Using cryptocurrency as collateral to borrow money lets borrowers keep their digital assets while avoiding taxation of the cash, Bloomberg writes.
The process is similar to borrowing against stock holdings—until a sale takes place, assets aren’t taxed. However, there are risks that go along with using crypto as collateral—cryptocurrencies are at a greater risk of price volatility, hacks, and thefts.
In order to get a loan, borrowers give the lender cryptocurrency as collateral. Depending on a lender, the digital assets are typically worth between 20 per cent to 50 per cent more than the money they receive.
However, if cryptocurrency prices plummet and the borrower doesn’t provide the lender with more collateral, the collateral may be forcibly sold; the borrower may also be forced to buy more digital assets. Moreover, the lender may secretly loan out the tokens it received as collateral. In that case, the IRS is likely to treat it as a sale taxable to the original owner.
The IRS does not treat crypto assets as money; rather, as capital assets, similar to stocks or property. As of now, there is no tax bill that would govern borrowing against cryptocurrencies, either. Cryptocurrency lenders are not regulated by the U.S. Securities and Exchange Commission or the Commodity Futures Trading Commission, either. In fact, according to Bloomberg, “cryptocurrency lenders aren’t subject to oversight by the U.S.”
BlockFi CEO Zac Prince advised, “If you’re still bullish, you’re better off from a tax perspective selling it, buying it back and then borrowing against it.” A capital loss is tax deductible—an investor may deduct up to $3,000 a year.