Crypto for Advisors: Bitcoin and Lending

One thing is for sure: the crypto landscape is changing; regulatory frameworks and new products continue to evolve. How can advisors help their clients navigate the options in the space?

In today’s issue, Meredith Yarbrough, managing partner at La Hoja Capital Partners, discusses bitcoin’s role as collateral in lending and the potential benefits it could provide.

In Ask the Experts, Eric Tomaszewski of Verde Capital Management discusses the existence of Bitcoin-backed mortgages, how they work, and the risks involved.

-Sarah Morton

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Bitcoin as Collateral: Good for Borrowers, Good for Lenders, Good for Investors

Finance, an ancient discipline shaped by a variety of moral philosophies, has seen borrowing and lending practices evolve over the centuries. Early Islamic, Jewish, and Hindu traditions prioritized mutual benefit and asset management, focusing on fair risk sharing rather than interest payments. In this context, thoughtful and pioneering credit managers are emerging to integrate bitcoin, a distinctive digital asset, into a new opportunity to reshape financial relationships. When added to the collateral package in a structured loan, bitcoin’s inherent properties create potential benefits for borrowers, lenders, and investors. By aligning the interests of all parties with a long-term perspective on asset value, bitcoin collateralization can foster a more sustainable and mutually beneficial approach to private credit.

Bitcoin as collateral

We are seeing innovative asset managers like Battery Finance Inc. use bitcoin in a hybrid collateral model where loans are made based on the value of the real estate asset and an amount of bitcoin that will be purchased with the loan proceeds, thus creating two collateral assets to secure the loan.

Bitcoin’s unique features strengthen its credit structure as it functions as both a growth asset and an inflation-sensitive asset. Its increasing adoption and market demand are due to its innovative blockchain technology and decentralized structure, which positions it as a store of value against inflation and geopolitical turmoil. Unlike precious metals, bitcoin’s supply is truly finite, capped at 21 million coins, with mining expected to be completed around 2140. This scarcity contributes to its value proposition by strengthening its role as a growth asset while increasing its sensitivity to inflationary dynamics.

Benefits for Lenders and Investors

The primary responsibility of the credit manager is to ensure the return of principal and interest. Managers must balance return objectives with credit risk, often introducing increased risk as the need for increased return fluctuates with the consequences of interest rate changes and inflation.

The story continues

Moreover, in an environment of rapid and profound technological change, many industries are under pressure to adapt their business models amidst uncertain transformations. Periods of relatively high inflation intensify the challenges for these businesses. For credit managers, any significant change in operational strategies means a significant change in credit risk. By adding bitcoin to the collateral structure, a manager can reduce credit risk while maintaining return targets.

Additionally, bitcoin’s significant growth potential enhances overall portfolio returns. By including bitcoin collateral, portfolios benefit from enhanced diversification because bitcoin’s performance is uncorrelated with traditional credit portfolio characteristics such as interest rates and inflation dynamics. With this tool in hand, managers can prioritize high-quality borrowers and durable structures, bypassing the common dilemma of taking on incremental credit risk to generate incremental returns.

Benefits for Debtors

Integrating Bitcoin into the collateral structure offers significant benefits for borrowers by developing a shared long-term perspective on its value. This alignment ensures that lenders are incentivized to act in the best interests of the partnership.

Borrowers benefit from professional management of their bitcoin assets by a loan manager who monitors price thresholds and manages profit events. This active management helps optimize the value of the asset and provides borrowers with an additional layer of expertise and control. Additionally, accruing bitcoin equity offers borrowers greater flexibility, allowing for early repayment and exit options.

Additionally, incorporating Bitcoin into the collateral package could provide borrowers with access to more favorable credit terms. Improved collateral security could lead to lower interest rates and better borrowing terms, reflecting the reduced risk profile of the loan. The emergence of Bitcoin in collateral structures has the potential to revolutionize the lending landscape. Its ability to mitigate credit risk amidst increasing uncertainty highlights its transformative power.

Ultimately, the successful implementation of this strategy depends on the competence and agility of the credit management team.

-Meredith Yarbrough, managing partner, La Hoja Capital Partners

Ask an Expert

Q: Can I use Bitcoin as collateral to buy a house?

Yes, there are ways to use bitcoin for this purpose, but it is complex and depends on a variety of factors. However, how the bitcoin is stored or packaged can narrow down the options.

It’s more important to ask yourself how Bitcoin fits into your goals and expectations for you and your family. From there, it’s about evaluating the risks to your collateral, which are volatility, potential liquidation risks, regulatory risks, and custody risks.

Q: Can you provide more detailed information about the risks?

Regulatory Environment: The legal/regulatory environment for using Bitcoin as mortgage collateral is still evolving. Staying informed is key.

Volatility and Risk Management: Bitcoin’s price volatility poses significant risk. This is an underestimate, as BTC is trading 20% ​​lower in less than 24 hours. Price movements are significant because lenders typically require a lower loan-to-value (LTV) ratio to mitigate this risk, meaning borrowers may need to provide significant collateral.

Interest Rates and Fees: Interest rates and fees for Bitcoin-backed mortgages can differ from traditional mortgages and have been a few percentage points in most cases. Borrowers need to compare the costs and benefits of these innovative products.

Security/Custody: Keeping collateral secure is also important. Lenders often use third-party or multi-signature wallets to protect bitcoin collateral.

– Eric Tomaszewski, Financial Advisor, Verde Capital Management

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