How do I repay my student debts? With the use of cryptocurrency, you can ~ Integrated loans
(This information is destined for educative ends alone and Is not constitute financial advice.)
The US student loan market is approximately $ 1.73 trillion, with more than 42.3 million debtors owing an average of $ 39,351. The government has delayed federal loan repayments until January 2022, but that day is approaching.
There are many Decentralized Finance (DeFi) solutions that are worth learning for students who own crypto assets and want to explore other loan repayment options. (This is not financial advice; do your own research and consult a professional before making an investment.)
What is DeFi?
Blockchain is now used for increasingly complex financial services. DeFi is an ecosystem of decentralized applications that run on smart contracts instead of being managed by a central company.
When specific circumstances are met, smart contracts execute self-executing computer programs. Every decentralized application relies on these applications.
DeFi apps provide financial services similar to traditional bank loans, insurance and savings accounts.
The main distinction is that DeFi apps are open to anyone, regardless of document, credit history, or region. People can earn income by lending, borrowing and staking crypto assets using DeFi.
Why is a DeFi loan a good option?
These solutions are attractive because they offer lower interest rates. Loan rates are sometimes close to zero.
Another reason is the availability of flexible repayment loans. DeFi loans do not require monthly payments by a certain date. You can skip a month or two without affecting your credit score.
Moreover, since these loans are given through smart contracts rather than financial institutions, you don’t need to have good credit to access them.
DeFi loans also allow customers to borrow against their crypto holdings, thus avoiding future price increases and capital gains taxes. This eliminates the need to sell crypto to pay off debt or finance a project.
The protocols generally encourage users to borrow with DeFi loans. Think of it as a reward for borrowing. Unlike traditional financial systems, DeFi protocols exploit this method to attract cash and reward users for their contribution to their ecosystems. Users are frequently remunerated with governance tokens, which allow them to help manage the platform.
How Can DeFi Loans Be Used To Pay Off Student Debt Now That You Know How They Work?
Peter owes a $ 10,000 student loan to a private lender. Assuming Peter’s crypto firms earn $ 20,000 from Ether, he can sell $ 10,000 of digital assets and write off his debt. While this sounds like a good idea, it puts Jim in a bind. He sold half of his crypto holdings, reducing his position in the market. The amount he would have earned if digital asset prices continued to rise has been halved. Jim must also pay a Capital Gains Tax (CGT) when he sells his crypto holdings. In the United States, the amount of CGT owed depends on the age of the asset and the taxpayer’s tax bracket.
An alternative is to put $ 20,000 in a DeFi loan platform as collateral and borrow $ 10,000 in stable coins. To pay off his student loan, he can exchange stablecoins for currencies. Peter’s loan is in stablecoin, which means there are no price fluctuations. Peter can take as long as he needs to pay off the DeFi loan, as long as his collateral is worth enough to avoid liquidation. This method relieves the pressure of monthly repayment.
Stablecoins are digital assets backed by fiat currencies. These assets are generally indexed 1: 1 to a fiat currency. The USDT, for example, has a 1: 1 link to the US dollar, which means that if you have 30 USDT tokens, their value will be around $ 30.
Peter’s debt hasn’t gone away. Instead, he has moved his debt to a decentralized environment where he has more control over repayment. Additionally, governance tokens or incentives can be sold to pay off part of the debt. For example, AAVE rewards USDT borrowers with 1.66% APR paid in AAVE staked tokens. A loan in USDT now has an interest rate of 3.88%. As a result, a borrower can use his income to pay off part of his debts.
Likewise, Peter’s DeFi loan will be smaller as the value of the digital asset used as collateral increases. To fully grasp this potential, we need to look at the LTV statistic and its influence on DeFi borrowers.
What is LTV?
LTV measures the size of your loan against your collateral. LTV is the loan to value ratio. In this case, Peter borrowed 50% of his collateral. Its LTV is 50%. The LTV would have been 75% if he had borrowed $ 5,000. To eliminate counterparty risks, some protocols allow users to borrow more than 50% of their collateral.
The borrower’s LTV is subject to fluctuation over the term of the loan, especially if the collateral is in volatile cryptocurrencies. So, if Peter pledges 5 ETH at $ 4,000 each, the LTV automatically drops if the price of ETH rises to $ 6,000 in two months. Let’s do arithmetic to prove it.
ETH price = $ 4000
5 ETH deposited
Guarantee value = $ 20,000
Loan amount of $ 10,000
LTV = 50%
End-of-year ETH price = $ 6,000
Value of the guarantee at the end of the year = $ 6,000 * 5 = $ 30,000.
LTV at year end = $ 30,000 * 100% = 33.3
In summary, Peter’s LTV fell from 50% to 33.33% due to the increase in ETH prices. Note that this example assumes that Peter has not made any payments. But, just as the volatility of cryptocurrency can decrease the value of debt, it can also increase the chances of liquidation (we’ll talk about that later).
AAVE, Maker and Compound all offer variable rate loans. The demand for the digital item in question influences the prices. You can also get fixed rate DeFi loans according to the protocol, but they cost more.
The average levels of the 30-day compounds and AAVE range from 0.01% to 5.12%. The rates vary from 2.79 to 28.06% on Compound and from 0.04 to 168.98% on Aave. No information about Maker.
There are alternative solutions that do not use any borrowing rate. The borrower only repays the amount borrowed. Liquity is a DeFi option that offers interest-free borrowing.
Another element that sets DeFi loans apart are the auto-repayable loans. We have already proven that placing digital assets as collateral can pay off some of the loans. Some protocols go further by including interest-generating mechanisms for self-reimbursement.
The protocol uses the collateral to finance agricultural enterprises yielding other protocols. The protocol then deposits the collateral on other DeFi sites to earn interest. The proceeds are then used to repay the loan over time. In other words, the potential money earned using your collateral will eventually pay off the loan. Alchemix is an example of such a platform.
What are the dangers of DeFi loans?
Given that DeFi is a new concept, it’s no surprise that it comes with some dangers. Consider the following before choosing DeFi to pay off your student loan.
These DeFi platforms include liquidity thresholds – the LTV to which the protocol sells collateral to settle the obligations. Suppose Peter borrows $ 10,000 at 50% LTV and the liquidation threshold is set at 75% LTV. Even if the price of ETH drops significantly, Peter must keep the value of his loan below 34% of the total value of his collateral.
DeFi lending protocols frequently offer variable rates depending on the demand and supply of digital assets. DeFi loans become expensive when the APR increases. The lack of stable interest rates makes it impossible to predict how long it will take to repay the loans.
Smart contracts power DeFi protocols, automating borrowing operations. Notably, the underlying code of smart contracts is written by people. Thus, it is difficult to rule out the possibility of errors endangering consumers’ digital assets. The bugs expose smart contract-based protocols to security and systemic threats.
Before using DeFi techniques to pay off your student loans, as with other crypto-related possibilities, do your homework. While DeFi loans are a great method of avoiding debt from traditional lenders, they also put borrowers at risk.