When getting a loan, the lender may require the borrower to surrender an asset to act as collateral against the amount disbursed. The asset pledged as security may be a vehicle or property where the title documents are handed over to the lender. The borrowers are to get the proof of ownership document back after fully repaying their loan. However, if the borrowers fail to meet their obligations, the lender may sell the property to recover the loan amount.
With the advancement of technology and the finance industry’s evolution, new assets have come up, and these are the cryptocurrencies. Besides being a medium of exchange, cryptos also act as a store of value, thus are investments in themselves. Some of the most popular cryptocurrencies include bitcoins, litecoins, and ethereum. Just like the physical assets, cryptos, or virtual assets, can be used as collateral for loans.
Loan to value ratio (LTV) in crypto loans
When getting loans using crypto assets as collateral, the loan to value ratio refers to the value of crypto assets. You need to surrender to the lender to receive a specific crypto-backed loan amount. This is only applicable where the borrower is receiving a secured loan. For collateralized loans, it is mandatory for the borrower to give the lender security, and for this case, digital currencies, to keep until the loan is repaid.
How to Calculate Loan to Value Ratio
The LTV for crypto-backed loans is calculated as follows:
LTV =Loan Amount/Crypto Assets Value
Determining the LTV ratio in crypto-backed loans
With traditional financing methods, the size of the LTV is influenced by factors such as the borrower’s income size, credit score, and the monthly repayment structure that the borrower chooses. However, lenders of crypto-secured loans do not carry out credit checks, background checks, or other such checks. Therefore, they may have some loan plans with varying LTV ratios options for the borrower to choose from, each with different implications.
Implications of various LTV ratio options
One of the leading lenders of crypto-backed loans has three options of loan to value ratio. The three LTV ratio options are as follows:
The LTV is 90 %, to be repaid in 90 days with a loan fee of 1.70% and a price down limit of -5%.
The LTV is 70%, the repayment period is 60 days, the loan fee is 2.9%, and the price down limit is -25%.
The LTV is 50%, the repayment period is 180 days, the loan fee is 7.5%, and the price down limit is -40%.
The three loan plans have various pros and cons. When we look at Loan 1 with an LTV ratio of 90%, the outright advantage is that you derive the most value from your collateral. For instance, if you post 1BTC as the collateral (assuming 1 BTC = $10,000), the lender will extend you a $9,000. This means you get a loan amount almost close to the value of your security.
However, Loan 1 has a significant downside, and that is its price down limit. In case the collateral value, BTC, for this case, drops by more than 5% during the loan duration, so the lender has no choice but to sell the collateral so they do not suffer any losses. Alternatively, the borrower has to act fast to save their collateral from liquidation. It is upon the borrower to measure how much risk they can take before deciding their best loan plan.
On the other hand, loans 2 and 3 have the better price down limits, thus being less risky in collateral liquidation, but their loan fees are quite high and your collateral fetches you less money. However, each plan suits a particular situation in the crypto world, and it’s for each borrower to decide their best loan plan.
Crypto loans help save the day when you need quick short-term funding, but you do not want to sell your crypto assets. One demerit of selling your cryptos is that it can lead to tax consequences; hence it is less desirable. Borrowers can easily obtain collateralized loans than non-collateralized ones, so using crypto as security makes it easier to get funding for various short term needs. For lenders, issuing secured loans reduces repayment risks.
Borrowers can choose their best LTV ratios when taking crypto-backed loans and thus determine their risk. Higher LTV means higher risk but more funds for the value of the crypto assets and fewer loan fees.