How Bitcoin, Ethereum and swing guarantee loans will change Crypto

The advent of guaranteed cryptocurrency loans will have deep ramifications on the encrypted markets. Although several exchanges and credit companies have tried to enter the space, none of them has achieved market dominance.

The idea for secured cryptocurrency loans has existed for a while. Many ICOs have successfully collected money for the idea, and at the moment there are many dubious companies operating in space. In addition, there are also a number of smart contracts that allow decentralized loans on the Ethereum blockchain.

That said, none of these services has achieved significant traction. There are many obstacles to setting up a reputable lending company and, as a result, the industry will have to consolidate or wait for the entry of a major player into the market.

However, once there is an important player these cryptocurrency secured loans will have a profound impact on investors and cryptocurrency users. These services would increase the liquidity of the market, make the encryption easier and reduce the transaction costs of acquiring encryption.

How Crypto Collateralized Loans Work

Cryptographic loans work using a Bitcoin, Ethereum, Ripple or other major cryptocurrency deposit as collateral. Before obtaining a loan, a borrower is first assessed for creditworthiness. Often, a borrower's credit score, demographics and online activities are assessed to determine credit worthiness. The score obtained from these data determines the interest rate of the loan and the ratio of guarantees required for the loan.

Thus, a borrower deposits cryptocurrency and receives a fraction of its value in fiat or another resource. Depending on whether the issuer of that fiat is an organization or an individual determines whether the loan is peer-to-peer (P2P) or a conventional institutional loan.

These secured loans are an important service for cryptocurrencies. A solid credit industry around encrypted-collateralized loans will benefit from adoption and reduce the complications associated with the ownership of the crypt. If a reliable and well-regulated encrypted credit sector existed, this would benefit users in three main ways:

1. Reduction of the tax burden
2. Provide commercial leverage
3. Facilitate the conversion from Crypto to Crypto

Reduction of the tax burden

Taxes under generally accepted accounting principles (GAAP) and internationally recognized International Financial Reporting Standards (IFRS) are a major concern for cryptocurrency users. Transactions such as the exchange of a cryptocurrency with another or the use of cryptocurrency to buy a good or service result in capital gains and losses.

In the United States, the short-term capital gains tax is enormously 30 percent. Many other countries have taxes on capital gains around this figure. Using an intermediate lender, a user can prevent these fees.

If someone borrows fiat using cryptocurrency as a guarantee, purchases made with that fiat do not support capital gains or losses. Moreover, this loan allows the owners to encrypt to spend fiat waiting for long-term capital gains to apply to equity investments. In the United States, if the cryptocurrency is held for one year or more as an investment, these gains are granted favorable tax treatment with a 10% long-term capital gain tax.

Provide commercial leverage

Another advantage of the cryptocurrency loans is the trading margin. Margin trading is the practice of borrowing funds against a financial asset, such as shares or encryption, to amplify gains or losses from market movements.

Many important exchanges such as BitMex, Bitfinex, Poloniex and Kraken already offer negotiation margins. However, the terms of this service can often be predatory, with high warranty requirements, exorbitant interest rates and unreliable service.

Access to loans can provide another mechanism for margin traders to gain additional leverage. A competitive market for these loans would mean lower interest rates and lower guarantee requirements.

Simplification of cryptographic conversions in Crypto

The final benefit of secured loans is the relaxation of commercial frictions. Commercial friction occurs when it is difficult to directly trade two assets with limited liquidity, or when the costs of trading one business in another are high.

An example of friction trading is when someone is trying to buy an obscure one altcoin using another altcoin; since liquidity in these markets is low, the spread on this transaction is high, which means higher trading costs.

To get around these problems, most users first convert to an intermediary like Ethereum or Bitcoin before exchanging with another alternative currency, but this trade also entails its own costs.

Loan services can alleviate the friction of trading. Furthermore, some operators in this market are exploring encrypted cryptographic loans. These loans would allow the user to borrow a cryptocurrency against one another. For example, using Bitcoin as a guarantee to borrow Ethereum.

This type of loans would increase the liquidity of these markets and consequently the friction of the transactions will decrease. However, to have a major impact on the friction of trading, these services should gain more traction.

Risks with secured loans

Although these types of loans offer a solution to some of the drawbacks of crypto, there are also a number of risks involved. Firstly, margin calls on a loan from price volatility can penalize a borrower. Secondly, the encrypted loan is mature with Ponzi schemes and scams and, finally, the regulators can interrupt the legitimate businesses of the sector.

Margin calls

Given the volatility of cryptocurrency, whenever there is a price drop, there is the possibility of a margin call. A margin request occurs when the value of the deposit decreases and the creditor needs additional guarantees or requires the lender to sell existing collateral to cover potential losses.

Many cryptocurrencies that would be used as collateral for these loans are extremely volatile. Even if the price tanks for a fraction of a second, they would continue to generate a margin request and liquidate part or all of the borrower's guarantee.

Potential for scams

As highlighted in a TechCrunch exhibition, between a third and a quarter of the 3,500 encrypted lending platforms in China were Ponzi schemes, were involved in police investigations or made it difficult for users to withdraw deposited funds.

These results are not limited to Chinese lending platforms. The loan around the cryptocurrency is ripe for scams, especially the peer-to-peer loan. Often, these companies operate on the edge of the law and exploit the decentralized nature of cryptography. When these unscrupulous companies cease their activities, those who suffer the consequences are often users.

If a loan provider should default or, worse still, steal user deposits, borrowers usually have limited recourse, since these companies usually operate outside the countries with loose regulations.

Regulatory risk

On the other side of the spectrum, the regulators themselves pose a risk to this sector. Entering important markets such as the United States, Europe, China or South Korea requires a huge investment in legal compliance.

Through the introduction of new regulation or stricter enforcement of existing regulation, regulatory authorities can seriously hamper lending companies. Although regulation is necessary for a fair and reliable credit market, regulation can also be an impediment to legitimate businesses.

The future of the loan

The loans guaranteed by cryptocurrency are a valuable service in space. These loans will reduce the tax burden, increase the ease of trading and reduce the cost of conversion for cryptocurrency users.

The market is ready for a legitimate company to enter the industry. Whether that competitor is a successful ICO, a looming cryptic company like Coinbase that enters the space, or a traditional player like Square Inc. who explores the loans, the sector is waiting for a reliable source of credit.

As the industry matures around cryptocurrency, its uses and utility will increase with it. At its core, the price of any technology is tied to the value it provides to its users. Financing and credit are just another value-added application.