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Crypto Loans — How They Work, and Why They’re So Cheap

If you have a fair bit of money invested in cryptocurrencies, there may come a time when you need some or all of it returned to you as fiat currency. Fortunately, you can take out a crypto loan, keep your assets appreciating, and save on taxes.

How Do Crypto Loans Work?

A loan from your bank requires either a high rate of interest (a personal loan or a credit card) or a large chunk of collateral (e.g., your house in return for a mortgage).

Crypto loans also require collateral. And the more you provide, the cheaper the interest rate you’ll pay on those loans.

You’ll typically have to use 2 to 4 times the loan amount as collateral (1:2 to 1:4), compared to a mortgage, which is has a loan ratio of 1:1.33 if you’re borrowing 75% of the value of the property.

Two Important Caveats

1. If you’re using a platform to earn rewards on your crypto, you will not earn rewards on the collateral during the term of the loan.

The crypto may appreciate during that term, which is one benefit of taking out a loan rather than converting the crypto to fiat money. But it won’t earn rewards.

This is to avoid what you might call double-dipping, which is using money received from the loan to invest in more crypto while also earning rewards on the original amount. Fortunately, no platform can stop you from transferring your loan proceeds to another platform and earning rewards there.

Here’s an example: If you put up $4,000 in collateral on a $1,000 loan, you could pay as low as $1.00 a month in interest.

If you then withdraw the $1,000 USDC and place it on another platform, you can convert it to Bitcoin and let it appreciate. The total cost to you over the life of a three-year loan will be $36 plus the trading fees, while the Bitcoin could appreciate 2x or more during that time.

Or convert the USDC to a token that earns a reward. If you earn 7%, 10% or more, you’ll come out way ahead.

Note, however, that there’s a risk that the BTC or token you bought will go down in price during the term of the loan, resulting in a loss to you, plus the interest on the loan.

2. If the value of the collateral falls below the LTV threshold, you’ll be required to add more collateral for the loan. Here’s an example:

You take out a $1,000 loan and put up $4,000 in collateral for a 1% interest rate. If the price of the crypto falls and your collateral is now only worth $3,500, the LTV is no longer 25%. It’s 28.57%.

So you will need to add another $500 (at the current crypto price) to your collateral to return it to the 25% LTV. Or switch to a higher interest rate with a higher LTV. Or pay off the loan.

This happened in early 2022, when most cryptos dropped by over 10% in a matter of hours, and continued dropping for a few days more. Many loan holders had to add more collateral, pay a higher interest rate, or close out their loans altogether.

Every platform that makes loans against crypto put out these margin calls, which affected thousands of crypto borrowers.

Length of Crypto Loans

Terms for loans are typically for at least one year, ranging up to three years

Most platforms use balloon payment loans. So for the entire term of the loan, you’ll pay interest only.

At the end of the term you selected (1-3 years), you’ll pay back the entire loan amount. If you can’t pay it back, it will come out of your collateral.

Tax Benefits

In the U.S., every crypto transaction is considered a capital gain (or loss) event. So if you bought Bitcoin at, for example, $50,000, and the price goes to $60,000, you have a 20% unrealized gain on whatever amount of BTC you purchased.

If you then trade your BTC for Ethereum or another altcoin, or convert it to a fiat currency, or buy something with it, that gain is now a realized gain, and you have to pay capital gains tax on it.

However, if you take out a loan and use the BTC as collateral, you haven’t sold your BTC, so you have no realized gain. So there’s no tax to pay.

Learn more about crypto taxes here.

Cheap Crypto Loans and No Tax Consequences

It’s not often that you can borrow money and also be the winner in the transaction. Taking out crypto loans is the exception.

If you ever find yourself short of cash, you’ll probably find it cheaper to borrow against your crypto than it is to go to the bank and beg them for a loan.

Remember, the only time a bank is happy to give you a loan is when you don’t need it.

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