Collateralized lending is nothing new. This is something that has been utilized in traditional assets such as stocks and real estate for centuries.
Thus, it is no surprise to see it starting to enter the crypto realm.
Digital assets are the next financial frontier, with an entirely new system being developed. This is not separate from the old one, now terms "tradfi". Instead, we are looking at a blending of the two realms, forming a hybrid approach. How this eventually shapes up in terms of transformation to something completely new remains to be seen. For the medium term, the hybrid formation will prevail.
Lending is a central premise to any economy. This typically comes from banks or through capital markets. The later could include venture capital along with other forms of startup funding, something that might not be available through the public markets.
Crypto backed loans, specifically Bitcoin, are starting to become more commonplace. This is an idea that could help transform the global financial system.
Bitcoin Backed Lending Will Help To Shape The Future of Finance
Individual loans are dominated by real estate. This is the most common form of lending and one the majority are familiar with.
Under this scenario, the value of a property is leverage via debt. What is unique is the asset is leverage before acquisition. It is how 90% of the properties are purchased.
Nevertheless, a loan-to-value is established, providing the borrower with a certain amount that can be financed for the purchase of the property. The transaction takes place and, as long as payments are made, the house remains in one's hands.
Of course, fall behind and one enters default. Here is where liquidation takes place.
Moving this to crypto, we can see something similar being constructed. People are now able to take their Bitcoin and use it as collateral for a loan. The world of finance has done this with stocks, treasuries, MBS, and other assets.
Crypto lending is going to offer individual the potential to follow the same path.
Income Via Debt
Bitcoin lending tends to work the same as a mortgage. The difference is the BTC must be in one's hands to start.
Under this scenario, one gets a loan at a certain LtV, lets say 75%. That means the lender will offer up 75% of the Bitcoin posted as collateral. For simple math, let us say it is $100K of BTC.
That means a $75K loan can be take out.
Of course, volatility is also something to consider. If the LtV drops below that level due to a decline in BTC price, then liquidation takes place, usually with a penalty.
For this reason, people opt for lower levers, perhaps 35%-50%.
Ultimately, this is a strategy that could be used as an income stream. If the value of the Bitcoin keeps rising, the LtV actually declines. Since there is an interest rate charged, that has to be factored in.
When the rate of price increase exceeds the interest rate, one has an annual income stream.
For example, if the price of BTC is increasing at 35%, yet the interest rate is 5%, we can see a 20% net gain (in USD terms) on the holdings. Even when we factor in the 5% interest, we see the LtV decline.
What does the math look like?
$100K in BTC, 30% LtV:
- 35% increase puts the value at $135K.
- $30K loan increased to $35K with interest added
The LtV is now 25.9%.
In this scenario, the loan can be closed, the $35K paid back, and the individual still has $100K. Another loan can be opened duplicating the original.
We know markets do not always cooperate. This is why there is a risk to borrowing. However, if someone needs income, it can be a viable overall strategy. The 30% LtV might be well below the liquidation line, say 70%. That could enable one to ride through the tough times.
Crypto Collateral System
Institutions are long aware of this. Individuals are starting to find out the potential here. Could we see another baseline for the financial realm due to crypto?
This naturally starts with Bitcoin. For the moment, that is where a significant part of the value resides. It is being accumulated by institutions, something that lends itself to being collateralized in the future.
We also see the spread of other crypto-assets used as treasury. Ethereum is starting to gain momentum in this area.
Once again, the value of this can, at some point, be collateralized.
My view is that we could see many markets affected. For example, why buy a house with cash or mortgage if a crypto loan is available? Instead of selling the crypto to purchase the property, simply leverage it. The result is the same, a loan on the house yet it is not used as collateral. One acquires the residence while also maintaining the potential for upside gain on the crypto (as well as the property).