a few months to several years. The terms are set and agreed upon at the onset of the loan.
In contrast, Crypto loans offer flexible loan durations, with options for short-term loans of a few days to long-term loans spanning years.
Banks and credit institutions carry out rigorous credit checks for loan approval. A good credit score is important to qualify and the amount you can get.
In contrast, most crypto loan platforms are exchanges that do not require a credit check, making them more inclusive and easily accessible than the traditional lending platforms.
While repayment for traditional loans is strictly in fiat currency through an established banking system, crypto loans require repayment in cryptocurrencies, though some platforms may allow repayment in fiat which is then converted to crypto or stablecoin.
Crypto loans on platforms such as Binance are often used for leveraging trading positions or accessing liquidity without selling the underlying asset.
In contrast, traditional loans are used for a broad range of purposes including purchasing homes, cars, or covering other expenses.
Internet access and the working of crypto is all what you need to get crypto loans. The platform doesn’t care about the color of your skin. As such, crypto loans are more global irrespective of local banking regulations.
In contrast, traditional loans are typically bound by regional and international financial regulations, making it difficult for people in certain countries to access them.
Crypto loans can offer more flexible and customizable loan terms, like duration and interest rates, traditional loans have fixed terms with less room for customization.
Traditional loans have a well-established regulatory environment. Regulatory bodies such as the Federal Reserve in the U.S, the Financial Conduct Authority in the U.K., Central Bank of Nigeria in Nigeria, and the Financial Consumer Agency of Canada govern the issuance and management of these loans.
These regulations aim to ensure the stability of the financial system, protect consumers, and prevent illicit activities like money laundering.
In contrast, the regulatory landscape for crypto loans is still emerging. Due to the decentralized nature of cryptocurrencies, regulating them is very challenging.
For example, some countries require crypto loan platforms to register as a Money Services Business, which brings them under the purview of financial regulators. Others have focused on implementing Know Your Customer (KYC) and Anti-Money Laundering (AML) requirements to enhance security and transparency.
- Traditional loans use physical assets as collateral, while crypto loans use digital assets.
- Traditional loans use fiat currency as a loan medium, but crypto loans can use either cryptocurrencies or stablecoins.
- While traditional loans often require a lengthy approval process, which includes a thorough check of the borrower’s credit history, in contrast, crypto loans can be approved and disbursed quickly.