In lending agreements, collateral is frequently mentioned. Acting as security for repayment, it is a vital component in loans. When it comes to crypto lending, it is just as important, but the concept and incorporation are a little different from what we are familiar with concerning fiat currencies.

 

What is it?

 

‘Collateral’ refers to an asset that a lender will accept as security for a loan. Oftentimes, it will take the form of real estate, but there are other kinds of assets it will embody. It ultimately depends on what the purpose of the loan is. Collateral acts as protection for the sake of the lender. That is to say, should the borrower evade loan payments, the lender will be able to seize the collateral and sell it to recoup its losses, whether it be some of or all of it.

 

The loan type will typically predetermine the nature of the collateral. Taking out a mortgage makes your home the collateral and taking out a car loan means that the car is the loan’s collateral. The collateral types that lenders will frequently accept include investment accounts, cars (though only when paid off in full), and bank savings deposits. In contrast, retirement accounts are not normally accepted as collateral.

 

Relation to crypto

 

In crypto-backed lending, collateral is basically the crypto asset that the borrower pledges to guarantee the loan’s repayment. In terms of traditional banking, a standard example of collateral is – as mentioned before – mortgage. The asset (be it a house or apartment) that is being financed is often the collateral effectively securing the credit. The crypto collateral is returned once the credit has been repaid in full.

 

Crypto lending, at its core, is not that hard to grasp. Borrowers can use their cryptocurrency assets as collateral in order to procure a fiat or stablecoin loan. Lenders, meanwhile, provide the assets that are necessary for the loan at an established interest rate. This can work in the reverse, too. Borrowers use fiat or stablecoins as collateral so that they can borrow crypto assets.

 

The practice of crypto lending is not necessarily groundbreaking as they are easily comparable to collateralized loans. In fact, collateralized loans are essentially what they are. However, credit and lending are financial primitives that hold immense power. They can open a wide variety of applications and benefits for traders, users, businesses, and institutions. Moreover, in the ever-growing DeFi (Decentralized Finance) space, this primitive has been utilized for lending access that is open, permissionless, and composable.