How do Bitcoin Loans Work? Exchanges, Fees, and Tax Benefits

Key Points

• Bitcoin loans provide liquidity in exchange for your Bitcoin without having to sell your BTC tokens and incur a taxable event. 
• Bitcoin loans require collateral to be deposited and have a schedule of repayments of principal and interest.

How do Bitcoin Loans Work?

Bitcoin loans are when borrowers offer up their existing Bitcoin as collateral to borrow cash against the BTC assets. Bitcoin loans are often used as a tax-efficient way to capture returns from Bitcoin appreciation.

You can use your borrowed funds for anything that you would use cash for — making purchases, paying down other debt, or even investing in additional cryptocurrency. In order to take out a Bitcoin loan, you will first need to deposit some Bitcoin as collateral. 

For example, if you are looking to take out a $10,000 loan using $20,000 worth of Bitcoin as collateral, you would submit the $20,000 worth of Bitcoin to a lending platform and receive $10,000 in return (paid out in fiat or a coin of your choosing). Once you have taken out your loan, you are responsible for adhering to the terms set out by the lender regarding how and when your loan should be paid back. This part usually works like a normal loan — you have certain monthly payments you are responsible for, and you pay back your loan over time. Keep in mind that, like with traditional loans, your borrowed funds will accrue interest over time.

What is a Bitcoin Loan?

Bitcoin loans are an “overcollateralized” type of loan. This means that, unlike traditional loans from banks, in order to take out a Bitcoin loan, you must put up collateral that exceeds the value of the funds borrowed. This is to insure the lender in case you do not pay your loan back. 

Bitcoin loans normally lend out cash that represents anywhere from 20% to around 80% of the deposited collateral. For example, if you put down $10,000 of collateral in Bitcoin, you can borrow anywhere between $2,000 and $8,000 in a coin of your choosing. Of course, these loans also charge interest, but the benefit is that they are not subject to a credit check for approval since you are posting collateral that guarantees the loan funds.

Once you have taken out your loan, you will have to pay it back according to the terms of the lender. These terms usually include a monthly repayment schedule that covers the principal of the loan + interest that is accrued, as well as a loan term that determines how many months your payments are spread over. Many crypto loans, however, do provide the option to borrow funds indefinitely (without a set repayment schedule) that also have flexible repayment amounts. Some loan programs only require monthly payments covering the accrued loan interest and a lump sum payoff of the principal at the end.

5 Bitcoin Loan Platforms For October 2022

The competition for the best crypto lending platforms is fierce, and there are a lot of great choices out there. Here are our picks for the best Bitcoin lending platforms out right now.

SALT Lending

SALT Lending is a relative newcomer to the scene but is currently one of the best lending platforms. The platform features 0% fees across the board for prepayment, withdrawal, and origination as well as some of the lowest APRs in the industry (starting at only 0.52%).

SALT also offers a unique “Stabilization” program, which converts your collateral into stablecoins whenever it gets close to your liquidation LTV. This prevents the collateral from dropping further in value and being liquidated. This also means that your assets are theoretically worth much more when you re-enter the market vs. if they had been liquidated, and you have to re-purchase.

• Interest Rates: Fixed

Why Borrow With SALT?

• Unique features such as portfolio stabilization that protects collateral from liquidation and crypto rebates for making payments.
• Low APRs starting at 0.52% and topping out under 10%.
• Also offers business and personal loans.

Start borrowing at SALT now.

CoinLoan

CoinLoan offers a range of fiat (EUR, GBP) and crypto loans with flexible repayment terms between 1 and 36 months. The platform features a crypto exchange and their platform-native CLT token.

The CoinLoan platform also has an extensive loan dashboard along with loan health notifications via email that are triggered whenever LTV gets too high.

• Interest Rates: Fixed

Why Borrow With CoinLoan?

• They have support for borrowing fiat currencies directly rather than borrowing through a stablecoin.
• Flexible loan repayment terms and a breadth of supported collateral assets.
• Extensive platform ecosystem with an exchange and a native cryptocurrency.

Start borrowing with CoinLoan now.

Nexo

Nexo is a heavyweight in the lending space known for their 0% APR loans. The platform has an extensive loyalty program based on their native NEXO cryptocurrency (with the 0% loans available to members of their Platinum tier).

The Nexo platform also includes a cryptocurrency exchange, high-yield crypto savings accounts, and their credit line borrowing product which allows you to only pay interest on what you use rather than on an entire lump sum loan amount.

• Interest Rates: Fixed

Why Borrow With Nexo?

• Extensive loyalty program that offers interest rates as low as 0%.
• Crypto credit line available instantly with no credit checks.
• 24/7 customer support and good reputation in the crypto industry.

Start borrowing with Nexo now.

BlockFi

BlockFi is an established lender that provides USD loans in exchange for Bitcoin, Ether, Litecoin, or PAXG. Their loan minimums are $10,000, and their interest rates are less than 10%, making BlockFi a great pick for institutional investors and high-net-worth individuals.  

• Interest Rates: Fixed

Why Borrow With BlockFi?

• No prepayment fees.
• Great for borrowers looking for bigger loans.
• Get your loan funds the same day.

Start borrowing with BlockFi now.

YouHodler

The YouHodler platform provides loans in several fiat currencies and USD-denominated stablecoins. They issue loans with repayment terms up to 364 days, and their loans support a whopping 90% LTV. 

YouHodler’s loans start at 50% LTV, and they support over 50 different collateral options with minimum loan amounts starting at just $100.

• Interest Rates: Fixed

Why Borrow with YouHodler?

• LTV of up to 90%.
• Features $150M pooled crime insurance by Ledger Vault.
• Supports true fiat currencies like GBP and CHF.

Start borrowing with YouHodler now.

Tax Benefits

Bitcoin loans are a wise strategy for anyone looking to put their Bitcoin earnings to use without the hefty tax burden. The IRS does not tax loan proceeds, so Bitcoin loans are exempt from taxation. This means that these loans can be used to access liquidity without having to sell your crypto and pay taxes on any realized gains. 

Here’s how it works: Say you started out with $10,000 of Bitcoin that has appreciated during a bull market and has doubled in value to $20,000. If you sell your Bitcoin, you will be subject to a capital gains tax on the $10,000 of appreciation. What you can do instead is use your $20,000 of Bitcoin as collateral for a Bitcoin loan, and thus access the same $10,000 of liquidity without creating a taxable gain. You will have to pay interest on the borrowed funds, but this can be a better deal than paying the capital gains tax.

DeFi Loans

While many borrowers opt for taking their loan funds in a fiat currency or a stablecoin, loans can technically be taken out in any cryptocurrency that the loan platform supports. 

In fact, there are “decentralized finance” (DeFi) platforms that facilitate direct peer-to-peer lending and borrowing. When you borrow funds from these platforms, you are borrowing directly from the money that someone on the other side has lent out. DeFi platforms support lending and borrowing functions for the majority of popular cryptocurrencies, meaning that coins like ETH, SOL, ADA, and others can be borrowed against your Bitcoin collateral. 

There’s one caveat when borrowing against Bitcoin through DeFi, though. You cannot borrow against your actual BTC, rather, you must borrow against “wrapped” Bitcoin (WBTC). This is because your BTC must be converted to an Ethereum-compatible token in order to trade throughout Ethereum’s ecosystem. WBTC has the same value as BTC and can be converted back to BTC at any time.

What Do I Need in Order to Get a Bitcoin Loan?

If you already have a Bitcoin wallet with some BTC ready to use as collateral, you are ready to get a Bitcoin loan. 

There is no credit check necessary, however, many platforms require a know-your-customer (KYC) check. This is an identity verification process that is required by law for any centralized entity giving out loans. These processes usually involve submitting pictures of your government ID and may require entering your social security number and providing your address. KYC checks are usually automated and normally verify you in just a few minutes.

Preparing for a Bitcoin loan is relatively simple. You will need

• Your Bitcoin to use as collateral
• A platform to borrow from
• An understanding of the terms of your loan
• An understanding of key definitions relating to your loan (see below)

What is Loan-to-Value (LTV), And How Does it Affect Loan Rates?

Every crypto loan has a loan-to-value (LTV) ratio. This represents how large your loan amount is compared to your deposited collateral. The loan LTV is calculated by dividing the loan amount by the value of the collateral. 

LTV is important because it determines how big of a loan you can take out. Most lenders loan out on LTVs between 20% and 80%. LTV also comes into play when the value of your collateral fluctuates. Using Bitcoin as collateral means that your LTV will constantly be changing as the price of Bitcoin changes. 

Let’s take a look at some examples.

• If you take out a $5,000 loan using $10,000 worth of Bitcoin as your collateral, your loan’s LTV will be 50%. Alternatively, if you take out a $2,000 loan using the $10,000 of BTC collateral, your LTV will only be 20%. Generally, the lower your LTV, the lower the interest rate you will receive from lenders.
• If you have a $5,000 loan that’s guaranteed by $10,000 worth of BTC and the market crashes, your BTC (which was formerly worth $10,000) may now only be worth $8,000, for example. In this case, your loan has gone from a 50% LTV to a 62.5% LTV ($5,000/$8,000 = 62.5). As the value of your collateral decreases, your loan’s LTV increases

If your LTV rises above a certain threshold, your lender may request that you pay down some of your loan or deposit more collateral. Failure to do this may force your lender to sell your collateral to cover your loan amount. 

Most platforms have a “loan health” dashboard that shows your LTV and will notify you when your LTV gets within liquidation territory.

Margin Calls

If your LTV exceeds the threshold set by your lender (usually 80% – 90% for most loans), you will receive a margin call. 

Margin calls are a demand by the lender requiring you to either pay down a portion of your outstanding loan balance or deposit more collateral. The goal of margin calls is to get your loan LTV back within healthy territory. 

If you fail to meet a margin call, or if you do not deploy enough funds to get your loan LTV back within a healthy territory, your collateral is in danger of being liquidated.

Comparing the Different Types of Loans: Interest-Only, Interest & Principal, and Credit Lines

The overcollateralized nature of crypto lending means that lenders can provide borrowers with different types of repayment terms. Since lenders make their money by charging interest, it is in their benefit to allow you to keep your loan interest accruing indefinitely. This is why many lending platforms will give you the option of choosing between an interest-only and an interest & principal loan. 

• Interest-only Loans: These loans require the borrower to only pay the accruing interest month-over-month. The final sum of the loan is due at some specified repayment date when any outstanding interest + the original principal are due together as a lump sum. 
• Interest & Principal Loans: Similar to traditional loans, interest & principal loans give the borrower a set repayment schedule during which they will pay the principal and interest together in small payments. At the end of the repayment period, the entirety of the loan will be paid back.
• Credit Line: Some lending platforms have introduced “credit line” options for borrowers. These allow you to take out as much or as little as you need from a pre-specified loan amount and only pay interest on the funds you borrow (similar to a traditional credit card). Credit line loans can also feature flexible repayment terms.

An Example

Interest & principal loans require higher monthly payments but usually end up with a lower total loan amount after interest is calculated. Interest-only loans, on the other hand, feature smaller monthly payments but end up with a bigger loan amount at the end. 

Let’s look at an example that shows the differences between these two methods. For our example, we will be using the loan platform SALT Lending to borrow $50,000. Our collateral for this loan will be $100,000 of Bitcoin, putting our LTV at 50%. The loan repayment timeline will be 24 months.

As you can see, the interest-only option is about 7% more expensive in this example than the interest & principal repayment schedule.

Are Bitcoin Loans Taxed?

The IRS does not view taking out a Bitcoin loan as a taxable event. 

The tax-exempt nature of loans leads many savvy investors to use Bitcoin loans as a way to offset their potential tax liability from capital gains. Rather than selling their Bitcoin and incurring a taxable event, they will borrow against it through a loan and spend those funds tax-free.

What Are The Common Loan Terms?

• Loan Term: Most loans have a predetermined loan term during which the loan must be paid back. The loan term normally splits up payments during daily, weekly, or monthly installments that culminate in the loan balance being paid off.
• Collateral: The assets deposited that are used to guarantee a crypto loan. The more collateral that is deposited, the bigger a loan you can take out. In the event that a borrower does not pay back their loan, or their LTV exceeds a certain threshold, collateral may be sold to repay the outstanding loan balance.
• LTV: Loan-to-value (LTV) is the relationship between the loan amount and the value of the collateral. With Bitcoin loans, the LTV is always fluctuating since the value of the BTC collateral is always changing. LTV that is too high may force a lender to liquidate the deposited collateral.
• Margin Call: Whenever the LTV of a loan gets too high (normally over 80% – 90%), a lender will issue a margin call which requires the borrower to either deposit more collateral or pay down a portion of their loan. Failing to meet a margin call may result in your collateral being liquidated.
• Principal: The amount that you are borrowing when you take out a loan is called the loan “principal.” This sum is due at the end of the loan term, usually accompanied by an interest charge.
• Interest: In addition to the principal, the interest charged on a loan is due at the time of repayment. Interest is a percentage charged on the principal of a loan for the service of providing the funds. This is normally where lenders earn their money. Interest rates may either be variable or fixed — fixed interest rates are a set percentage of the principal that does not change, while variable interest rates change over the term of the loan.
  

What Are The Risks For Bitcoin Loans?

Bitcoin loans, like all loans, are not without risk. While it’s easy and fast to get a loan if you have the collateral, any time you borrow money, your deposited collateral is at risk.

• • Collateral Liquidation: It’s important to remember that even if you have good money habits and make your loan payments on time, your collateral is always at the mercy of the markets. If Bitcoin has a large, sudden price drop, your collateral may be liquidated before you have a chance to act.
  • Platform Risks: Crypto platforms are not immune to hacking and cyber-attacks. Drains of funds from hackers are not a rare occurrence in the crypto world. Additionally, massive market moves may topple lenders and make getting your collateral out impossible, even if your particular loan is unaffected by choppy markets.
  • More lucrative alternatives: The dynamic world of crypto always has fresh and novel ways to put your hard-earned tokens to work. While taking out a crypto loan can be a good way to get access to liquidity, there may be better ways to earn yield on your crypto through staking, lending, or other programs.

Are There Any Other Fees For Bitcoin Loans?

In addition to charging interest, many platforms also have some standard fees they tack onto loans. The fees shown below are usually percentages of the loan amount, so the bigger the loan, the bigger the fees.

• Origination Fees: For the service of providing, or “originating,” the loan, some providers will charge an origination fee whenever a loan is taken out.
• Withdrawal Fees: Most cryptocurrency exchanges and custodians charge a fee for withdrawing crypto assets from the platform. This isn’t necessarily related to loan amounts, but it’s still important to keep in mind when transacting with these lenders.
• Prepayment Fees: Since lenders make the majority of their money by charging interest, some will actually require borrowers to stick to the set prepayment schedule and will not allow early loan repayment without charging a “prepayment fee.”

Frequently Asked Questions

Will banks accept Bitcoin collateral?

No, most banks do not accept Bitcoin as collateral. The best way to get a loan by using Bitcoin collateral is through a lending platform like the ones covered above.

What is the interest rate on a Bitcoin loan?

For some platforms, interest rates can be as low as 0%. Normally, they are somewhere in the 2% – 15% range.

How to get a Bitcoin loan without collateral?

Bitcoin loans are not available without collateral. When depositing Bitcoin as collateral, you can borrow fiat or other cryptocurrencies.

Can you get free Bitcoin loans?

Most Bitcoin loans charge some interest rate as well as some loan servicing fees. There are platforms with 0 fees and APRs as low as 0%, however, which may be a good option for borrowers looking for the best rates

Are Bitcoin loans safe?

Bitcoin loans are generally safe, though no platform is 100% immune to cyber attacks, and the crypto markets are volatile, so losing your collateral is a real option when taking out a loan.

What do I need to get started with a Bitcoin loan?

You’ll need to pick a platform where you can deposit your Bitcoin as collateral and familiarize yourself with the definitions and loan terms for borrowing funds.