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Bloomberg
Former Wall Street trader Edgar Fernandez used some of his Bitcoin as collateral to borrow nearly $100,000, a move that let him keep his cryptocurrency and avert a tax bill on the newly acquired cash.
The tax perk stems from a longstanding principle that assets aren’t taxed until sold, much like borrowing against stock holdings. Yet digital currency carries far greater risks, from price volatility, to hacks and thefts that can make the collateral disappear, to sometimes shadowy players without long track records in the field.
Since last fall, when the value of digital money plummeted, lenders have been pushing people who have paper profits to leverage them into cash by borrowing against their cryptocurrencies. And the fact that there’s no tax bill on the transactions is a big selling point. The Internal Revenue Services treats crypto money as a capital asset like stocks or property, not as a currency.
Genesis Capital, a cryptocurrencies lender in Jersey City, NJ, an affiliate of Genesis Trading, says it handed out more than $1.1 billion in cash loans and borrowed virtual cryptocurrencies in 2018. That total volume doubled in the last quarter of 2018 from the volume of the previous two quarters. Other lenders have also said they are doing more transactions, including Nexo, a cryptocurrencies lender that says it has loaned $330 million since launching last April.
Swiss-based Nexo AG, which says it has affiliates in Delaware, the Cayman Islands and Estonia, conducts its cash loans out of London, according to co-founder and managing partner Antoni Trenchev, an ex-legislator from Bulgaria.
Experts call the digital-currency lending world a “Wild West†environment, because many of the lenders seem to pop up out of nowhere, have sprawling overseas affiliates, and can sometimes be opaque about where or how they store a borrower’s digital currency to keep it safe from hacking.
Even the lenders acknowledge it’s a risky bet.
Pat Larsen, the co-founder and chief executive officer of ZenLedger, said the dangers should be obvious. “It’s always risky to get a loan with a highly volatile asset,†he said.
Cryptocurrency lenders aren’t subject to oversight by the US Securities and Exchange Commission or the Commodity Futures Trading Commission. Those that claim to be “regulated†are governed by state agencies that oversee non-bank companies.
While the SEC has flagged initial coin offerings by some lenders for scrutiny, it doesn’t mention their or others’ cash lending operations.
The IRS hasn’t addressed crypto-backed cash loans.
Bitcoin enjoyed a steep climb at the end of 2017, rising in value from about $1,300 in April to $19,100 in December 2017, so early investors have paper gains against which they could borrow.
Since then, however, virtual currencies have hit their most protracted downturn ever. Bitcoin now trades at about $4,100.
That’s one of the biggest risks, because the loan is tied to the borrower “betting on whether the market is going to go up or down,†said Andrew Kernosky, the owner of Archer Tax Group, which specialises in cryptocurrency taxes.
Borrowers give the lender about 20 percent to 50 percent more cryptocurrency than the cash they want. Loan amounts range roughly from $500 to $2 million for as long as a year, with interest rates varying from a few percentage points to around 16 percent.
If prices plummet and the borrower doesn’t put up more collateral, the pledged coins could be forcibly sold, or the borrower could have to buy more virtual currency to make up the shortfall, all while shouldering the loan balance.