bitcoin has been among the best performing assets of the last decade. In 2023, it outperformed the S&P 500, high-yield corporate bonds and gold, rising as much as 156 percent in one year.
Today, demand for bitcoin is reaching record levels as the approval of new bitcoin spot ETFs has created a wave of institutional interest.
Although considered a risky and volatile asset, bitcoin remains a profitable investment, especially for its early investors. When it was released in 2009, it was practically worthless. In 2010, it was trading at $0.10.
By 2013, it was hitting highs of $250, a 250,000 percent growth for early investors. Those who invested in 2017 would see gains of more than 6,700 percent in 2024 as a crypto asset. bitcoin–btc-all-time-high-70k”>briefly touched $70,000 recently.
With this kind of growth, it's no wonder investors view it as a long-term investment and prefer to “HODL” it until it reaches new price highs.
However, any long-term btc holder knows that the path to profitability is not always easy. Sometimes selling or making a profit is necessary to sustain expenses or meet emergency cash needs.
As a result, you surrender part of your btc holdings and reduce your long-term earning potential. Those who try to replenish their bitcoin also end up buying back the asset at a price many times higher than the original purchase.
What if there was another way to gain access to much-needed funds without selling your btc? bitcoin loans offer a solution that provides access to liquidity without parting with your holdings.
How does a bitcoin loan work? Here, we delve into the unique mechanics of a bitcoin loan. We discuss how the world's leading cryptocurrency is revolutionizing the world of finance beyond trading by providing alternative means of borrowing while retaining access to potentially higher returns in the future.
Understanding bitcoin and Cryptocurrency Lending
bitcoin loans are a form of cryptocurrency lending. crypto lending platforms allow btc investors to borrow against their deposited assets. They can also lend their btc holdings to earn interest on crypto rewards. In 2020, crypto lending platforms began to gain significant momentum. Since then, they have expanded to have billions in total value locked (TVL) across various platforms.
You can divide crypto loans into two components. Interest-bearing cryptocurrency or btc deposits and cryptocurrency loans. Deposit accounts on such platforms behave like normal bank accounts. You can deposit btc and earn interest. The platform can use the deposited funds to lend to borrowers or for other investments, similar to how a bank operates.
Typically, crypto loans are offered as secured loan products. They require users to deposit a minimum of 100 percent to access the loan. Some require up to 150 percent, thus becoming oversecured loans.
How to get a bitcoin loan
A bitcoin-backed loan or bitcoin is a US dollar loan that is collateralized by btc. To secure this type of loan, you send btc to a lending platform as collateral. In exchange, you receive a loan in stablecoin or US dollars.
The mechanics of bitcoin-backed loans are similar to traditional secured loans, except that btc is the collateral. These loans eliminate the need for extensive credit checks. The steps include creating an account, a brief onboarding, uploading keys, and submitting a loan application. On decentralized platforms, the process could be even simpler.
Once your btc deposit is confirmed on the blockchain, US dollars or its stablecoin equivalent is sent to your bank account or crypto wallet. Interest on the loan is paid at regular intervals. For example, interest payments could be due every 30 days and will continue until the loan matures. The final interest payment and principal amount will be due at maturity.
The amount you receive is based on the value of your btc holdings and the LTV (loan-to-value) ratio of the platform. The LTV ratio is determined based on the risk factors associated with the volatility of the crypto market. If the value of bitcoin falls, the platform may require you to add more collateral to match the amount borrowed. If you don't add collateral, you risk liquidating your btc holdings.
Factors to consider when applying for a bitcoin-backed loan
bitcoin loans are not without risks. While they offer many benefits, consider the following before deciding to lend your btc holdings:
Risks associated with remortgaging
Some bitcoin lenders mimic banks' processes, meaning your deposited btc may be subject to remortgage. Rehypothecating is the process of lending client assets presented as collateral.
Thus, btc is put at risk. The lending platform, in turn, earns interest by using your digital assets for various purposes, including on-lending. Some bitcoin-backed loan providers lend their clients' bitcoin to third parties.
With remortgaging, the loan provider earns interest on both the borrower's interest payments and the proceeds from lending btc collateral to other parties. The lender passes a portion of the interest to the US dollar borrower through a marginally lower interest rate. However, some (or even 100 percent) of the borrower's collateral is at risk.
Borrowers are unaware of the counterparty risk surrounding btc-backed loans. Their holdings are exposed to multiple levels of counterparty risk. Therefore, lenders who remortgage collateral expose borrowers to risk when either party becomes insolvent.
Fortunately, some btc loan providers do not remortgage. It is up to the user or client to select the features of a lending platform and decide how much risk they can take.
Annual percentage rate (APR)
He annual percentage rate, also known as APR, is the annual interest rate generated by a sum collected from borrowers or paid to investors. The APR is a percentage that represents the annual cost of funds over the term of a loan or the income earned from an investment.
In other words, it annualizes the total cost of a loan. The value includes additional costs or fees associated with the transaction. The APR does not take into account capitalization.
The APR provides platform users with a final figure to compare investment products and lenders. Some loan companies offer low interest rates but charge high upfront fees. This feature will cause the APR to increase significantly. A higher APR means it is more expensive for the borrower when multiple loans are originated in a single year.
A short-term loan will promise low interest rates. However, you should check the origination fee. It will be cheaper to take out a 12-month loan at a slightly higher interest rate with a one-time origination fee than to take out a three-month loan with a 1 percent origination fee and renew it.
LTV requirement
The LTV or loan-to-value requirement should be considered when applying for a bitcoin-backed loan. For example, an LTV of 40 percent means that a $10,000 loan will require $25,000 in btc as collateral. The ratio is intended to prevent collateral liquidations as the market price fluctuates.
Some lenders offer low interest rates and lower LTV ratios. A lower LTV ratio could be between 20 and 30 percent. Therefore, customers will have to deposit more btc to access the loan. This practice is carried out in order to lend or remortgage the collateral to others. Another reason for a low LTV is that a higher collateral means less risk when lending.
Collateral on Principal (CTP) vs. Loan to Value (LTV)
The CTP, or collateral-to-principal ratio, is the inverse value of the LTV. For example, an LTV of 40 percent equals a CTP of 250 percent. CTP helps users understand the current status of their collateral index. This value is essential when the price of btc drops.
Tax implications
Tax legislation on bitcoin loans is still evolving. It is essential to consult a tax professional about your potential tax obligations, even if it is reasonable to expect the IRS to treat btc-backed loans analogously to traditional lending practices.
The IRS stated in 2014 that virtual currencies should be treated as property when it comes to tax treatment.
Therefore, they trigger capital gains taxes when sold. However, borrowing against bitcoin or cryptocurrencies would not trigger those taxes.
However, it is best to consult a tax expert regarding current and future tax issues with bitcoin loans.
What are the benefits of bitcoin loans?
bitcoin-backed loans offer several advantages, especially for long-term holders. The most obvious benefit is access to liquidity without the need to sell btc holdings. bitcoin loans preserve your digital assets. They also save you capital gains taxes as a result of not selling.
Additionally, btc loans tend to offer a higher level of privacy than those from traditional financial institutions. They generally do not require extensive credit checks or the disclosure of extensive personal information. To obtain a bitcoin loan, you will only reveal minimal information for identity verification.
Another benefit of bitcoin loans is speed. Some bitcoin-secured loans can be obtained in days, hours, or even minutes.
bitcoin Loans: An Alternative to Selling Your bitcoin
Owning bitcoin offers many advantages, including generating significant growth on your investment and having a scarce asset that also functions as a decentralized mode of payment.
Therefore, it is understandable that holders think twice before selling btc to finance urgent expenses in US dollars. However, we all need to take care of our financial needs.
bitcoin-backed loans bridge the gap between owning a profitable investment with high growth potential and temporarily covering expenses based on fiat money. Various platforms offer bitcoin-backed loans with different features and requirements. You should evaluate the pros and cons of each platform and use those that balance the risk with the most significant financial benefits.
By holding your bitcoin for the long term, you can explore novel products and services that protect your wealth by providing an avenue to meet financial needs, invest in other assets, and take advantage of business opportunities.
This is a guest post by Ivan Serrano. The opinions expressed are entirely their own and do not necessarily reflect those of btc Inc or bitcoin Magazine.
