Using Bitcoin as Collateral for High-Value Lending – Key Questions and Considerations

As of today, over 19 million bitcoins have been mined out of a maximum supply cap of 21 million. This limited supply has contributed to Bitcoin's growing appeal, especially as its price surged to record highs in 2024, attracting investors and speculators alike.

The rise in its value, coupled with increasing mainstream adoption, has shifted Bitcoin from a niche digital experiment to a prominent asset class, especially for the high-net-worth overseeing a balanced asset portfolio. As interest continues to grow, bitcoin's place in the financial landscape seems more secure than ever, sparking discussions about its role as a store of value and potential future applications.

Given this, we've asked our CEO, Islay Robinson, to review some of the main considerations and questions when it comes to using Bitcoin as collateral for high-value lending.

Borrowing against Bitcoin and other digital assets

It's pretty easy to borrow against Bitcoin – move all your assets to a platform, request a loan, select the amount you want to borrow and the term, accept the interest rate and sign the agreement (digitally), and it's done – the loan amount, in the digital currency you selected is in your wallet to do with what you please.

Borrowing "on-chain" is decentralised, simple, efficient and established – it works how it was intended, how all borrowing should be in a perfect world, and is used widely and often by speculators and institutional holders in the same way.

Borrowing against digital assets gives all the same advantages that exist with other assets – liquidity without selling. This means that you can still take advantage of future gains, speed, and flexibility and not unnecessarily trigger potential tax charges on disposal.

There are, however, risks involved and disguised by the speed and convenience. There are also a large number of areas that need to be professionally advised on, especially when it comes to higher-value transactions.

Can you trust the platform?

The scars from the demise of the likes of the Celsius Network Three Arrows Capital and others are fresh in the minds of many, and you can understand why - the losses during that period were catastrophic and long-lasting.

Platform risk remains a key consideration and one that needs to be thought through, especially because, with loans against crypto assets specifically, all your assets are posted to them as security, and they hold them in their custody for the duration of the loan.

So it's important to consider questions such as: What happens if the platform fails or if it runs out of liquidity? If a competitor buys it up in an unfavourable jurisdiction, How will it react if the asset value falls rapidly and you are forced into a margin call?

And – perhaps most importantly – how are your assets used during the loan period – traded, rehypothecated or out in cold storage? In this instance, you need to consider the interest rate you may be offered, and this is a significant question – more on this below.

Margin calls – the future risk which is always minimised

The level of margin calls differ from lender to lender and are set at different rates – given the potential volatility of Bitcoin and other crypto assets, it's an ever-present feature and one to be well thought through. 

A margin call is a demand from a lender requiring a borrower to deposit additional funds or assets to meet a minimum collateral requirement. It occurs when the value of the collateral pledged for a loan falls below a specific threshold due to market fluctuations or other factors.

In the context of borrowing or trading, a margin call ensures the lender is adequately protected from potential losses. If the borrower fails to meet the margin call by adding more collateral or repaying part of the loan, the lender may liquidate the existing collateral to recover the borrowed amount.

For example, in cryptocurrency lending, a sudden drop in the value of the pledged digital assets (e.g., Bitcoin or Ethereum) can trigger a margin call, as the collateral no longer meets the required loan-to-value (LTV) ratio. This mechanism is particularly significant in volatile markets where asset prices can change rapidly.

Is speed necessary?

Convenience, a simple process and a fast turnaround are great – I wish all lending markets were the same. However – speed often comes at the detriment of price, and some lenders prefer borrowers who accept the first, easy-to-complete offer they receive without consulting the whole market.

Just like with a mortgage on your home – only asking your own bank for a loan is a mistake, given how big and competitive the market is. It's the same principle when accepting a loan from your existing platform or from where your assets are stored; this could also cost you more in terms of interest and fees.

Shopping around, comparing lending terms and all the terms of the contract should always give a better outcome – even if that means you have a bit more admin to do.

How is interest calculated?

With fiat loans, interest is usually charged on a daily, weekly or monthly basis and payments – either interest only or interest plus capital are made monthly. The interest due to the lender is calculated based on how much you have outstanding by direct debit.

The alternative is where interest is added to the loan on a daily/ weekly or monthly basis, and it's all settled in one go when the loan is redeemed.

Many crypto-lending platforms adopt the latter approach – especially as loans are often set up for short-term periods; asking that the borrower services interest monthly will then result in them having to make sure that that is possible – that the borrower has income – and leads to additional levels of underwriting, credit check and process.

This approach of adding interest to the loan on a monthly basis and then charging interest on this higher amount, and this compounding during the term of the loan can add a significant amount to the total interest due on redemption. It pays here to understand the terms and to do the maths (or feel free to ask me to help you do this).

Taxation

Most loans are a simple security charge over and specific asset. Some, however, can involve elements of sale and buy-back options or are made on a "repo basis" where the ownership of assets is transferred to the lender during the loan term and then back to you when the loan is repaid. This may count as a disposal and acquisition in some jurisdictions. Given the focus on crypto taxation in many countries, together with the immutable audit trail that exists on the blockchain, you need to make sure that any nonstandard lending terms don't inadvertently trigger a tax charge.

So – take tax advice – fortunately, I know plenty of specialists who can help with this.

What happens with your assets while they are under the custody of the lender?

When you take a mortgage on your home, you stay in control of the asset, often living in it and the lender has a legal charge over it to secure the loan. With crypto loans, your holding will be sent to the lender and they will have custody of it until the loan is repaid.

What the lender does with the asset, as mentioned above, is really important to understand – and what they do with it dictates your interest rate and lending terms. What many people expect is that the tokens just idly sit there – in the wallet – doing nothing at all of interest. This is a "cold storage" approach and is often the preferred option.

In reality, many lenders will rehypothecate the assets – and will be entitled to do so under the terms of the loan. I suspect rehypothecate is a new word for you so I took the definition from chat GPT for us both.

"Rehypothecation is the practice where a financial institution, such as a bank or lending platform, reuses assets that have been pledged as collateral by its clients for its own purposes. These purposes can include using the collateral to secure its own borrowing, lending the assets to other parties, or other investment activities.

Key Elements of Rehypothecation:

1.  Collateral Use: When a borrower provides collateral (e.g., cash, securities, or digital assets) to a lender, the lender can legally repledge or reuse that collateral in its own transactions

2.  Legal Ownership: The lender typically gains temporary ownership rights over the collateral during the term of the agreement, allowing it to rehypothecate the assets

Common Scenarios

Traditional Finance: In margin trading or secured lending, rehypothecation allows brokers or banks to optimise liquidity and earn additional returns on the collateral they hold

Cryptocurrency: Crypto lending platforms may use rehypothecation with digital assets, such as lending collateral to third parties to generate yields

Benefits

Liquidity Enhancement: Rehypothecation can provide lenders with additional liquidity, which may lead to lower borrowing costs for clients

Earning Potential: Lenders can earn extra revenue by using the collateral for other investment or lending opportunities

Risks:

1.  Counterparty Risk: If the lender becomes insolvent, clients may lose access to their pledged collateral

2. Loss of Control: Borrowers have limited control over how their collateral is used

3.  Market Risks: If the value of the rehypothecated assets drops significantly, it can lead to financial instability for all parties involved

4. Lack of Transparency: Borrowers may not always be aware of whether or how their collateral is being reused

What this means, in simpler terms, is that your Bitcoin is being traded, hedged, lent, leveraged, shorted, and whatever else while in the custody of the lender. It will show as a balance in the wallet you are given access to but it will be used to create additional returns for the lender – often far and above the interest rate you are paying.

As a general rule at the time of writing – if the interest rate you have been offered is below the government lending rate you can bet your Bitcoin is being rehypothecated (if your rate is 0% - aggressively rehypothecated!)

If your lending rate is closer to 12% I would suspect that your assets are in cold storage and safe and secure.

Chat GPT provided a further build……

Rehypothecation in Crypto:

In the context of cryptocurrency, rehypothecation is a contentious issue due to the decentralised and volatile nature of digital assets. Many crypto users prefer platforms that explicitly avoid rehypothecation, as this reduces risks associated with insolvency or misuse of assets.

Borrowers should carefully review the terms of their agreements and assess the platform's reputation to understand whether and how their collateral may be rehypothecated.

So there you have it – get under the bonnet and, if nothing else, understand the terms of your loan agreement.

Who lends against Bitcoin and cryptocurrency?

As you would expect, Enness Global has wide-ranging relationships with a huge number of lenders for cryptocurrency. These range from global private banks, niche banks, specialist alternative finance providers, global platforms, private credit funds and plenty of blockchain-based lenders.

For higher value transactions - £500k and upwards – we are right here to help you navigate this vast and fragmented market, make sure you get the right lending terms and understand what you are signing up for. At the same time, we will consider the other side of the transaction – what are the funds being used for, and how will you complete that transaction?

For example -  if it's to buy a home, how will you manage the mortgage process and source of funds? Will the loan affect your borrowing capacity (or will your bank run a mile as soon as you mention it) Or, just as likely, is borrowing against your bitcoin the best approach – would a loan against your business-listed shares or other real estate be more effective – even if more difficult to achieve

If you are interested in this topic, please follow our dedicated social platforms, or if you want to discuss any of the above, including how Enness Global could help you, please get in touch.