Crypto-Based Passive Income Methods #1: Lending — Part 2
You’ve learned that any borrower in the crypto world can borrow cryptos in an instant, without any need for him to prepare income statements, undergo a KYC process, or have any good credit score.
There are only two things that he needs to have:
1. A crypto wallet
2. A collateral for his loan
This collateral for his loan is in the form of another digital asset that has value. Digital assets are assets that can be stored, transferred and traded electronically.
A common digital asset is cryptocurrencies. Another is NFTs.
By now you’re probably wondering:
If someone has cryptocurrencies in hand as collateral for his loan, why does he need to borrow cryptocurrencies in the first place?
Why is he not using his collateral for whatever purpose he wants to borrow cryptocurrencies for, so that he doesn’t have to borrow and incur interest charges?
For example, let’s say the borrower has 1 bitcoin in his wallet, now worth about USD26,000+. He can now use this 1 bitcoin as collateral for his loan of another cryptocurrency — let’s say for USDT10,000.
(Note that USDT is a stable coin, its value doesn’t fluctuate from day to day like non-stable coins. 1 USDT is always equal to 1 USDC, as each USDT is backed by one real USD in the bank.)
So why doesn’t the borrower simply sell part of his bitcoin for the equivalent of USDT10,000, instead of borrowing USDT10,000 and then paying interest on it?
The main reason a borrower does this is for him to RETAIN OWNERSHIP of his 1 bitcoin without selling any of it off, while accessing the ADDITIONAL FUNDS his 1 bitcoin as collateral can give him.
And because bitcoin’s price can go up over time, he gets the benefit of his entire 1 bitcoin appreciating in value during that time, while still having the means to use part of his 1 bitcoin’s value in the form of the loan, to make even more money.
So if he sells USD10,000’s worth of bitcoin to get USDT10,000, his remaining bitcoin is only worth USD16,000+.
If bitcoin then appreciates 100% in a year (as an example), his remaining bitcoin will only be worth USD32,000+ at the end of 12 months (USD16,000+ x 2).
But if he still retains his 1 bitcoin worth USD26,000+ and it appreciates 100% in a year, his bitcoin will then be worth $52,000+ instead of USD32,000+.
And he has an additional USDT10,000 that he took out as a loan against his 1 bitcoin collateral, to do as he pleases.
If he’s truly savvy, he would use this USDT10,000 to make more money for him, like using it to buy another crypto that he believes is going to trend upward.
Or if he runs a business, he can use the funds to buy more inventory to sell to make more profits.
Thus, as a borrower, if he ever needs to borrow more cryptos against his collateral, he needs to ensure that he uses the loan to make more money for him, not spend it on a holiday or on things that don’t make any returns for him at all.
There are exceptions, of course.
Like in emergencies where he needs access to funds right now that he can pay back later, without affecting the value of his 1 bitcoin.
Or if selling off part of his bitcoin triggers a taxable event in his country. By borrowing against his bitcoin, he avoids selling off part of his bitcoin, which means that he avoids having to pay a tax on that sale.
You can now see that you can make money both ways — as a Lender, or as a Borrower.
The Lender has a simple plan — to deposit his cryptos on a lending platform for Borrowers to borrow, in return for interest that is higher than what he would normally get with his bank, or most other assets that give passive returns.
The Borrower also has a simple plan — to use the borrowed funds to make more money than the interest he has to pay on the loan, or to avoid paying taxes legally by avoiding any sale of his collateral.
Having said that, the Borrower must have a plan in place that minimises his risks as he tries to make money with his loan. He should only do this if he has very clear signals that his use of the loan will more likely than not result in a profit for him.
This is because he has to pay back his loan in full eventually, as it is NOT free money. If he loses what he has borrowed and he can’t pay it back, his collateral will eventually be liquidated for the sum equivalent to the extent of his loan plus any interest owing on it.
So NEVER borrow to take a chance on something, unless your chances of making it with that something has a high percentage of succeeding.
Part 3 coming soon. Watch out for it.