Bitcoin Lending
As of today, over 19 million bitcoins have been mined out of a maximum supply of 21 million. This scarcity has driven Bitcoin’s increasing appeal, especially as its price surged to record highs in 2024, attracting both investors and speculators. Bitcoin has transitioned from a niche digital asset to a recognised financial instrument, particularly for high-net-worth individuals looking to diversify their portfolios.
Given this evolution, it is essential to explore the main considerations when using Bitcoin as collateral for high-value lending.
Borrowing Against Bitcoin and Other Digital Assets
Securing a loan against Bitcoin is relatively straightforward. The process typically involves transferring assets to a lending platform, selecting loan terms, agreeing on an interest rate, and digitally signing an agreement. The borrowed amount, often in fiat or another digital currency, is then transferred to the borrower’s wallet for use as needed.
On-chain lending is decentralised, efficient, and widely adopted. It allows asset holders to unlock liquidity without selling, preserving potential future gains and mitigating tax liabilities associated with disposal.
Platform Risk – Can You Trust the Lender?
The failures of platforms such as Celsius Network and Three Arrows Capital have left lasting scars. It is crucial to assess platform security and stability before using digital assets as collateral.
Key questions to consider include:
- What happens if the platform collapses or lacks liquidity?
- How are your assets managed – stored in cold wallets, traded, or rehypothecated?
- What safeguards are in place in case of rapid asset devaluation and margin calls?
Understanding Margin Calls
Given Bitcoin’s volatility, margin calls are an inherent risk. A margin call occurs when the value of the collateral falls below a required threshold, prompting the lender to demand additional funds or liquidate assets to cover the loan.
Understanding margin call thresholds and maintaining a conservative loan-to-value (LTV) ratio can help mitigate forced liquidation risks.
Speed vs. Cost – Should You Prioritise Convenience?
Quick and straightforward loan approvals may come at the expense of higher interest rates and unfavourable terms. Exploring multiple lending options, much like shopping around for a mortgage, ensures competitive rates and better conditions.
How Interest is Calculated
Unlike traditional loans where interest is paid periodically, many crypto-lending platforms apply compound interest, adding it to the loan balance over time. This structure can significantly increase the total repayment amount. Borrowers should scrutinise terms and calculate the total cost of borrowing before committing.
Tax Implications
Certain lending structures, such as repo agreements where ownership temporarily transfers to the lender, may trigger tax liabilities. Given global scrutiny on crypto taxation, consulting a tax specialist is essential to avoid unintended financial consequences.
What Happens to Your Bitcoin While in Custody?
Unlike mortgages where borrowers retain control of their property, Bitcoin used as collateral is typically held by the lender. Understanding how your digital assets are stored and utilised is crucial:
- Cold Storage: Secure storage with minimal risk, but potentially higher borrowing costs.
- Rehypothecation: Lenders may use your Bitcoin for trading or lending activities, impacting asset security and borrowing rates.
If an interest rate seems exceptionally low, it is likely that the lender is aggressively rehypothecating your assets.
Who Provides Bitcoin-Backed Loans?
A wide range of financial institutions now offer Bitcoin-backed lending, including private banks, alternative finance providers, global platforms, and blockchain-based lenders. For high-value transactions (£500k+), working with an expert to navigate the market and structure optimal loan terms is highly recommended.
Final Thoughts
Bitcoin-backed lending presents unique opportunities but also comes with risks. Conducting due diligence, understanding loan terms, and seeking professional advice ensures a secure and cost-effective borrowing experience.
For further guidance on Bitcoin lending and its legal implications, Vicox Legal is here to help.
