Bitcoin-Backed Loans May Be The New Future

December 9, 2022 2:00 pm Comments

Investors and industry experts are speculating on how the future of decentralized finance will turn out and how it might disrupt many traditional financial industries.

One of the most prominent sectors is the lending market where people are able to take out loans from institutions while using another asset as collateral.

The rise of crypto has now given credibility that you can now take out loans and use a digital asset like Bitcoin as collateral instead.

The increasing popularity of this type of loan indicates that there is a lot of faith on the Bitcoin protocol’s security and store of value.

In turn, this will provide decentralized financial services to everyone which includes even people who were excluded from having access to such services today.

BitcoinMagazine reports:

Bitcoin’s total value locked (TVL) is $108 million as of October 2022, while Ethereum’s sits at $30.37 billion.

Even though the potential of unlocking DeFi on Bitcoin is evidently enormous, there are reasons behind the extreme gap in such comparison.

One of them is Bitcoin’s true decentralization which prevents any central planning or venture capital funds from interfering with its prodigious independent development. While this is the best thing for Bitcoin, it also means that money for development is limited, making it slower than Ethereum, which is backed by big corporate money.

Furthermore, Bitcoin’s base layer is excellent for money transaction settlement, but smart contracts, which are the fundamental components of DeFi, need to be built on upper layers like the Internet is built upon the base TCP/IP layer.

This article will explore the opportunities that Bitcoin lending could open in DeFi, how it works and where you can look for the current services offered.

In order to understand the potential opportunities that are available here in this new DeFi world, its important to understand the differences between decentralized finance and centralized finance.

n DeFi, there is no middleman and the process is completely reliant on the blockchain technology and protocol.

Obviously, whenever there is a middleman, people would have to trust this entity which makes it similar to the traditional financial model where people place their trusts on the banks.

With Bitcoin backed loans, you are only trusting the integrity of the blockchain protocol as you are borrowing money from someone also in the blockchain.

Essentially, the blockchain allows anyone to either receive a loan or provide loans which is why it may be the future because of its ease of accessibility.

However, such Bitcoin-backed loans are not without their risks.

BitcoinMagazine reports:

It would be best if you did your research to find the most suitable Bitcoin DeFi lending platform. You are giving your money to a centralized entity or an escrow that will hold it until you pay back the loan, so you should ensure your money is safe.

The lending or borrowing process is usually straightforward, supported by user-friendly interfaces and little to no verification required. Strategies exist to help you save money or reduce fees and the risks of being liquidated. For example, you should try to keep the total portfolio loan-to-value (LTV) ratio at 20% to better withstand a possible 50% drawdown in BTC price.

Your primary strategy should work around the LTV element because you risk getting liquidated if the loan’s bitcoin collateral falls in value, making it a margin loan unless you keep topping up with additional bitcoin. Exploring such strategies will better prepare you for facing loan challenges.

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