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Everything you need to know about Crypto-Backed Loans

Discover the benefits of borrowing against crypto assets, such as avoiding tax liabilities and benefiting from future appreciation, as well as the risks involved and ways to mitigate them.

This Blog was written in partnership with Arch Lending

Crypto and digital asset returns

Crypto and digital assets have appreciated greatly over the last couple of years. As an example, from 2010 to 2021, BTC had an average annual return of ~115%. You may also believe that we are still in the early innings of crypto adoption and are poised to see further growth in assets such as BTC, ETH and other blue-chip cryptocurrencies and NFTs. As a result, you’d like to hold onto these investments to continue to capture future upside.

Why get a loan?

Life happens, and perhaps you need cash to make other investments, handle expenses, or make a large purchase. Oftentimes, individuals sell their assets in order to make other investments or make larger purchases. Selling assets is not only inefficient from a tax perspective, as it triggers a tax liability by locking in capital gains**, but it also deprives the individual of benefiting from the future appreciation of the asset**, as they no longer own it. However, this is where borrowing against your assets can be used as an advantage. You can use a loan to:

  • Access leverage to buy additional crypto
  • Make other investments
  • Make large one-off purchases
  • Pay for large one-off expenses, such as a tax bill
  • For everyday cash flow purposes

Generally

Leveraging existing assets is a common way to invest in stocks (through margin lending) and real estate (through home equity lines of credit). Unfortunately, the traditional financial system disadvantages crypto and NFT owners as it does not accept these assets as collateral. This is a gap that Arch fills. Please note, however, that borrowing against crypto assets is not completely risk-free.

Risks for borrowing against crypto & digital assets

One main risk when borrowing against crypto and digital assets is the risk of liquidation. Liquidation occurs when the value of your collateral decreases and starts to approach the value of your outstanding loan balance. In these events, Arch will notify you across channels and ask you to deposit additional collateral, pay down some of the loan, or some combination of the two. This is a very similar mechanism to margin loans on stocks. How is this tracked? See below.

Loan-to-Value (LTV)  is a calculation used to assess the risk of a loan. LTV is calculated as the loan amount in USD divided by the value of the collateral in USD, expressed as a percentage.

A loan with a higher LTV is generally seen as higher risk, and a loan with a lower LTV as lower risk. The level of risk is directly tied to the likelihood that the collateral will need to be liquidated.

Here is an example of a loan to show how much the collateral price has to drop to get liquidated once the LTV reaches 90%. At Arch, customers can configure their starting LTV to be lower (thus safer) than the maximum allowed, as shown below.

Loan Amount: $100,000.00
Collateral type: Bitcoin
Collateral Price: $23,198.52

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The risk of liquidation is a key risk associated with borrowing against your crypto assets. That being said, there are three ways to mitigate this risk.

  1. Add additional collateral to your loan when the value decreases. Lenders will typically send you notifications with time for you to act and add collateral as your LTV starts to decrease.
  2. Pay down a portion of your loan amount early. The second way to mitigate the liquidation risk is to pay down a portion of your loan amount early. Note that liquidation is only in the event that the value of your assets decreases. If the value increases, you can qualify for an additional loan amount.
  3. Select a lower LTV (Loan to Value) ratio at the beginning of the loan. The third way is to decrease the LTV (Loan to Value) ratio at beginning the loan. To circle back to the example above, you could also decide to only take a $25,000.00 loan against the $200,000.00 of BTC collateral. This would give you a wider margin of safety in the event that the BTC price decreases. 

We at Arch have been helping various customers borrow against their crypto assets to accelerate their financial journey. If this is of interest to you, please reach out to us. For ZenLedger customers, we’re offering a special promotion of a reduced 9% APR on your first crypto backed loan

ZenLedger

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