Bitcoin-Backed Loans and Mortgages: How They Work and What Can Go Wrong

Key takeaways

• A bitcoin-backed loan lets you borrow money while pledging bitcoin as collateral. You generally keep your exposure to the coins, but you hand control of them to the lender for the life of the loan.
• Because the price can fall fast, lenders set loan-to-value limits. If the collateral drops too far, you may face a margin call or the lender may sell your coins.
• The lender is a counterparty. Several crypto lenders failed in 2022, and customers who had pledged or deposited coins were left waiting as creditors.
• Borrowing can avoid selling, which may delay a tax bill, but the details depend on your situation and the structure of the loan. Ask a tax professional before you rely on it.
• This is general education, not a recommendation to borrow. A licensed financial professional can look at your own finances.

How does a bitcoin-backed loan work?

A bitcoin-backed loan is a loan secured by bitcoin you pledge as collateral. You send coins to the lender, or to a custodian the lender uses, and in return you receive money, most often US dollars. When you repay the loan and any interest and fees, the collateral is returned. If you do not repay, the lender has the right to sell the collateral to recover what it is owed.

The appeal is simple. If you want cash but do not want to sell your bitcoin, perhaps because you expect to hold it for years or because a sale could trigger a tax bill, a loan lets you keep the coins in the meantime. Compared with an unsecured loan, the collateral may also make the approval process simpler, since the lender cares more about the value of the coins than about your credit history. That varies by lender.

The cost is risk. You have taken on a debt in dollars against an asset whose price moves a great deal, and you have put your coins in someone else’s hands. Both of those can go wrong, and the sections below take each in turn. The broader landscape of products that sit between bitcoin and the banking system is described in Bitcoin Bank Accounts and Savings: What Actually Exists.

What is loan-to-value, and why does it matter?

Loan-to-value, or LTV, compares the size of the loan with the current value of the collateral. If the loan is a small fraction of the collateral’s value, there is a large cushion. If the loan is close to the collateral’s value, the cushion is thin.

Because bitcoin’s price can change quickly, lenders generally set the starting loan-to-value well below the full value of the collateral, and they set a higher threshold at which they will act. Those figures are written into the loan agreement. They differ between lenders and over time, so this article does not quote any. What matters is the concept: the lower your starting loan relative to your collateral, the more price decline you can absorb before anything happens.

Remember that the ratio moves for two reasons. The collateral can fall in price, and interest and fees can add to the amount you owe. A loan that starts comfortably can drift toward the threshold even if the price stays flat, if interest is added to the balance.

What are margin calls and liquidation?

A margin call is a lender’s demand that you restore the cushion, either by adding more collateral or by repaying part of the loan. Liquidation is what happens when the lender sells your collateral to cover the debt instead.

Here is a simple, non-numeric example. Imagine you borrow against a quantity of bitcoin and the price falls steeply over a weekend. Your loan-to-value reaches the lender’s threshold. The lender sends an alert, and you have a set period to respond. If you cannot, or if the price keeps falling faster than the process allows, the lender sells some or all of the coins and applies the proceeds to your loan.

Several features of this deserve attention. Bitcoin trades around the clock, so a call can arrive at any hour. Some agreements allow automatic liquidation with little or no notice. The sale price may be worse than the price you saw a few hours earlier. And the sale is generally treated as a disposal of property, which can have tax consequences even though you did not choose to sell. A decline can therefore leave you with fewer coins, a smaller loan balance and a possible tax bill, all at once, at the moment the market is at its weakest.

None of this makes borrowing against bitcoin wrong in itself. It means the risk of liquidation should be understood before you borrow, not after.

Who holds your collateral?

Your coins do not stay in your wallet. Understanding who holds them, and what that party is allowed to do with them, is as important as the loan terms.

There are a few general arrangements. The lender may hold the collateral itself or through a third-party custodian. The collateral may be kept separate from the lender’s own funds, or it may be pooled. And in some arrangements the lender is permitted to reuse the collateral, for example by lending it onward or using it in other activity.

Reuse is the issue that hurt people. If your pledged coins have been lent on to others and the lender fails, your claim may be only a claim against the lender, not a right to specific coins that are sitting safely set aside. In 2022, several crypto lenders failed, and many customers found themselves in bankruptcy proceedings waiting to learn how much they would recover. This site does not name the companies, because the lesson is structural. It is the same one that applies to interest-bearing accounts, and it is why The Power of Self-Custody matters as background: once the coins are with a lender, you have stepped away from holding your own keys.

Ask for the answers in writing. Do not rely on a marketing page that says your assets are “safe” or “secured.”

What about a bitcoin mortgage?

A bitcoin mortgage is not one product. The phrase covers a few different ideas. In one, a conventional lender looks at a borrower’s crypto holdings as part of assessing their finances. In another, a borrower pledges bitcoin as additional security for a home loan. In a third, a borrower takes a bitcoin-backed loan and uses the cash toward a purchase.

Mortgage lending is heavily regulated, and the rules about documenting income and assets are strict. How a particular lender treats crypto varies and has changed over time. Because the pledge of volatile collateral adds a second source of risk to the largest debt many people take on, it deserves more caution than a smaller loan, not less. A licensed mortgage professional can explain what is available and how lenders in your state handle it.

Taxes in general terms

Under US federal tax rules, bitcoin is treated as property, as described in Is Bitcoin Regulated in the US? and covered in more depth in How Is Bitcoin Taxed in the US?. Generally, taking out a loan is not itself a sale. That is a large part of why people borrow instead of selling.

But the picture is not that simple. If your collateral is liquidated, that is generally a disposal. How a particular structure is treated, for example if the lender takes legal ownership of the coins or if the loan is arranged differently, can depend on the details of the agreement. Interest paid on the loan may or may not be deductible depending on what the money is used for. These are questions for a qualified tax adviser, and current IRS guidance is at https://www.irs.gov/.

Alternatives to consider

Before pledging bitcoin, it can help to compare the other ways to meet the same need.

• Selling a portion of your bitcoin. This is simple and removes the liquidation risk, but it can be a taxable event and means giving up that exposure.
• Borrowing against other assets. A conventional loan secured by something less volatile avoids tying your debt to bitcoin’s price.
• Not borrowing. Waiting, or reducing the amount you need, is a legitimate choice.

Each has its own costs, and which one suits you depends on your finances. That is a conversation for a licensed financial professional, not a ranking from an article.

Questions to ask any lender

• Who holds my collateral, and is it held separately from your own funds?
• Can you lend, pledge or otherwise reuse my collateral? If so, under what terms?
• What is the starting loan-to-value, at what level do you issue a margin call, and at what level do you liquidate?
• How much notice will I get, in what form, and how long do I have to respond?
• How is the sale carried out if my collateral is liquidated, and who decides the price?
• What are all the interest charges and fees, and are they fixed or can they change?
• What happens to my collateral if you become insolvent?
• Which regulators oversee you, and in which states are you licensed?
• Can I repay early, and are there penalties?

If a lender will not answer these clearly, that is information in itself. Rules in this area change and differ by state, so check the current position with the relevant regulators.

If you are still building your understanding of the basics, Start Here is a good place to begin.

Where to go next

• Bitcoin Bank Accounts and Savings: What Actually Exists for custody risk and the limits of deposit insurance.
• How Is Bitcoin Taxed in the US? for taxable events and records.
• The Power of Self-Custody for what you give up when someone else holds the keys.
• Is Bitcoin Regulated in the US? for who oversees lenders and exchanges.