How Crypto Loans Work

LTV stands for loan-to-value. It is the ratio of what you borrowed to the value of your collateral. If you deposit $10,000 of ETH and borrow $5,000, your LTV is 50%. Most protocols liquidate your collateral if LTV rises past a liquidation threshold — for example, 80% on Aave for ETH. Always keep a buffer below that threshold.

If your LTV exceeds the liquidation threshold, the protocol (in DeFi) or the lender (in CeFi) sells enough of your collateral to bring the ratio back to safe levels. You lose that portion of collateral but keep the borrowed funds. DeFi protocols charge a liquidation penalty — typically 5% to 15% of the liquidated amount — on top of the loss. You may still owe tax on the collateral that was sold.

In most jurisdictions, taking out a loan secured by crypto is not itself a taxable event — you are borrowing, not selling. However, if the lender liquidates your collateral, that liquidation is treated as a disposal and triggers capital gains tax. The tax rules on this point are consistent in the US (IRS) and UK (HMRC), though it is always worth confirming with a local tax professional.

A flash loan is an uncollateralized loan that must be borrowed and repaid within a single blockchain transaction. If the repayment is not included in the same transaction, the entire operation is reversed as if it never happened. Flash loans are used by developers for arbitrage, collateral swaps, and liquidations. They are not a consumer product — they require custom smart contract code to use.

DeFi lending has different risks from CeFi, not necessarily lower ones. DeFi is non-custodial — the protocol cannot take your collateral for operational reasons — but smart contract bugs and oracle manipulation can drain funds. CeFi is custodial — Celsius and BlockFi both collapsed in 2022 — but regulated CeFi lenders may offer some creditor protections. Neither is risk-free.

DeFi borrowing rates float with supply and demand in each lending pool and typically run in the low-to-high single digits APR for major stablecoins on Aave or Compound, though they can spike higher during periods of heavy borrowing demand. CeFi lenders have historically advertised fixed rates in a similar range or somewhat higher, often varying by loan-to-value tier. Always check the live rate on the platform itself before borrowing — it is variable, not fixed, on DeFi protocols.

For DeFi crypto-backed loans, Aave and Compound remain the two most established platforms — both are non-custodial, audited, permissionless money markets where you deposit collateral and borrow directly from a lending pool through your own wallet, with rates set algorithmically by supply and demand. The CeFi side of the market has consolidated significantly since 2022 — Celsius and BlockFi both collapsed and stopped operating that year — but custodial lenders still exist; Nexo, for example, continues to offer crypto-backed credit lines across many jurisdictions. Because CeFi platform availability, terms, and regulatory status vary by country and change over time, always verify a CeFi lender's current jurisdictional availability and terms directly on its own site before depositing collateral — DeFi's Aave and Compound don't carry that same platform risk, since there's no company that can unilaterally halt withdrawals.

On DeFi platforms, liquidation happens almost immediately — typically within the same or next block once an oracle price update pushes your loan-to-value ratio past the liquidation threshold, because the process is executed automatically by a smart contract, often triggered by an independent liquidator bot competing for the liquidation bonus, with no human review and no grace period. On CeFi platforms, liquidation is usually still fast but can include a short buffer — some lenders send a margin call or warning and give you a window, often just minutes to a few hours, to add collateral or repay before they liquidate, though this varies by platform and is never guaranteed. In both cases the underlying risk is the same: a fast, sharp price drop can cross your threshold before you're able to react manually, which is why keeping a buffer below the liquidation threshold matters more than reaction speed.

Most DeFi crypto-backed loans have no fixed maturity date or required repayment schedule — you can hold the loan open indefinitely as long as your loan-to-value ratio stays below the liquidation threshold, since interest simply accrues continuously and compounds into the amount you owe rather than triggering a due date. This is different from a traditional loan: there's no monthly payment requirement, and the only thing that forces action is your collateral ratio drifting too close to liquidation, either because the collateral's price fell or because accrued interest grew the debt over time. CeFi lenders sometimes structure loans with a fixed term instead, so check the specific product before assuming it works the same way as an open-ended DeFi position. Repaying early carries no penalty on DeFi protocols like Aave or Compound — you can close out part or all of the loan at any time, and interest simply stops accruing on whatever you repay; some CeFi lenders with fixed-term products may handle early repayment differently, so confirm that specific term before assuming it's penalty-free.

There's no protocol-enforced minimum on major DeFi lending platforms like Aave or Compound — you can deposit collateral and borrow against any amount your wallet holds, though gas costs on Ethereum mainnet can make a very small loan not worth the transaction fees to open and manage. CeFi lenders often set their own practical minimum collateral value, commonly in the low hundreds of dollars, though the exact figure varies by platform and changes over time, so check the current terms on whichever lender you're considering. In practice, the real floor isn't a rule — it's whether the interest you'd pay and the gas or platform fees you'd incur make borrowing against a small amount worthwhile compared to just not borrowing.

Your liquidation price is the collateral price at which your loan-to-value ratio — the amount you borrowed divided by your collateral's current value — crosses the protocol's stated liquidation threshold for that asset. To find it: divide your borrowed amount by the liquidation threshold, expressed as a decimal, to get the collateral value that triggers liquidation, then divide that figure by how much collateral you deposited to get the price per unit. The liquidation threshold itself varies by protocol and by asset, so pull the exact current figure from the platform you're using rather than assuming one universal percentage.

Flash loans get a full page of their own at /free/free-crypto-loans, covering how the atomic borrow-and-repay mechanic works, what they're used for (arbitrage, collateral swaps, self-liquidation), and the risk they pose to other protocols. The flash loan FAQ above covers only the basics as they relate to a standard collateralized loan — the dedicated page goes much deeper into the mechanics and DeFi-specific risks.

If a DeFi lending protocol is hacked through a smart-contract bug or an oracle-manipulation exploit, funds in that protocol's pools — including your deposited collateral — can be drained, and there's no central company to appeal to for recovery. If a CeFi lender is hacked or becomes insolvent instead, your collateral is subject to that company's own security and, in bankruptcy, its creditor-recovery process, as happened with Celsius and BlockFi in 2022. See /learn/what-is-defi for a broader look at the smart-contract, oracle, and custody risks that come with using any DeFi protocol.