Bitcoin, the first peer-to-peer electronic cash, is used for storing value and exchanging value, but can also serve as collateral for loans.

First off, what are collateralized loans?

Collateralized loans involve borrowers pledging valuable assets to secure cash loans.

The collateral serves to protect the lender by providing security assurances for their investment. If the borrower defaults on the loan, the lender can sell the collateral to recover their funds. This assurance provides the foundation for the loan to exist, benefiting both borrowers and lenders.

A key aspect of collateralized loans is the Loan-to-Value (LTV) ratio, comparing the loan amount to the collateral’s value. The larger the loan, the more collateral is required. For lenders, effective LTV management—including collateral value assessment, tracking, transfer, and liquidation—is crucial for risk management across their portfolios of loans. The quality of a loan’s collateral, or its suitability to meet the lender's needs, is paramount.

Among the many types of collateral that exist, each offers its own unique qualities, market size, strengths, and weaknesses, both for lenders and borrowers. Some of the most common types of collateral include:

Real estate: Homes, properties, or land

• Positives: Large and well-established market, relatively low volatility, potential for long-term appreciation, tangible asset as security
• Negatives: Illiquid, slow to sell, subject to local/regional market conditions, uncertain sale price or speed, lengthy administrative processes and costs involved in selling, limited divisibility

Personal property: Cars, collectibles, jewelry, etc…

• Positives: Access to capital using existing assets, potentially quicker than some loans, versatile use
• Negatives: Difficult appraisal, tracking, and ownership transfer, potential depreciation, high interest rates.

Stocks: Portfolio of securities in a margin trading account

• Positives: Easy transfer/valuation (digital), large market (public securities), potential appreciation.
• Negatives: Trading hours, settlement delays, varying liquidity, volatility risk tied to portfolio diversification, potential rapid devaluation, regulatory limitations

Lenders need to weigh the qualities of a given type of collateral to properly manage risk and set interest rates for their portfolios. With Bitcoin's emergence as a new type of asset, lenders now have the opportunity to evaluate this new asset class as a potential collateral option.

Evaluating bitcoin as new type of collateral

Bitcoin offers new dimensions to collateral, with an entirely new set of qualities and limitations:

Advantages of bitcoin as collateral:

• Liquidity: Bitcoin trades 24/7/365 across all major currencies, with substantial and growing daily trading volumes.
• Ease of transfer: Bitcoin can be transferred with final settlement between borrower, lender, and escrow accounts, in a matter of seconds to minutes depending if you’re using the Lightning Network or on-chain transfers.
• Verifiability: Ownership can be easily verified on-chain, providing a transparent and secure record.
• Transparency: The total supply, individual holdings, and the time of transfers are equally transparent on-chain for all participants.
• Efficiency: Bitcoin eliminates the need for credit checks, property appraisals, or lengthy settlement delays, since its price is continuously updated and settlement can be made peer to peer.
• Programmability: Bitcoin can be managed programmatically, enabling sophisticated tools like multi-signature escrow wallets, time-locked transactions, and smart contracts.
• Scalability: Each bitcoin is divisible into 100 million sub-units (called satoshis) enabling loans ranging from a few dollars to billions, with negligible operational costs for managing collateral.
• Global accessibility: Bitcoin is a global asset, where borrowers and lenders can access markets and liquidity across borders.

These qualities represent an unprecedented opportunity, unmatched by any prior form of collateral.

With bitcoin, you can programmatically transfer full custody of collateral, with final settlement in seconds to minutes, in amounts ranging $1 to over a $1 billion, from domestic or international customers, with no need for credit checks or property appraisals. If need be, collateral can be added, removed, transferred or liquidated, anytime, from anywhere.

Bitcoin is unprecedented collateral.

Potential drawbacks of bitcoin as collateral

Despite these advantages, bitcoin as collateral also presents unique challenges:

• Volatility: Bitcoin can have large short-term price swings, potentially leading to margin calls or liquidations of collateral at inopportune times.
• Counterparty risk: Bitcoin-backed loans require trust in the lender's ability to securely manage and return the collateral.
• Technical skills: Issuing, managing, and disbursing bitcoin-backed loans requires lenders to have specialized skills, particularly regarding security and potentially Lightning Network or L2 integrations.
• Market size: The market of borrowers and lenders seeking bitcoin-backed loans is still emerging, which may limit accessibility and potentially result in unfavorable terms compared to more established forms of lending.
• Borrower's loss of control: Borrowers give up direct control over their bitcoin collateral, temporarily foregoing the sovereignty and optionality that comes with self-custody.

From borrowers, bitcoin-backed loans offer a way to access cash liquidity while avoiding selling their bitcoin. The above risks can be mitigated through careful loan sizing (using lower LTV ratios), choosing reputable lenders, actively managing their loans, and pledging only bitcoin they are comfortable risking.

This approach aligns with the incentives of many bitcoin holders, who prioritize long-term accumulation for potential price appreciation. Bitcoin-backed loans allow them to maintain exposure to this upside while accessing capital, encouraging them to acquire and hold their bitcoin, using it strategically to fund lifestyle expenses or investments without selling and foregoing potential future gains.

Leveraging bitcoin's appreciation with loan rollovers

Bitcoin-backed loans present a unique dynamic due to Bitcoin's historical price appreciation, even with its inherent volatility.

Imagine a loan with a 12% APR. If you believe that bitcoin's price will appreciate significantly, for example, by 25% annually on average, the collateral's value could increase more than the interest owed. This creates an opportunity where, instead of repayment at maturity, a borrower might refinance by taking out a new loan to cover the existing one. For certain lenders, this can be done as a single transaction, effectively “rolling-over” the loan.

This strategy could be repeated over multiple years, with subsequent loans repaying prior ones, as long as bitcoin's price appreciation continues to outpace the loan's APR. It’s key to note that while bitcoin’s price is unlikely to match the dramatic gains of its early years, it could still see significant long-term growth driven by broader adoption across consumers, businesses, and even countries, in the face of its strictly limited supply. Furthermore, as the market for bitcoin-backed loans matures, increased competition could potentially lead to lower interest rates, further enhancing this dynamic.

If bitcoin’s price appreciation outpaces the loan’s interest accrual, the LTV would decrease, naturally reducing risk over time. Additionally, if the borrower uses some or all of the loan proceeds to buy more bitcoin, the loan repayment burden could potentially decrease relative to their holdings. This creates a scenario where the lender maintains their desired risk and return profile, while the borrower has an ever-easier time repaying the loan as their holdings grow faster than their debts.

Bitcoin-backed loans offer a new opportunity with unprecedented features for both lenders and borrowers. Learn more about bitcoin backed loans here.