How a bitcoin-backed loan works: collateral, loan-to-value, interest and liquidation, with one worked example and the risk in plain words.
Intermediate
Your machines pay you in bitcoin. Sooner or later you need dollars: for a hosting invoice, another machine, or life. One way is to sell. The other is to borrow dollars and leave bitcoin with a lender as security. This guide explains how that works and what it can cost you.
Careful: Borrowing against bitcoin can lose the collateral. If the price falls far enough, your bitcoin is sold to repay the loan, and you cannot undo it. This guide is education, not investment, tax or legal advice.
Why people borrow instead of selling
They keep the bitcoin. When the loan is repaid, the collateral comes back.
They get cash now, without waiting and without finding a buyer.
Selling is final. Once sold, the bitcoin is gone at that day's price. In many countries a sale also has tax consequences that a loan may not have. Ask a tax professional about your own case.
None of that is free. You pay interest for as long as the loan is open, and you carry the risk described below.
The four moving parts
Collateral: the bitcoin you lock up. You cannot spend it while the loan is open.
Loan-to-value (LTV): the loan divided by the value of the collateral. Borrow $40,000 against $100,000 of BTC and the LTV is 40%. The LTV moves every time the price moves.
Interest: what you pay for the money, usually quoted per year. It can be fixed for the term or change over time, depending on the lender.
Liquidation: if the LTV rises above the lender's limit, the lender sells some or all of your collateral to repay the loan. Some lenders warn you first, known as a margin call. On-chain protocols do not.
A worked example
Good to know: The numbers below are round figures chosen to make the arithmetic easy. They are an example only. They are not today's price, a forecast, or any lender's terms.
You own 1 BTC. In this example the price is $100,000.
You lock the 1 BTC as collateral and borrow $40,000. Your LTV is 40%.
In this example the lender liquidates at an LTV of 80% and charges 10% interest a year, so about $4,000 a year.
The price falls to $66,000. Your collateral is worth $66,000 and your LTV is now about 61%. Nothing is sold, but the cushion is thinner.
The price falls to $50,000. The LTV reaches 80%. The lender sells collateral to repay the $40,000, plus any fee. You keep the $40,000 you borrowed, and most of your bitcoin is gone.
If instead the price holds or rises, you repay $40,000 plus interest and get the whole 1 BTC back.
In this example the price had to fall by half before liquidation. Borrow more against the same collateral and it takes a smaller fall. Borrow less and it takes a bigger one. That single choice, how much you borrow against what you lock, is most of the risk.
The risk, plainly
Price risk: bitcoin has fallen by more than half from a peak more than once. A liquidation sells your bitcoin at the low, exactly when you would least want to sell.
Lender risk: with a custodial lender, your collateral is in someone else's hands. If the lender fails, getting it back can be slow or impossible.
Protocol risk: with an on-chain protocol, the collateral sits in software. A bug or an attack can lose it.
Cost: interest accrues every day. A loan left open for years can cost a large share of what was borrowed.
What lowers the risk
Borrowing a small share of the collateral's value.
Keeping extra BTC outside the loan, ready to add as collateral.