Borrowing fiat using crypto
Normally, crypto loans work quite similarly to taking regular loans at a bank or financial institution. As we’ve mentioned, you’ll offer up collateral (in this case an amount of cryptocurrency, such as Bitcoin or Ethereum) to a lender in exchange for a loan either in fiat currency or in a cryptocurrency. The advantage of this, is that you’re not disposing of your crypto and thus not incurring a capital gains tax event. This is particularly advantageous if you expect the particular type of coin you’re using as collateral to appreciate over time, so you won’t be losing out on future gain by selling it in the short term to access money.
How do crypto loans work?
Ok so that sounds simple enough in theory, but what’s actually involved in borrowing fiat using crypto?
Firstly, like any loan, you evaluate and select a lender based on who can provide the most acceptable loan terms for your situation. You’ll deposit at this lender an amount of cryptocurrency you wish to use as collateral, and in exchange you’ll be able to withdraw a percentage of your deposit’s dollar value in cash, stable currency or a stablecoin.
You will have to pay interest on a weekly or monthly basis depending on the terms of your crypto loan and lender. Once you have repaid your loan amount and interest you will be able to withdraw the cryptocurrency you used as collateral.
So what’s the catch here? Quite simply, it’s the usual thing that makes and breaks any investment (particularly cryptocurrency), volatility. As you’re probably aware, it’s highly unlikely any brick and mortar bank is going to accept highly volatile assets as collateral as the value of that asset could drop 20% or more overnight. Banks typically take houses as collateral as they are unlikely to fall below 80% of their initial value at any point during the loan and more likely to appreciate gradually over time. They’ll typically loan you a greater percentage of the total value of your collateral accordingly.
With a crypto loan, most lenders hedge the risk of volatility by typically lending amounts starting at around 50% of the value of the collateral, often referred to as LTV (Loan-To-Value ratio). If the value of the cryptocurrency fell below the amount you borrowed, you would have little incentive to pay back the amount you borrowed. Throughout the term of your crypto loan you will need to keep aware of the loan-to-value ratio (we’ll touch more on this later).
What are the tax implications of borrowing fiat using crypto?
As with normal loans, the fiat you receive from the crypto loan is not taxable income under the ATO’s current guidelines. Likewise any repayments of the loan are not taxable events.
What you do need to consider is how your crypto is being managed when you deposit it or withdraw it from a lender. Some lenders will wrap your crypto when you deposit it. Under current tax guidelines, this wrapping is likely to be treated as a token-to-token transfer which would be seen as a taxable event. Likewise when you withdraw the crypto upon loan repayment, the unwrapping would be another token-to-token transfer and taxable event. As such you’ll have to evaluate whether this loan or provider is the right choice for you as opposed to directly disposing of the crypto for fiat currency or going with a different provider.
Additionally, if you receive a stablecoin instead of a direct fiat payment, the use of this stablecoin will be treated using the usual token-to-token capital gains rules. For example, you could obtain USDT or BUSD from a loan with Binance, but would have to pay CGT on the disposal of this stablecoin if you sold it for regular fiat currency or used it to purchase other cryptocurrency, etc.
The Loan-to-Value Ratio: How crypto lenders account for volatility
As we mentioned earlier the loan-to-value ratio is what lenders will evaluate throughout your loan to make sure they’re not undertaking too much risk. You may be aware of the loan-to-value (LTV) ratio if you have taken out a loan to purchase property. In short, the LTV is the value of the loan divided by the value of the collateral, times 100:
LTV = (loan amount)/(value of collateral) x 100
Most lenders will start with an LTV of 50%, meaning that if you deposited 1 BTC as collateral with a lender (valued at $80,000 AUD at the time of deposit), you could borrow $40,000.
However, as the crypto market can be quite volatile, the LTV of your loan can change if the value of your collateral drops. For example, if the value of that 1 BTC fell by 25% to $60,000 AUD, your LTV would change:
LTV = (40,000)/(60,000) x 100 = 66.67%
Most lenders put terms into their loans that allow them to trigger margin calls that make automatic repayments using your collateral if the LTV becomes too high. These margin calls usually start around 70%, with the liquidation of your assets if your LTV reaches over 80-85%, depending on the lender. So it’s important to keep track of not only the current market price but also the LTV of your loan. In the example above, the -25% change in value of BTC resulted in a 16.67% increase in LTV. In order to avoid missing a margin call, you would have to either deposit more collateral to reduce your LTV, or repay the loan to reclaim your collateral.
What are the risks of borrowing fiat with crypto?
Like any form of loan or investment, taking out a crypto loan involves certain risks, with the potential to lose your collateral. As we’ve mentioned, you need to be aware of:
- Large changes in the value of your collateral impacting your LTV, potentially triggering a margin call and automatic repayment using your collateral
- Complete liquidation of your capital if the LTV becomes too high
- The security of the lenders’ storage of your collateral as you will no longer be in control of it. You should evaluate their security options, whether they use cold storage wallets, insurance, security history (hacks), etc.
- Unknowingly triggering CGT events if you haven’t carefully reviewed how your collateral is stored (wrapped or unwrapped)
As such you should only be borrowing within your limits and should carefully review the terms of the loan including LTV and margin call information. Most importantly, you should consult an accountant before taking out a loan with any institution. Get in touch today to schedule a consultation:
What are the main advantages?
These are the following advantages of using crypto to borrow fiat currency:
- You can use your crypto assets to access fiat currency without disposing of it and missing out on potential future gains
- No capital gains event is likely to be triggered as you are not disposing of the crypto (unless it is wrapped)
- You can leverage the current value of your cryptocurrency to access liquidity whilst still being able to hold the currency for over 12 months to access the 50% CGT discount.
How can I get a loan?
Borrowing Fiat with Crypto
Three of the main providers that allow you to borrow fiat using cryptocurrency are Crypto.com, Binance and Nexo. Each of these providers accepts deposits of cryptocurrency such as BTC, ETH, XRP, LTC and more. They start with an initial LTV of 50%, with triggers for margin calls and liquidation if your LTV changes dramatically. For more information on these crypto loan providers, please refer to this article on CryptoTaxCalculator: A Guide to Borrowing Crypto.
DeFi Crypto Loans
Rather than relying on a centralised institution like Binance for your loan, there are also decentralised finance (DeFi) options available allowing you to borrow in a similar manner. These options allow you to access different types of fiat currency or other crypto tokens (rather than just the fiat denominations supported by the lender or stablecoins).
DeFi Crypto loans can be useful if you want to access specific protocols that require certain crypto tokens, but you don’t want to liquidate your portfolio in the process.
It’s important to keep in mind that DeFi Crypto loans are dictated by market forces. How much you can borrow is influenced by supply and demand as well as the current value of the cryptocurrency you want to use as collateral. Additionally, interest is incurred on a daily basis (or even by the second), rather than weekly or monthly. That means that while you can pay off the loan at any time, the interest is added continually and if the amount owing exceeds the collateral ratio, your collateral will be liquidated.
You can learn more about Defi Crypto loans in this article on CryptoTaxCalculator, as well as an additional type of DeFI loan known as Flash Loans.
Expert Crypto Consultations & Crypto Tax Reporting
With how rapidly the cryptocurrency landscape is evolving, it’s always best to consult the experts to make sure you are making sound financial decisions. With POP Business you’ll have the support of expert Chartered Accountants, whether you’re looking to take out a loan for business or personal reasons. When it comes to crypto taxes and keeping you out of trouble with the ATO, POP Business uses CryptoTaxCalculator, Australia’s leading crypto tax reporting platform. CryptoTaxCalculator integrates directly with major exchanges and blockchains and actively consults with the ATO to quickly and easily identify, categorise and reconcile cryptocurrency transactions. Follow the links or call 1300 180 630 to get started.
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