Crypto Loans: How to Borrow Against Bitcoin as Collateral

What Is Borrowing With Bitcoin?

Borrowing against Bitcoin involves using your BTC as collateral to take out a loan without selling your holdings. This allows you to access liquidity while maintaining long-term exposure to BTC. However, if the price of Bitcoin falls too much, the collateral may be partially or fully liquidated.

Key Takeaways

• Crypto loans allow users to lock up their crypto assets as collateral in order to access more liquidity without having to sell their holdings.

• It is especially attractive to bitcoin holders who may want to keep long-term exposure to the token but still want to access further investment opportunities.

• There are several key factors to consider, such as loan-to-value ratio, repayment terms, and loan duration, before selecting the best platform to borrow against bitcoin.

What Are Crypto Loans?

Crypto borrowing is the process of unlocking liquidity by using crypto assets as collateral to secure a loan. It is a rapidly growing sector because it enables holders to access funds without having to sell their assets. 

The concept of crypto loans is closely tied to decentralized finance (DeFi) technology which utilizes smart contracts to secure transactions. This helps to provide a more transparent, accessible, and efficient process while removing the need for any intermediaries.

We will be focusing on how to borrow against your Bitcoin (BTC) in this piece but the process can be applied to almost all crypto assets. 

Why Choose Crypto Loans Over Selling Bitcoin?

Borrowing crypto instead of selling your assets can be an attractive option when you are bullish on the long-term prospects of the token. Since most Bitcoin enthusiasts prefer to hold on to their tokens long-term, taking out a loan against their BTC allows them to take the proceeds to buy more crypto or participate in other DeFi activities. 

Selling your crypto can also trigger a capital gains tax event depending on the regulations in your location. Since borrowing against your BTC is not considered a true disposal of your tokens, it will not be considered as a capital gains tax event. That means you can gain access to liquidity without selling your BTC and paying tax.

How to Borrow With Bitcoin

Just like traditional finance, crypto loans are based on the principle of lending and borrowing. Unlike traditional finance, this process is facilitated through smart contracts built on blockchain platforms.

Lenders can lend their crypto assets to the lending pool and receive compensation in return. Borrowers will need to put up their own crypto assets (like BTC) as collateral if they want to borrow any of the tokens in the lending pool.

Terms to Know

Before you start borrowing against your Bitcoin, you should take note of several key terms. Here are the essential ones to know. 

• The liquidation process refers to when the lending platform sells your assets to protect against losses.

• Collateral is the crypto assets you deposit with the platform to secure your loan. If you are unable to repay the loan or the value drops significantly, the lender may liquidate your assets.

• Loan-to-Value (LTV) ratio indicates the amount you borrow in comparison to the value of your collateral. A lower LTV usually indicates lower risk for the lender and better interest rates. However, a liquidation may be triggered if your LTV value increases too much. The LTV ratio is calculated as (Loan Amount ÷ Collateral Value) × 100%.  

• A margin call will be issued by the lending platform if your LTV ratio gets too high. You can either add more collateral or repay part of the loan to avoid your collateral being liquidated.

• The interest rate is the cost you pay to borrow the funds. It is usually quoted as an annual percentage rate (APR) but that might change depending on the platform, loan term, or LTV ratio. 

• Repayment terms will outline details of the loan such as the duration, how often payments are due, and any other requirements for repayment. Some crypto loans might have flexible terms while others will be fixed. 

• Overcollateralization is when you are required to pledge more collateral than the amount you borrow. Lending platforms implement this to help offset the risk of price volatility. 

• A conditional interest rate is when platforms offer reduced interest rates if you can meet certain requirements like longer lock-up periods. 

Step-by-Step Guide to Borrowing with Bitcoin

Now that you are familiar with the key terms of a crypto loan, it is time to learn about the process.

• Choose a lending platform that supports Bitcoin-backed loans. Each platform will have its own terms and conditions that you should consider and compare first.

• Deposit Bitcoin in your account to act as your collateral. Most platforms tend to offer LTV ratios ranging between 40% to 70% which means you can only borrow a portion of your Bitcoin’s value. 

• Decide on the loan terms which include details such as the borrowed amount, loan duration, and interest rate. 

• Receive the loan once the terms are confirmed. The platform will transfer the loan amount to your account and you can then use the funds in whatever manner you want such as taking an investment opportunity or paying off other debts.

• Repay the loan with interest. After the loan is paid off, your BTC will be sent back to you. Make sure you can repay the loan to avoid any unwanted fees or being liquidated.

Advantages of Borrowing Against Bitcoin

Being able to borrow against Bitcoin instead of just simply holding it in your wallet can offer several benefits.

• Decentralized: Not having to rely on third-party facilitators means that you are not required to disclose your identity or go through traditional bank checks. However, some platforms may require you to go through a Know Your Customer (KYC) procedure to adhere to regulations. 

• Opportunities to reinvest: The borrowed funds can be used at your own discretion to participate in other opportunities like buying more BTC, investing in other cryptocurrencies, and more. 

• Flexibility: Borrowing against your Bitcoin can offer more flexibility than traditional loans. Unlike going through traditional banks, with crypto loans you can choose the amount you borrow, the loan duration, and even the repayment schedule. 

• Tax efficiency: Borrowing against your crypto like Bitcoin will not be considered a taxable event.

Risks of Borrowing Against Bitcoin

While borrowing against your Bitcoin provides a number of benefits, there are also risks and considerations you should keep in mind. 

• Collateral requirements: Most platforms require the collateral to be worth more than the loan itself, especially in the case of Bitcoin. This means that you will need more capital to commit while receiving less. 

• Market volatility: The crypto market is notorious for price volatility and if the value of Bitcoin drops significantly, the platform might require you to add more collateral to maintain the loan’s terms. Either you will need to commit more assets or risk being liquidated.

• Platform security: DeFi platforms are still at risk of malicious actors. It is important that you choose a platform with a good reputation and security measures in place such as two-factor authentication (2FA) and regular audits. 

• Regulatory risks: The legal landscape for cryptocurrencies is still evolving and new regulations could potentially alter the borrowing process.

Tax Implications of Crypto Loans

As mentioned above, selling Bitcoin could trigger a taxable event, namely the capital gains tax. Borrowing against your BTC will avoid this tax liability since loans are not considered taxable. Crypto loans present the opportunity to access cash in a more tax-efficient way. 

Despite crypto loans generally being a non-taxable event, some transactions may still come with tax implications. For example, you will incur a capital gain or loss if your collateral is liquidated. Even though you do not receive the proceeds of the liquidation, you might be required to pay tax. 

Crypto Lending Platforms: Where to Borrow Against Bitcoin

Crypto loans might be commonly associated with DeFi but they are available on both centralized exchanges and decentralized exchanges. Here are some platforms that offer BTC-backed loans.

Top Centralized Platforms for Crypto Loans

Binance’s Flexible Rate Loans lets you borrow assets using BTC as collateral while still earning. Your collateral is automatically subscribed to the Binance Simple Earn Flexible Products to earn rewards. Each collateral-loan pair has its own LTV, margin call, and liquidation thresholds. 

Coinbase provides BTC-collateralized loans in USDC through Morpho’s on-chain lending protocol. Users can borrow up to $1 million USDC depending on how much BTC they can put up as collateral. There are no repayment schedules but the LTV ratio must remain under 86% to avoid an automatic liquidation event. This is currently only available in the U.S, except New York State. 

On Crypto.com, you can borrow against your BTC while also taking advantage of DeFi lending protocols, such as Aave, within the mobile application. Yield-generating lending pools are integrated into the app, enabling users to earn interest on supplied collateral. However, availability of the DeFi Lending feature is subject to availability depending on location.

Other than that, Bitfinex Borrow is a peer-to-peer lending marketplace where users can borrow USDT by depositing BTC as collateral. Borrowers and lenders are able to set their own terms such as fixed or variable interest and duration. 

As a global exchange, OKX is also known for offering crypto-backed lending services where you can deposit BTC as collateral to borrow USDT. The loans typically have an LTV ratio set at around 75%. Interest rates depend on the chosen loan terms, and borrowing limits are based on user tier and collateral availability.

DeFi Protocols: Borrowing With Bitcoin Without Restrictions

Aave is a decentralized liquidity protocol operating across Ethereum and other EVM-compatible chains like Polygon and Optimism. The protocol supports BTC-backed borrowing using wrapped tokens like wrapped Bitcoin (wBTC) across multiple chains. These loans are overcollateralized and carry variable interest rates based on protocol usage.

Borrowing against BTC on Compound V3 requires using tokenized Bitcoin, including wrapped BTC, as collateral to borrow stablecoins such as USDC. A dynamic interest rate model means that interest rates vary according to supply-demand and protocol parameters. That means you pay interest on the borrowed amount only, and can repay loans at any time plus accrued interest.

Lastly, Sovryn Zero operates on Rootstock, a Bitcoin sidechain, and enables users to borrow the USD-pegged stablecoin DLLR against native BTC with 0% interest. It’s one of the few platforms where BTC holders can retain custody and avoid paying interest, though it enforces conservative loan-to-value ratios ranging from or at around 110%.

Frequently Asked Questions (FAQ)

What happens if the price of Bitcoin drops?

A drop in Bitcoin’s price will increase the risk of liquidation which is why it is important that you monitor your collateral value frequently. If a margin call is issued, be prepared to add more funds or repay part of the loan. 

Can I borrow against Bitcoin without KYC?

Yes, you can borrow against your Bitcoin without having to complete the KYC process. This is usually available on DeFi protocols.

What are the typical interest rates for a Bitcoin loan?

Borrowing with Bitcoin offers attractive liquidity but it is still important to compare available interest rates and repayment terms. The interest rates for crypto loans can vary significantly depending on the platform. While some platforms offer flexible terms, others might require shorter-term repayment with higher interest rates.

Can I repay my Bitcoin loan early without penalties?

Most crypto lending platforms allow you to repay your loan at any time without penalties. This flexibility can give you the option to reduce your debt at more ideal times. However, on some centralized platforms, early repayment might not refund the full unused interest.

What happens to my collateral if the platform is hacked or goes bankrupt?

If a centralized exchange gets hacked or goes bankrupt, your BTC collateral could be at risk if it is not insured or held in segregated wallets. On the other hand, decentralized protocols use smart contracts to hold your assets which helps minimize custody risks. Regardless of which platform you use, always look for one with strong reputations, third-party audits, and security features.

This article is only for informational purposes and should not be taken as financial advice. Always do your own research before depositing any assets into any crypto protocol.