Loan-to-value (LTV)

Used by lenders, loan-to-value (LTV) is the assessment ratio of risk involved while approving a loan. Simply, it is the ratio of the loan’s value to the value of the collateral.

What Is Loan-to-value (LTV)?

LTV is the ratio of the loan’s value to the value of collateral. In a typical financial market, credit scores determine the risk involved in a loan. The lower the credit score, the higher the risk for lenders. Instead of credit scores, the crypto lending process offers asset-backed loans.

Loan to value (LTV) determines the amount of cryptocurrency one would need as collateral before one could get a loan. The lender holds on to this collateral until the loan is fully paid back. 

The main benefit of LTV in crypto lending is that it helps minimize the risk on the lender’s part. The user also benefits from LTV in that they can access larger loans at lesser interest rates. 

How to Calculate LTV?

Case 1: When borrowing a crypto-backed loan, you calculate the loan-to-value (LTV) as follows:

Your LTV would be 50% if you borrowed $5,000 and deposited $10,000 worth of bitcoin. However, if the value of bitcoin fell, your collateral’s value would decrease, increasing your ratio. To get your loan back to its original LTV ratio, if your LTV rises too high, you might need to put up extra collateral.

Case 2: Once your loan is active, you can continue to monitor your LTV using the following formula:

Benefits of Loan-to-Value in Crypto Lending

In traditional collateral-based lending, LTV is a measure of the risk on the investor’s side. The higher the LTV, the higher the lender’s risk and, consequently, the higher the interest rate for the borrower. In crypto-backed loans, the LTV ensures full repayment in time, thus reducing the investor’s risks. If the borrower fails to pay back their loan for whatever reason, part of the collateral is sold to offset the loan. 

As a borrower, your LTV ratio is your way of determining your own risk. Depending on your platform of choice, your LTV risk can range anywhere between 5% and 70%. A lower LTV provides you with a safety bag. If the market falls, your assets will not likely be liquidated. A higher LTV, on the other hand, means that you have to think fast in case of extraordinary market situations because your collateral is likely to be liquidated to settle your loan.