Loan-to-Value (LTV) Ratio: Assessing Your Risk in Crypto Loans

The flexibility and convenience of cryptocurrency make it an ideal way to provide people with loans. If you're considering working with crypto loans, it's important to understand how loan-to-value (LTV) ratios work. This useful metric is a great way to determine whether or not a loan is risky. Explore this guide to learn more about LTV ratios and the mechanics behind them.

Key Takeaways:

• A crypto loan is any type in which an individual borrows cryptocurrency tokens from a lender in exchange for collateral, which is forfeited if the borrower doesn’t pay back the loan within a certain amount of time.

• Crypto loan-to-value (LTV) ratio is a helpful metric for assessing risk during a loan. It compares the value of the borrower’s collateral to the value of the loan.

• A high LTV ratio means the loan is riskier for the lender, so the interest rate will be higher. A low LTV ratio means the risk is lower, so the borrower doesn't have to pay as much in interest.

What Are Crypto Loans?

Crypto loans are any type of loans in which a person borrows cryptocurrency tokens from a lender. Lenders typically require borrowers to stake some sort of asset as collateral for a loan. A borrower will forfeit the collateral if they don’t pay back the loan within a certain amount of time.

Crypto loans come in many forms. There are several crypto lending ecosystems in which users can borrow crypto to fund other projects. Some lenders also offer leveraged trading, which allows users to borrow crypto to invest in bigger trades. Unlike traditional lending, crypto lending is usually very decentralized. Instead of being backed by a few big investors, crypto loans often come from individual crypto owners who want a way to earn passive income with their crypto.

What Is Crypto Loan-to-Value Ratio?

Crypto loan-to-value ratio is a helpful metric for assessing risk during a loan. It compares the value of a borrower's collateral to the value of the loan. Loan-to-value ratios are especially useful for crypto loans because they can take into account crypto's fluctuations in value.

Once the loan-to-value ratio is calculated, lenders and borrowers have a clear idea of how risky any particular loan is. A high LTV means the loan is riskier for the lender, so the interest rate will be higher. A low LTV ratio means the risk is lower, so the borrower doesn't have to pay as much in interest.

How Does the Loan-to-Value Ratio Work?

The basic process of creating a loan-to-value ratio is straightforward: take the amount of the loan and divide it by the value of your collateral. In most cases, with crypto, loan-to-value ratios are calculated by looking at the current market value of both cryptocurrencies in US dollars.

The final LTV ratio is expressed in decimal points. However, you can multiply it by 100 to view the ratio as a percentage. This number provides a simple way of expressing how likely the lender is to lose all their money if the borrower defaults on the loan. If the number is > 100%, it means the borrowed money is more valuable than the crypto assets being used as collateral.

Types of Loan-to-Value Ratios

Since they can serve many different purposes, loan-to-value ratios have several variants. Lenders may adjust the basic loan-to-value formula to suit different situations.

Initial LTV

Initial loan-to-value is essentially the most basic type of LTV ratio: it's the amount of the loan divided by the value of the collateral, used to determine who qualifies for a loan and the initial amount of coins that can be borrowed. A lender will look at the initial LTV when figuring out the beginning terms for the loan. Most initial LTVs are somewhere in the 50%–70% range.

Margin Call LTV

A margin call LTV involves keeping track of the current value of the collateral and the outstanding balance of your loan. The LTV ratio constantly fluctuates, based on things like whether you've paid any money back and whether the crypto assets you’ve used for collateral have lessened or increased in value. For certain types of crypto loans, your lender will constantly monitor your loan-to-value ratio and send you a margin call when the LTV is somewhere in the 70%–80% range. When you receive a margin call, you should either invest more collateral or pay off part of your loan to lower the LTV ratio back to an acceptable amount.

Liquidation LTV

If you ignore when your LTV ratio becomes high enough for a margin call, you can end up dealing with a liquidation LTV. When your loan-to-value passes above a predetermined liquidation LTV threshold, your crypto lender may choose to proceed with forced liquidation. The exact rating depends upon your previous agreement, but most lenders liquidate somewhere in the 80%–90% range, confiscating your collateral, closing out your loan and selling the collateral to regain their crypto assets. In addition, you may have to pay a liquidation fee.

Benefits of Using LTV Ratio in Crypto Loans

Why is the LTV ratio so popular among crypto lenders? Its main benefit is that it turns a lot of different concepts into a single, easy-to-understand number. Even if one loan is for $500 backed by DOGE, and the other is a $50,000 loan backed by BTC, an LTV ratio can let you instantly compare the two and see which is riskier. Loan-to-value ratios are very flexible and work in a variety of situations.

From a financial perspective, an LTV ratio is a highly effective way to calculate risks. As the loan-to-value ratio gets higher, the value of a loan approaches the value of the collateral. If the LTV exceeds 100%, the collateral can no longer cover the loan. When a borrower defaults on a loan with an LTV over 100%, the lender will end up losing money.

How to Calculate the Loan-to-Value Ratio

Technically, you can calculate LTV by hand. You start by finding the value of the loan. If you're just now applying for the loan, the value is simply the amount of the loan itself. If you've had the loan for a while, the value will be the unpaid portion of the loan plus any interest you owe. You then look at the crypto asset you want to use as collateral and find its current market value. The last step in calculating a loan-to-value ratio is dividing the loan amount by the collateral value to get your final LTV.

Things get a lot easier if you use a service like Bybit’s Crypto Loans feature. By working with a crypto lender, you can automatically receive access to loan-to-value ratio calculations. With Bybit, you can calculate and view the LTV for any loan by following the steps below.

Step 1:Head to the Bybit homepage. On the navigation bar at the top of the page, hover your cursor over Finance and click on Crypto Loans.

Step 2:Input the cryptocurrency and the amount you’d like to borrow, and the amount of collateral you’ll need will be tabulated automatically. Alternatively, you can enter your choice of collateral and the amount you’d like to put up for collateral.

Step 3:Once you’ve indicated the amounts, the LTV ratio will automatically be calculated on the right side of the page.

Can You Adjust Your Loan-to-Value Ratio?

A lower loan-to-value ratio gives a borrower peace of mind. Not only does it reduce your risk of forced liquidation, but it may also provide you with a lower interest rate. There are a few different techniques you can use to modify high LTV ratios on Bybit.

• Pick a smaller loan: If you're concerned about your LTV ratio but cannot offer more collateral, consider borrowing less. A lower loan amount leads to a lower LTV ratio.

• Provide more collateral: Another way of dealing with a high LTV ratio is to add more collateral to your loan. Being willing to put up more collateral as a guarantee will lower your LTV ratio.

• Pay off more of your loan: Once you've borrowed your money, your LTV only looks at the outstanding balance of your loan. Paying off part of your loan is an easy and effective way to reduce your loan-to-value ratio.

Should You Adjust Your Loan-to-Value Ratio?

Whether or not you need to adjust your loan-to-value ratio depends upon your goals. A moderately high LTV isn't always an immediate problem. Some lenders might charge a higher interest rate when you have a high LTV, but others provide the same interest rate regardless of your LTV. There's usually no need to panic just because your LTV is above 50%.

The bigger potential problem to be aware of is forced liquidation. If your LTV is so high that it's approaching your lender's liquidation threshold, you should probably adjust it. Liquidation can cause a lot of issues. If your crypto asset temporarily loses value in a market downturn, liquidation can take it away from you before its price recovers. You might also have to pay a liquidation fee or close out of your trading position before you’re ready to do so, which can cause further losses.

The Bottom Line

If you're interested in crypto borrowing, it's worth your time to pay attention to loan-to-value ratios. This useful metric can help you to determine whether or not a crypto loan is risky. In addition to preventing people from borrowing more than they can afford, LTVs also help with crypto loan management. Your LTV ratio can let you know when you need to add more collateral, and also encourage you to pay off your loan.

#Bybit #TheCryptoArk