The cryptocurrency landscape continues to expand and innovate on old financial models and products used in the centralized (traditional banking) system. With the invention of Bitcoin, along with other cryptocurrencies, a whole new world of possibilities has been introduced.
These possibilities are available as a result of crypto coins having monetary value, and to unlock this value, a trader has to swap coin X for coin Y, using crypto to make payment for merchandise or exchanging crypto for fiat. Today, however, crypto can be used for much more than just payments and trading, it can act as a form of collateral for a loan.
Blockchain Collateral Explained
Blockchain collateral is any cryptocurrency that has monetary or tradable value and can be used as a form of security for a loan. It is a blockchain asset accepted as a monetary value of another asset, which was lent to the provider of the asset and acts as a guarantee that the loan will be repaid. One of the accepted assets across all lending platforms as blockchain collateral is Bitcoin. Other blockchain collaterals may include Ether and Dash.
Blockchain collateral is also good for lenders as it minimizes risk for the lender because if the borrower defaults, the lender can automatically take possession of the collateral. This automatic possession makes up for any losses a lender would have faced in the default payments.
Characteristics of Good Blockchain Collateral
For a coin to qualify as good blockchain collateral it has to possess a few properties. These properties include:
No Counterparty Risk
Good blockchain collateral is not of any counterparty risk and the value of the collateral is inherent in the asset itself. Individuals can store their assets in their wallets. A good blockchain collateral’s network is decentralized and it is also secured by thousands of computers worldwide.
There is no intermediary or third party that censors or authorizes transactions. Users can simply apply for a loan without the worry of censorship of any kind. A good example is Bitcoin, which is free of counterparty risk and is fully controlled by the individual owner.
A Global Market
Good blockchain collateral is borderless and available to everyone without a centralized authority. For example, Bitcoin is one cryptocurrency asset that knows no borders and it can be instantly transferred worldwide without relying on an intermediary such as a bank or government.
Availability of Market
Since the blockchain never sleeps, good blockchain collateral should always be available. As good blockchain collateral, access to Bitcoin is always available. Other forms of collateral have limited availability as to when they can be accessed. This 24-hour availability makes blockchain collateral unique and one of the most liquid types of collateral in existence.
Transferable and Very Portable
Blockchain collaterals are very easy to access as they can be stored in mobile devices such as USB drives or crypto wallets on mobile phones. The value of the coin stored can range from a few hundred dollars to hundreds of millions of dollars. This means, loan owners can easily access their loan anytime, and this same ease comes into play in the transferring of ownership as it is done instantly with little or no cost.
The Role of Blockchain Collateral
Blockchain collateral is a very essential component of the lending industry because it performs so many roles. These include:
The collateral serves as a means of compensation for a lender’s losses in case there is a default on the loan payment by the borrower. Lenders may seize the collateral and sell it off, using proceeds to cover up for the unmade loan payments. Therefore, it serves as a means of insurance for lenders.
Reduced Systemic Risk
In a case where the value of the collateral used to acquire a loan is sufficient to cover the full value of that loan, the lender would experience no losses if the loan payments are unmade. The lending platform would be in no way affected by this defaulting. This facilitates a smooth process for the platform’s lending activities and allows sufficient cash flow so the lending platform can meet the demands of other lenders and borrowers.
Reduced Moral Hazard
This is a situation where borrowers tend to use the loan they got for a different purpose other than the one specified while applying for the loan. The funds acquired may be used for other expenses or purchases quite riskier than the ones in the loan application.
These expenses may include consumer purchases that do not make returns. In this situation, setting the blockchain collateral against the loan ensures that the borrowers pay their loans as specified in the agreement. Failure to comply with this agreement can lead to the risk of the borrower forfeiting their collateral in the process.
Generally speaking, good blockchain collateral helps reduce the risk involved in the crypto lending process. This results in the loan having a larger value and reduces the borrowing cost involved in the process.
In today’s lending world, blockchain collaterals have proven to be very reliable assets for loan acquisition. Bitcoin is the most widely accepted blockchain collateral and it is accepted in other sectors of the economy, not just on crypto lending platforms.