Debt is a bit like playing with fire. If you’re not careful, you can get burned and end up with scars that stick around for life. On the other hand, fire and debt are both tools. If properly exploited and used safely, they can allow for a better quality of life.
All you need is to follow a few simple rules. With these rules in mind, you can become a master of money and learn to exploit debt, instead of the other way around.
It just so happens that debt plays an important role in the crypto ecosystem, so it’s worth understanding the fundamentals of debt and how it can be used for better or worse.
Set a credit score
An important aspect of debt is establishing and maintaining your credit score. Put simply, your credit score is your entire credit history condensed into a single number. The number varies between 300 and 900 and measures your ability to repay loans.
From a lender’s perspective, it tells them how risky it might be to lend you money. If you are under 18, you do not have a credit score, as you are not legally eligible to take on debt. The sooner you start building a solid credit history, the stronger your credit score will be in the future. This assumes that you act responsibly with your debt.
You don’t need to take on a line of credit or mortgage to build a good credit score. A simple credit card that pays your monthly cell phone bill is enough to establish a baseline for your credit history. Just remember to always make payments on time.
Losing a payment and allowing your credit card to accrue interest is both bad for your credit score and bad for your wallet. Once you’ve hired and paid bills with your credit card for a few years, your financial institution may offer you a good-sized line of credit. This is where the real fun begins.
One way to put debt to work is to find another place to lend it. Debt arbitrage is best illustrated with an example. Imagine you were just offered $10,000 at a 5% interest rate.
This means that if you withdrew all $10k, at the end of the year, you will have to pay the lender $500. If you find someone else borrowing this money at a higher interest rate, you can pocket the difference.
Crypto.com, for example, historically offered between 8% and 12% of APY on stablecoins. If you lent those $10k you borrowed to Crypto.com and earned 10% APY, you end up with $1,000 at the end of the year and owe $500 to your original lender. At the end of the day, you can pocket and profit from the remaining $500.
This strategy of taking money from one place and putting it in another carries risks. You need to trust that whoever you are lending the money will be able to pay you back when you want the money.
In the example above, if for some reason Crypto.com went bankrupt and you lost that $10k, you still owe it to the person who lent you $10k in the first place. You will be stuck paying a loan plus interest. There is little recourse for you to recover your money from a bankrupt company. And that’s exactly what happened last year with lenders like Celsius Network, Voyager Invest and BlockFi.
This brings us to the most common way people take advantage of debt. This next method allows you to maintain a certain amount of control over the money.
Buy an asset that generates cash flow
Perhaps one of the most common ways debt is used is to buy an asset that generates cash flow. This can be anything from a house or condo, to a commercial or entrepreneurial enterprise.
The bottom line is that this asset should be able to generate recurring cash flow. The idea is that the cash flow of the asset is sufficient to pay interest on the loan. So ideally, when you want to sell the business, you appreciated in value. That’s where your profit comes from.
If the cash flow of the asset is greater than the interest you are paying on the debt, then this is a bonus in some way. Some people choose to reinvest the extra cash flow in the asset.
An example from real estate could be the renovation of the kitchen or bathroom, thus increasing the overall value of the house. This is not only a good way to increase your chances of selling your asset for more in the future, it is also ethical. Taking care of the goods means that they will be in good shape when the next person arrives to buy them. Whether it’s a car, a house, a plot of land or a business, it is in your interest and others to take care of, maintain and even improve the state of the asset.
If you have done a good job and are patient, then your reward is a nice amount of money from the sale of the asset in the future.
Debt and cryptocurrency
While we haven’t talked much about cryptocurrency in this article, the two are more closely related than you might initially think. We have written other articles on how to borrow from cryptocurrency and whether or not you should be. It is also important to recognize that debt is much more expensive than it was a year ago thanks to governments around the world tightening their fiscal policies. Crypto is an interesting counterpoint, however.
Simply put, there are no credit scores in the crypto realm. All loans are secured by collateral, which means you need to lock in and risk your funds to take on debt. In a way this is a good thing as it means you will never default on your debt. On the other, you’re putting your hard-earned cryptocurrency at risk to take on debt.
Regardless of how or if you take on debt, be aware that it is a possible tool in your tool belt. Many people got rich playing with debt. Many others burned themselves. Remember, debt is playing with fire.