You can’t open a news or finance journal nowadays without finding an above-the-fold piece on cryptocurrency. Once the darling of only the most adventurous and tech-savvy investors, cryptocurrency has gone mainstream. A recent poll by NBC found that 21% of Americans have experience buying, trading or using crypto—up from just 16% in November 2021. They’re reaching into their crypto wallets to grab coffee at Starbucks and shop the best deals on Amazon Prime Day. Cash, not crypto, is still king. But consider this harbinger of things to come: more and more people are buying homes with crypto, too.
As an entrepreneur, what does the crypto craze—and the recent crypto-crash—mean to you? You’ve got a great idea. Now you need a way to commercialize it. Should you be looking to the cryptocurrency market to fund your startup? The answer, as is so often the case, is a definite maybe. Let’s look at some of the ways cryptocurrency can figure in getting your business off the ground or perhaps even flying higher.
Crypto loans for entrepreneurs
Have you been turned down for a traditional personal or small business loan? If so, you’re not alone. Many new businesses can’t show off the 2-year profitable track record lenders require to qualify for a loan. They may not have high credit scores high enough to meet traditional loan qualification standards. Many traditional lenders deem startup companies too great a risk and deny entrepreneurs the funds they need to launch or scale small businesses.
But let’s say you’re a crypto investor and you’re sitting on a pile of coins. You may be eligible to take out a collateralized cryptocurrency loan, without cashing out of your crypto positions. Crypto loans are commonly available through crypto exchanges, but the number of crypto-specialized lending platforms is also growing.
How do cryptocurrency loans work?
With a crypto-collateralized loan, you pledge an amount of crypto greater or equal to the amount of cash you want to borrow. Technically, you still own your crypto when you take out a crypto loan. But depending on the type of loan you take out, there may be some restrictions on how you manage your crypto assets during the term of your loan.
CeFi crypto loans
Centralized Finance (CeFi) loans make up the majority of crypto loans. Loans are facilitated by regulated centralized exchanges. CeFi loans are generally considered more secure than the other type of crypto loan: the decentralized (DeFi) loan.
With a CeFi loan, in addition to pledging an amount of crypto to cover the balance of your loan, you will pay interest on the money you borrow. Rates vary widely, but they are often lower than the rates you’ll encounter with traditional personal loans. Currently, crypto loan interest rates range between 1% and 10%. Compare that to personal loan rates, which can top 35% for borrowers with less-than-ideal credit scores. On the other hand, you may be able to find a lower rate with a small business loan from the Small Business Administration.
If you take out a Ce-Fi loan, you will be unable to sell or trade the crypto you’ve pledged as collateral for as long as you have an outstanding balance. If you’re an active crypto trader, accustomed the watching the market and making timely trades to drive the value of your portfolio higher, that feature of CeFi loans may trouble you. But if you’re in it for the long-term and always intended to take a buy-and-hold approach to crypto investing, the control you lose over your crypto funds may not be an issue.
Either way, because your funds are controlled by your lender under a CeFi loan arrangement, you must trust your lender to make smart management decisions and keep your best interests in mind. Keep in mind, too, that if the value of your pledged cryptocurrency decreases, you may be required to pledge more crypto to cover your loan balance.
DeFi crypto loans
If maintaining control of your crypto assets is your top priority, a DeFi crypto loan may represent a more attractive choice. When you take out a DeFi loan, you are free to sell and trade your pledged crypto at will. Unlike CeFi loans, which are governed by regulating bodies, DeFi crypto loans are peer-to-peer. You negotiate the terms of your loan with your lender. DeFi loans offer the advantage of cutting out the middleman and, depending on your credit position, can be less expensive than traditional loans.
But DeFi loans come with some disadvantages, too. They rely on the use of smart contracts—essentially bits of code recorded on the blockchain that automatically execute the terms of a contract between individuals. DeFi loans are not closely regulated and come with a greater risk of hacking. Interest rates are typically higher with DeFi loans. In addition, lenders may require you to pledge crypto that’s much higher in value than the amount you borrow. That’s to mitigate the risk they take on when crypto owners self-manage their crypto assets.
Is a cryptocurrency loan right for you?
Crypto loans don’t make sense for all entrepreneurs. But here are some of the reasons why you might want to forgo a traditional personal or small business loan in favor of its crypto counterpart:
- You aren’t in a great credit position. Most traditional personal loans require a minimum credit score in the low-to-mid 600s. So-called “bad credit” loans may be available, but only at the highest interest rates—rates that are much higher than most crypto-collateralized loans offer. In fact, most crypto lenders don’t even require you to go through a credit check.
- You’re heavily invested in crypto. If you have significant crypto holdings and you don’t expect to have to use them to pay your bills, a cryptocurrency loan can be a relatively painless way to access cash to fund your new business venture.
- You need cash fast. A traditional personal or small business loan may take up to two months to close. It may not give you the money you need when you need it. You may be approved for a cryptocurrency loan in a matter of hours and funded in as few as two days.
The other side of the crypto funding coin
If you have a large store of crypto at your disposal, there’s another way to use it to fund your startup. Rather than borrow crypto, you can become a crypto lender. Crypto lending is a means of earning passive income from your investment. The amount you can earn lending crypto can be quite a bit more than you’d earn if you cashed out of your position and stashed your funds in a high-yield savings account. It could earn you more than some stock, bond or real estate investments, too.
Crypto loans are facilitated by crypto exchanges. Individual crypto owners deposit crypto funds with an exchange. These funds are, in turn, loaned out to borrowers. Interest rates are determined by the exchange. Extending crypto loans to borrowers may earn you 15% interest or more. Depending on the exact coins you deposit, the interest rate you earn may be higher or lower.
But again, crypto lending is not without risk. When you deposit funds in a traditional savings account, they’re insured by the FDIC for up to $250,000. No such insurance protects crypto deposits. The value of the crypto you deposit may change at any time, which can result in loss of income and your principal investment. And once you deposit crypto funds with an exchange, you never really know what they’re going to do with it. Your funds may be re-loaned several times over without your knowing it. You can’t control how much risk an exchange decides to take on. It’s a lot different than loaning your trustworthy uncle a sum of money for an agreed-upon rate. Finally, take into account that cryptocurrency exchanges—like cryptocurrencies themselves—often go belly-up. In 2020 alone, some 75 exchanges around the world became insolvent. So choosing the right crypto exchange becomes paramount.
How much risk can you handle?
Even in the best of times, you have to be brave to start a business. And 2022 is not the best of times. Many experts believe we are on the cusp of a deep recession. Cryptocurrency markets, in particular, have been hard hit recently. If you own a lot of cryptocurrency, you’re probably painfully aware of that. Maybe you’ve been thinking of liquidating your crypto assets. No one would blame you if you did. Incidentally, that’s another way you can fund your startup.
The promise of high rewards always comes with risk. Certainly many people—entrepreneurs among them—are willing to tolerate the volatility of crypto investing because they believe that, ultimately, it’s a game they can win. So before taking out a crypto loan or becoming a crypto lender, do some financial soul-searching. Can you comfortably relinquish control of your crypto assets? Can you stomach the volatility of the cryptocurrency market knowing your business depends on it? What would a significant loss mean to you? Would it have a strong impact on your lifestyle or put your retirement at risk? These are all questions you should ask yourself before jumping into crypto lending. William Shakespeare’s advice—neither a borrower nor a lender be—may be more meaningful than ever in the context of crypto lending. In any case, you may want to exhaust all of your traditional financing options before staking your hopes on crypto.