What is the crypto loan? Key Legal Considerations For Lenders Dentons
During the pandemic alone, the cryptocurrency’s total market capitalization grew from around US $ 150 billion to US $ 2.5 trillion.1 Looking ahead, the market is expected to grow at a compound annual growth rate of 60.8% between 2021 and 2026.2 Whether or not you believe in the widespread adoption of cryptocurrency as a form of money, the immense growth of the crypto market reflects a permanence of crypto as a type of financial asset that will continue to be of interest to people. people in the years to come.
However, despite the bullish behavior of the crypto markets, the purchasing power of holders of crypto assets is still relatively limited. This limitation exists in part because: (1) there are few ways to spend crypto on real-world goods and services, and (2) crypto-asset holders prefer to hold onto their crypto-assets in the hope that ‘they continue to appreciate in value. The overall result of this strategy is that the value of the crypto is not exploited like other financial assets and remains locked in the wallets of the holders of the crypto.
What is the Crypto loan?
Crypto loan involves a lender lending fiat money to a borrower who owns the crypto and securing said loan by taking collateral on the borrower’s crypto assets. In this relationship, the lender often exercises control over the crypto assets, holding them as collateral until the loan is repaid or the crypto assets are liquidated. Repayment of the loan in a centralized crypto lending relationship, between a traditional financial institution and a borrower, is often done in cash installments over a term defined in the loan agreement. If a borrower does not repay the loan, the lender can liquidate the crypto assets under their control with the aim of recovering the loan amount they provided. The centralized crypto lending relationship, also known as the Ce-Fi model, differs from decentralized or peer to peer lending solutions that fall under the realm of decentralized finance (De-Fi). In De-Fi loan agreements, the money is typically pooled by participating lenders in an application governed by code (i.e.
Either arrangement allows the borrower to monetize and mine their crypto assets, providing them with liquidity without forcing them to sell their underlying crypto assets. At the same time, the lender is able to generate additional secured loans with attractive returns, using a loan structure which can minimize its risks in the event of borrower default.
Legal Considerations for Crypto Lenders
Before offering a crypto loan, it is essential that the potential lender understands the contractual mechanisms and remedies necessary both to take security over a particular crypto asset and to assert its collateral in the event of default.
For example, a lender should take into account some (or all) of the following legal considerations:
- Regulatory conformity : Ensure compliance with any regulatory regime that governs whether and how it is able to grant crypto loans.
- Security lock: Determine how to take a first ranking security interest in the crypto asset.
- Market volatility: Consider how to protect their position against the physical volatility of the underlying crypto assets, and design the appropriate mechanism and process for requiring additional collateral from the borrower, if necessary.
- Use of crypto assets: Understand the rights the borrower will have with respect to crypto assets serving as collateral during the term of the crypto loan. In some crypto loan agreements, the lender can make money not only by charging loan fees and collecting interest on payments, but also by managing crypto deposits to generate income.
- Collateral security: Develop methods to protect the security of the crypto asset during the term of the loan in order to prevent computer theft, ensure proper administration of keys and respond to certain blockchain-related changes that may affect the collateral during its life. detention. Examples of blockchain related changes can include token exchanges, cancellations, or splits / forks in a particular blockchain.
- Taxation and other matters: Taxes, transfer limits, and other currency regulations can affect both how loan proceeds are transferred from lender to borrower and the repayment of principal and interest from the borrower to the lender. The regulatory classification of the underlying crypto asset will inform tax considerations and determine whether transfer limits may exist. Accordingly, the lender will need to consider the shape of the crypto asset, whether it is a protocol token, application token, non-fungible token, etc., and determine its shape. ownership and its impact on lending considerations. A qualification as currency, tangible or intangible property each has different implications for the structuring of loan agreements.
- Repayment: How will the loan be repaid? For example, will it be reimbursed in cash installments or by cryptocurrency?
- Security application: What contractual mechanisms and remedies are in place to allow him to assert his security in a timely manner?
If you are interested in participating in the crypto lending space, it is important that you consult with a legal advisor who has expertise in the secure lending and crypto space to ensure that you are managing your risk properly.
1 https://coinmarketcap.com/charts/ filtered to compare dates from March 16, 2020 to October 18, 2021.
2 Global Cryptocurrency Market (2021-2026) – Industry (globenewswire.com)