What are Bitcoin-backed loans and how do they work?
Bitcoin-backed loans let you borrow money using your Bitcoin as collateral without selling it. This allows you to access liquidity (cash or stablecoins) while keeping your Bitcoin, preserving its potential for future price growth.
In this post, we’ll explain how Bitcoin-backed loans work, compare them to a traditional loan, and explore their benefits and risks.
How do Bitcoin-backed loans work?
Bitcoin-backed loans are similar to traditional secured loans but use Bitcoin as collateral. To understand the difference, let’s compare a traditional car loan with a BTC-backed loan using a simple example.
💡 Collateral is something valuable you give to a lender when you borrow money. If you can’t pay back the loan, the lender can take the collateral and sell it to get their money back.
Let's look at the working with an example. Here's what taking a car loan looks like in the traditional financial system.
Sarah wants to buy a €10,000 car and applies for a loan at her local bank:
Process: Sarah submits her ID, proof of income, and credit score. The bank approves a €10,000 loan, using the car as collateral. Approval takes 3–5 days, but poor credit could lead to rejection.
Terms: The loan has an interest rate decided by the bank, repayable over a predecided term, with monthly payments.
Risks: If Sarah misses payments, the bank can repossess the car, and her credit score may drop, affecting future loans.
Now, let's look at the same example. In this case, Sarah opts for a Bitcoin-backed loan.
Suppose Sarah has 0.2 BTC (worth €20,000) and wants €10,000 for purchasing the car.
Deposit Bitcoin as collateral: Sarah deposits 0.2 BTC on to the Bitcoin-backed lending platform. Important to note here, platforms can be non-custodial platforms (like Firefish) letting her retain control of her private keys, or custodial platforms which take control of the collateralised Bitcoin.
Receive a loan: With a 50% loan-to-value (LTV) ratio, for example, Sarah can borrow up to €10,000 in EUR. Note, platforms can have different LTVs. In some cases, an LTV of 80% may look appealing, cause that means having lesser Bitcoin as collateral. But, this increases the risks associated with liquidation.
Repay the loan: Sarah repays the €10,000 plus 7% APR (€700 interest over 12 months), often times at the end of the period, requiring no monthly commitments. Once repaid, her 0.2 BTC is returned.
Important: Bitcoin’s price volatility can affect the LTV ratio. If BTC drops to €15,000, the LTV rises to 66.7%. In this case Sarah may opt to add collateral or repay part of the loan to stay safe.
Benefits of Bitcoin-backed loans
Keep your Bitcoin: Borrow against Bitcoin without selling, retaining potential price gains.
Fast approval: Getting a Bitcoin-backed loan typically involves no credit checks, thus enabling guaranteed funds quickly.
Tax advantages: Borrowing is typically not taxable, unlike selling Bitcoin, which may trigger capital gains taxes.
Risks to consider
Price volatility: A sharp Bitcoin price drop could trigger liquidation if the LTV exceeds the platform’s limit. Hence, it is important to opt for platforms with conservative LTVs. Like, we said before, some platforms offer higher LTVs such as 80% - while this may sound attractive, considering the lower amount of Bitcoin needed to secure the loan, the risk of liquidation is higher here.
Platform risks: Custodial platforms face risks like hacks or bankruptcy. Non-custodial platforms reduce this significantly.
Rehypothecation risk: On custodial platforms, your Bitcoin might be reused for other purposes (rehypothecation), increasing risk if the platform fails.
Conclusion
Bitcoin-backed loans are perfect for those who believe in Bitcoin’s long-term value but need liquidity immediately. Whether funding a car, business, or other expenses, these loans unlock Bitcoin’s value without losing exposure. The comparatively easier access to liquidity with these loans in driving growth globally. You can get a loan faster, without the typical hassles of credit checks, cumbersome forms and endless waiting times (often, at the mercy of the bank).
Disclaimer: This blog is for informational purposes only, not financial or legal advice. Bitcoin-backed loans carry risks like price volatility and loss of collateral. Do your own research before deciding.
