Interest in Bitcoin-backed loans returns: Will TradFi join this time?

On Jan. 16, Coinbase re-launched a Bitcoin-backed loan service, allowing US users to borrow USDC (USDC) using their Bitcoin (BTC) as collateral. 

Coinbase’s loan service is a mix of CeFi and DeFi. The company converts BTC into wrapped BTC (cbBTC), which it then transfers to Morpho, a DeFi protocol built on Base. The latter then manages the loan terms and interest rates dynamically. 

While the concept itself isn’t novel — Bitcoin-backed loans have existed at least since 2017 — this move is noteworthy and possibly reflects growing market demand.

Interest in Bitcoin and crypto-backed loans appears to be returning. In its August 2024 report HTF Market Intelligence estimated the current size of the Bitcoin loan market at $8.6 billion and projected this figure to reach $45.6 billion by 2030.

Putting one’s Bitcoin to work can be a smart move, but it’s not without risk (remember Celsius?). Some investors might view the entry of traditional finance institutions, with stronger customer protection procedures as a sign that Bitcoin-backed loans could be more secure going forward. Take, for example, Cantor Fitzgerald, a New York financial firm that has invested in Tether and launched a Bitcoin lending program in November 2024. 

After the repeal of the infamous SAB 121 accounting rule on Jan. 23, publicly traded banks can now start developing their own Bitcoin-backed loan services. 

Buy, borrow, die

Bitcoin-backed loans allow users to unlock the trapped liquidity of their BTC holdings without forcing them to sell their coins, and it can help investors avoid taxable events. 

Bitcoin investor Mark Harvey noted that Bitcoin-backed loans give investors the option to implement the so-called “buy, borrow, die” strategy. 

According to Harvey’s calculations, by posting 1 BTC as collateral at a conservative 10% loan-to-value ratio, an investor could get $9,784 in cash in the first year. If the investor borrows against the growing value of his BTC each year—assuming a 50% annual appreciation—his cash flow would balloon to $164,000 over a decade. A cunning cycle designed to maximize gains while keeping taxes at bay.

From a lender’s perspective, using Bitcoin as collateral can help reduce idiosyncratic risks. Newmarket Capital CEO Andrew Hohns told CNBC that it is a novel lending strategy used by his firm. Newmarket Capital lent money to a real estate owner who used a part of it to purchase Bitcoin, then added it as additional collateral. This move provided the lender with enhanced protection and a more diversified risk profile.

“By fusing Bitcoin with credit and traditionally financeable assets, it gives us the luxury of expressing that medium-term view on Bitcoin.”

The risks of Bitcoin-backed loan services

Currently, there are around 20 service providers that allow users to borrow stablecoins and fiat using Bitcoin as collateral. CeFi firms like Wirex, Nexo, Bitcoin Suisse, and DeFi protocols like Aave and Compound also allow investors to supply wrapped Bitcoin (wBTC) as collateral.

Crypto-backed loans provided by CeFi firms boomed from 2019 to 2022 before misuse and theft of customer funds were exposed and led to the downfall of Celsius, BlockFi, and Voyager Digital. DeFi-based loans offer greater transparency compared to other options but come with their own set of challenges like smart contract vulnerabilities, a lack of regulation and hidden leverage through poorly managed rehypothecation strategies.

Related: MicroStrategy may owe taxes on $19B unrealized Bitcoin gains: Report

While many people praise Bitcoin loan services, others are still wary.

Bitcoin investor and self-proclaimed “value maximalist” Brad Mills shared in an X post that he hasn’t used any Bitcoin loan services despite investing in companies that develop them. He explained that he values his Bitcoin holdings more than his equity in Bitcoin businesses.

“[…] I won’t recommend a service I wouldn’t use personally… I didn’t take loans on BlockFi, Celsius, etc etc because of rehypothecation risk. When I find something that fits my BTC maximalist risk parameters, I’ll be its biggest cheerleader, whether I’m an investor or not.”

Bitcoiner @btc_overflow has also expressed his skepticism:

The end of the Bitcoin lending roadblock

Until Jan. 23, most major banks were unable to offer Bitcoin-backed loans. This limitation stemmed from the SEC’s accounting guidance, SAB 121, which required listed companies to disclose crypto assets held on behalf of clients as liabilities on their balance sheets. 

For banks, this complicated matters, as capital requirements are tightly linked to balance sheet contents. Although both the US House and Senate voted to overturn SAB 121, former President Biden vetoed the decision, leaving the rule intact (albeit granting some exceptions to BNY Mellon). 

On Jan. 23, the SEC officially rescinded this controversial guidance. This marks a significant shift and a potential opening for banks to enter the Bitcoin-backed loan market.

Additionally, Coinbase’s legal team clarified that the FDIC was compelled to further un-redact the “pause letters” sent to banks in 2022 and 2023. In a thread on X, Nic Carter listed 25 FDIC documents requesting banks to halt various Bitcoin-related operations.

The recent pro-crypto turn among US legislators is likely to lead to increased Bitcoin exposure among America’s major banks. This will not only increase crypto adoption but also likely result in reduced sell pressure on Bitcoin and help to drive its price higher. From a user and investor perspective, a larger Bitcoin loan market could lead to more competitive rates and improved loan conditions. 

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.