Crypto Lending - What Is It, How Does It Work, and Should Your Small Business Consider It?

April 27, 2023

Small businesses have faced a barrage of problems so far in 2023. Inflation is still high and supply chain issues remain a stumbling block. At the same time, labor costs are rising, further taxing for your scarce resources.

An extra source of cash could be critical to maintain stability and fund expansion during this turbulent time. However, with interest rates also rising, what should you do if your small business or startup needs funding?

This article will look at a potential solution. We'll outline the basics of crypto loans and give you the information you need to begin considering whether this is a viable solution for your small business.

Inflation, borrowing, and small businesses

The persistently high inflation of the past couple of years has put pressure on businesses. As costs rise, many companies have had trouble increasing prices to keep pace. This has led to cash pinch, as margins suffer and firms scramble for additional resources.

Given this environment, it's no wonder that businesses have turned to loans to bolster their cash positions. One data set showed that 45% of business owners have engaged in some form of borrowing in recent years in order to deal with inflation.

45% of business owners have engaged in some form of borrowing in recent years in order to deal with inflation.

Unfortunately, inflation marks just one of the headwinds businesses have faced lately. In an effort to slow price increases, the Federal Reserve has dramatically raised interest rates. This makes borrowing more expensive. As a result, firms are seeking out alternative ways to raise the cash they need.

What is a crypto loan?

Crypto loans provide a possible way to deal with the current environment. The process works much like a traditional loan. However, in this case, you use cryptocurrency holdings as collateral.

The general operation works much like a securities loan. You submit your cryptocurrencies as collateral. Meanwhile, the amount of the loan is determined by a percentage of the value of the underlying assets. Bitcoin and Ethereum are the most common cryptos involved but, depending on the institution, other options can be used as well.

There are two major categories of crypto loans:

  • Centralized Finance (CeFi): In this model, the crypto lender takes control of your digital assets, keeping it until the loan is repaid.
  • Decentralized Finance (DeFi): Here, you maintain control of your assets. However, smart contracts help oversee the relationship, ensuring that you stick to the conditions of the agreement.

Benefits of crypto lending

Inflation and higher interest rates have complicated the economy in recent years. Of course, the crypto market has had its own share of troubles. The high-profile collapse of industry powerhouse FTX was just one of a series of bankruptcies that have roiled the asset class since the start of 2022.

This has led many companies to sour on cryptocurrencies. However, there's no need to turn your back completely. Even with its tarnished reputation, these assets can still provide value to your operations. Here are some benefits to crypto lending:

  • No credit requirements
  • Relatively low rates
  • More choices of loan currencies
  • Streamlined process

Given these potential upsides, there are a number of scenarios that make this avenue a great choice. Here are some to consider:

  • You have stockpiles of crypto you don't want to sell. If you invested in bitcoin or other cryptocurrencies during the boom, you might be looking at large unrealized losses. Rather than sell a depreciated asset, a loan lets you extract some near-term value while you wait for the market to recover more.
  • You accept crypto as payment. Do your customers use crypto to purchase your offerings? If so, you can take advantage of this infrastructure to get the most out of this particular revenue stream.
  • You use the blockchain as part of your operations. If you use the blockchain in your overall organization, like in the minting of NFTs or as the basis for smart contracts, you likely already have a vibrant organizational knowledge of this technology. Using digital assets as part of your financing could represent a natural extension.
  • You have been taking a "buy the dip" strategy in the crypto market. While some people gave up on crypto following the post-FTX collapse, others saw it as an opportunity to jump into a distressed market. If you've gathered crypto assets since the selloff, borrowing against these holdings lets you get cash while still holding onto your investment.

Risks of crypto lending

Of course, crypto lending isn't right for every organization. The market is complicated and the process requires a certain level of technical expertise. Meanwhile, there are other risks that could make this a bad option for you.

To understand those dangers, here are some of the downsides to consider as you weigh your crypto-lending options:

  • Lack of regulation: Cryptocurrencies remain outside the broader regulatory structure that oversees traditional financial institutions.
  • You'll tie up your crypto assets: Once you use your cryptocurrencies as collateral, you can't dispose of them in another way. Until you pay the loan back, you'll have to hold onto them.
  • Asset volatility creates margin call risk: As the last few years have shown, cryptocurrencies can swing dramatically in value. A sharp, sudden drop could trigger a margin call, depending on the terms of your loan.
  • Lender risk: The FTX situation underlined that even the biggest institutions can run into problems. It's important to choose your partners carefully and understand the potential dangers involved.

How to get a crypto loan

Your decision whether to pursue a crypto loan will come down to the specifics. You can like the idea in general but not find the ideal situation. Therefore, it’s important to understand how to get the most out of the process. Here are some tips to keep in mind:

Set your goals

Before tapping into any new source of funding, draft a detailed plan about how you will use the cash. Review your business and delve into the likely market conditions that will drive your decision-making in the near term. This way, you'll have a clear action plan once you receive your loan, making sure you get the most out of the opportunity.

Before tapping into any new source of funding, draft a detailed plan about how you will use the cash.

Research your options

Even if you've settled on a crypto loan as the best way forward, there are still significant decisions to make. You have many options regarding the structure of the arrangement, as well as a wide variety of potential lenders to consider. Learn everything you can and focus on the situations that seem like the best fit for you.

Choose a platform

Once you've determined a short list of potential lenders, it's time to target the deal that suits your circumstances. With your action plan as a guide, weigh your alternatives carefully. An organized process will let you discover the most advantageous option.

Decide on terms

Along with targeting the institution that you want to become your partner in this crypto loan, you should also think about specific terms. Leverage your research to know what constitutes a good deal. At the same time, consider your priorities in figuring out what terms represent potential deal-breakers.

Deciding whether a crypto loan makes sense for you

The blockchain is not just for buying and selling bitcoin. The technology can also be used for business financing, in the form of a crypto loan.

There are both benefits and risks that come with this type of funding. However, in challenging times, it may be worth considering. Use the information provided here to determine if a crypto loan is right for your company.