What Is Crypto Lending? Growing Trend In Australia Raises Concerns

A new form of lending is taking off in Australia, where creditors are accepting cryptocurrencies like Bitcoin and Ethereum as collateral for loans, worrying economists.

Though the lending practice started in 2017, it became more common during the pandemic and has attracted both attention and concern from experts.

What is crypto lending?

Crypto lending is a practice in which borrowers use their cryptocurrency assets as security for a loan. In return, they can receive funds, often for large purchases like homes or cars.

Meanwhile, lenders make money by charging higher interest rates on the loans compared to what they pay to borrow money themselves.

For example, a typical crypto loan might be worth AU$140,000, with the lender borrowing money at an 11% interest rate and lending it at 15%. If the value of the cryptocurrency increases, the borrower can borrow more. If it decreases, they must add more collateral. The lower the loan-to-value ratio, the lesser the risk for the lender, but higher the cost for the borrower.

Banks often hesitate to provide crypto lenders with financial support, with a possible reason being the associated risks.

"Currently, if you walk into a typical bank, if you have equity in your Bitcoin, a bank is not going to lend it to you," Sydney-based crypto platform Vield co-founder Johnny Phan said. "They only lend against property or against your credit profile. We also do that in same manner, but we're using Bitcoin instead of property, for the security."

Why are experts worried?

While crypto lending is legal and licensed, many economists worry about the risks. Cryptocurrencies are volatile and have no intrinsic value, making them risky assets. If the value of Bitcoin or Ethereum drops sharply, borrowers could lose their collateral.

"In the event that there's a dramatic reversal in the value of those assets and the market for them dries up, then what history tells you what happens is that people sell what they can, rather than necessarily what they should, in order to get out of a sticky or illiquid position," economist Saul Eslake urged.

"And that's how contagion happens, from what might be a small asset class of no great systemic significance on its own, to assets that do matter from the perspective of financial stability as a whole."

The risk was highlighted in 2022 when one borrower lost all his Bitcoin after its value fell, leaving him with just AU$13,000 after paying back his loan.

Experts are also concerned about the impact of widespread crypto lending on Australia's financial stability. If these loans become more popular, and large amounts of money are at stake, financial institutions might struggle to cover their obligations in case of a crypto market crash.

"Crypto assets can be highly volatile," corporate regulator Australian Securities & Investments Commission (ASIC) pointed out.

For instance, if one group starts selling assets to cover loans, it could cause panic and spread financial problems worldwide. Economists warn this could affect everyone.

"Lenders securing loans with crypto may risk the collateral becoming insufficient to cover the loan if the value of the crypto drops quickly. For consumers, this means a higher risk of having your loan called back early, and needing to sell your crypto assets to cover a default," ASIC warned.