To borrow against Bitcoin, you pledge your coins as collateral on a lending platform, choose a loan-to-value ratio, and receive cash or stablecoins that you repay with interest to get your Bitcoin back. Most centralized platforms let you borrow between 50% and 80% of your Bitcoin’s market value, with rates starting around 5% annually.1Coinbase. Crypto-Backed Loans The appeal is liquidity without selling; the catch is that a price drop can force a sale you didn’t choose, and that forced sale can trigger a tax bill on top of the loss.
Choose a Centralized Platform or a DeFi Protocol
Your first decision is who holds the collateral. Centralized lenders such as Coinbase, Nexo, and Ledn take custody of your Bitcoin and run the loan through their own systems. Because they operate under federal anti-money-laundering rules, you’ll upload a government photo ID and a recent proof of residence (utility bill or bank statement dated within the last 90 days) before you can borrow.
Decentralized protocols like Aave replace the company with a smart contract on a blockchain. You connect a software or hardware wallet, and the contract locks your collateral automatically. No identity documents. But if a bug in the contract is exploited, your collateral can be drained with limited legal recourse.2U.S. Department of the Treasury. Illicit Finance Risk Assessment of Decentralized Finance
Set Your Loan Terms
Loan-to-Value Ratio
LTV is the single most important number in the loan. It expresses your loan as a percentage of the collateral’s market value. Deposit $100,000 in Bitcoin and borrow $50,000, and your LTV is 50%. Lower LTV means a bigger cushion before a price drop puts you at risk. Higher LTV puts more cash in your pocket but starts you closer to the liquidation threshold. Initial LTV options usually run between 50% and 80%.
Interest Rate and Duration
Rates depend on the platform, the LTV you pick, and how long you borrow. Some platforms advertise rates from around 5% annually, with higher LTVs and longer terms costing more.1Coinbase. Crypto-Backed Loans Many Bitcoin-backed loans run 12 months or less. Others are open-ended: you pay interest on an ongoing basis and repay the principal whenever you choose.
Loan Currency
You can take the proceeds in U.S. dollars sent to a linked bank account, or in stablecoins like USDC or USDT sent to a digital wallet. Stablecoin payouts settle on-chain and arrive faster. Dollar transfers can take one to three business days.
Fund the Loan by Sending Your Bitcoin
Once you finalize terms, the platform generates a deposit address (a custodial wallet on a centralized platform, or a smart contract address on a DeFi protocol). You send the specified amount of Bitcoin from your personal wallet to that address. Blockchain transactions are irreversible, so a typo in the address means permanent loss.
Centralized platforms usually require two-factor authentication before they’ll accept the deposit. The platform then waits for a set number of blockchain confirmations, typically three to six, before the deposit is final and the loan proceeds become available. That wait usually runs 30 to 60 minutes depending on network congestion.
Watch Your LTV After Funding
Your main job after funding is watching the LTV as Bitcoin’s price moves. Your dashboard shows it in real time. If the price drops, your LTV rises because the same loan is now backed by less valuable collateral. If the price rises, your LTV improves.
Most platforms send automated alerts when your LTV crosses warning thresholds, often around 70% to 75%. Those alerts are your window to act before you hit the liquidation threshold, which varies by platform. Coinbase, for example, liquidates at 86% LTV.1Coinbase. Crypto-Backed Loans
When you get a margin call, you have two ways to bring your LTV back down:
- Send additional Bitcoin to the platform’s deposit address. Once confirmed, your LTV recalculates automatically.
- Make a partial payment on the principal. A smaller loan against the same collateral means a lower LTV.
What Happens if You’re Liquidated
If your LTV hits the liquidation threshold and you haven’t responded, the platform’s automated systems sell enough Bitcoin to cover the outstanding loan. No human reviews it. It can happen within minutes.
Most platforms tack on a liquidation penalty. Coinbase charges 4.38%.1Coinbase. Crypto-Backed Loans DeFi protocols often impose penalties around 10%, split between the person who triggers the liquidation and the protocol. After the loan and penalties are covered, any Bitcoin left over is returned to you; the platform only sells what it needs.
The forced sale also creates a tax event. Because the IRS treats crypto as property, a liquidation is a disposition, and you may owe capital gains tax on the difference between what you originally paid and the sale price, even though you didn’t choose to sell.3Internal Revenue Service. Notice 2014-21
Repay the Loan to Get Your Bitcoin Back
To close the loan, you repay the principal plus accrued interest through the platform, typically in the same currency you borrowed. Partial repayments are usually allowed and lower your LTV, which can be useful if you want to free up some collateral without closing out.
Once the platform verifies full repayment, it releases the hold on your collateral. You provide a destination wallet address, and the Bitcoin transfers back, settling within a few hours after blockchain confirmation. At that point the loan is closed and the Bitcoin is fully yours again.
How Taxes Work on Bitcoin-Backed Loans
The IRS classifies digital assets as property, not currency.4Internal Revenue Service. Digital Assets Two rules follow from that.
Taking the Loan Is Not Taxable
Receiving loan proceeds against your Bitcoin doesn’t trigger a tax obligation. You’re taking on a debt, not disposing of the asset, so there’s no taxable event when the loan funds. This is the same principle behind a home mortgage or a securities-backed line of credit: proceeds aren’t income because they come with an equal obligation to repay.5Office of the Law Revision Counsel. 26 USC 61 – Gross Income Defined
Liquidation Is Taxable
If the platform sells your Bitcoin during liquidation, or if you sell it yourself to repay, that sale is a property disposition. You owe tax on the difference between your original cost basis and the sale price.3Internal Revenue Service. Notice 2014-21
- Held one year or less: gains are taxed at ordinary income rates of 10% to 37%.
- Held more than one year: gains are taxed at long-term capital gains rates of 0%, 15%, or 20%.
A liquidation can produce a strange result. If you bought Bitcoin at $10,000 and the platform sells it at $50,000 during a crash from $80,000, you still realized a $40,000 gain for tax purposes, even though you lost a large share of your collateral’s peak value. Starting in 2026, crypto brokers must report cost-basis information to the IRS on certain transactions, so keep good records.4Internal Revenue Service. Digital Assets
Risks the Loan Agreement Won’t Cover
No FDIC or SIPC Protection
Bitcoin held on a lending platform isn’t protected by federal deposit insurance. FDIC coverage applies only to deposits at member banks and doesn’t extend to crypto assets, custodians, or exchanges.6Federal Deposit Insurance Corporation. What the Public Needs to Know About FDIC Deposit Insurance and Crypto Companies SIPC, which covers brokerage failures, doesn’t cover cryptocurrency either. If a centralized platform becomes insolvent, your collateral may be pulled into the bankruptcy estate rather than returned. Several major crypto lenders filed for bankruptcy in 2022, and their customers spent years trying to recover assets.
Platform and Smart Contract Risk
With a centralized lender, the risk is that the company mismanages funds, gets hacked, or goes bankrupt while holding your Bitcoin. With DeFi, the risk moves to the code. The U.S. Treasury has documented that DeFi services are vulnerable to exploits where attackers find flaws in smart contracts and drain locked funds without authorization.2U.S. Department of the Treasury. Illicit Finance Risk Assessment of Decentralized Finance There’s typically no insurance or government backstop to make you whole after either kind of failure.
Where Your Legal Rights Come From
When a lender takes your Bitcoin as collateral, the transaction creates a security interest in personal property under Article 9 of the Uniform Commercial Code.7Cornell Law School. UCC Article 9 – Secured Transactions A newer provision, UCC Article 12, addresses “controllable electronic records,” a category that includes cryptocurrencies. As of early 2025, more than 24 states and the District of Columbia had enacted Article 12. It establishes clearer rules for who holds enforceable rights in digital assets when they’re transferred or pledged. If you’re borrowing a large amount, checking whether your state has adopted Article 12 can help you assess how well your collateral rights are protected in a dispute.