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Know Before You Borrow: The Two Types of Bitcoin Loans

Know Before You Borrow: The Two Types of Bitcoin Loans
Photo by Aleksi Räisä on Unsplash

If you’re willing to risk losing your collateral if your loan isn’t paid, a secured loan can be a great way to ensure a low interest rate. And if you have existing Bitcoin holdings, why not use them as collateral instead of your home or vehicle?

Before jumping into a Bitcoin loan, it’s essential to understand that not all loans are equal. One critical facet to examine is the type of Bitcoin loan you’re considering: centralized finance (CeFi) or decentralized finance (DeFi).

Why does the type of Bitcoin loan you get matter?

If you aren’t already familiar with the world of crypto loans, it might seem like the CeFi/DeFi distinction just comes down to minute details. However, the type of loan you choose impacts several key factors:

  • Who has control over your Bitcoin during the loan term
  • What actions a lender can take if you default or miss payments
  • The interest rate of your loan
  • What kind of customer service you receive
  • The security of your Bitcoin

Let’s look at how CeFi and DeFi Bitcoin loans stack up.

Centralized finance (CeFi) Bitcoin Loans

Most Bitcoin loans out there are CeFi loans. A central exchange carries out these loans in the same way a bank or other financial institution executes traditional loans. They’re more user-friendly, but they also offer less freedom and transparency.

The Pros:

  • Generally lower interest rates than DeFi loans.
  • CeFi lenders usually have more regulatory oversight than DeFi lenders.
  • They typically have customer service and support.

The Cons:

  • The lender controls your Bitcoin until you can pay off your loan.
  • The lender handles accounting and regulation, so there’s less transparency than with a DeFi loan.
  • The lender must verify your identity, so there’s no option for anonymity.

Decentralized finance (DeFi) Bitcoin Loans

Instead of relying on centralized control, DeFi Bitcoin loans are effectively a form of peer-to-peer lending. They offer borrowers more control, but their complexity and anonymity make them more challenging for many people to navigate.

The Pros:

  • Borrowers still retain control of their Bitcoin.
  • Anonymous borrowing is possible.
  • Fees are generally lower than those for CeFi loans.

The Cons:

  • Much of the process is algorithm-controlled, so there’s little to no customer service available.
  • DeFi systems tend to be targeted by hackers more often than CeFi ones.
  • Interest rates are often higher than those for CeFi loans.

Which one should you choose?

As you can see, there’s a significant learning curve when navigating Bitcoin loans. The best way to make the right decision for you is to thoroughly understand each lending model and what it entails.

However, the simplified version is this: choose a CeFi loan if you want a user-friendly process that resembles traditional lending, and choose a DeFi loan if you value cost-efficiency, privacy, and transparency above all.

If you’re new to Bitcoin loans, a CeFi loan is probably the best one to start with. Once you get a feel for the Bitcoin lending process, you’ll be better equipped to navigate the more anonymous DeFi loan experience.

Ombir is an Editor at Active Noon Media. He is an SEO and Writer who has experience of 3 years in these respective fields. He likes to spend his time doing research on various topics.