Bitcoin-backed loans for institutional portfolios

Disclosure: The views and opinions expressed herein are solely those of the author and do not necessarily represent the views and opinions of crypto.news editorial.

As we move towards 2024, the idea of ​​using Bitcoin (BTC) as loan collateral is becoming increasingly common. Individuals and businesses around the world are depositing their Bitcoins in exchange for significant amounts of liquid capital.

Consider how real estate investors use mortgages. They have long known that borrowing against an asset they believe will appreciate in value is a smart move. Why sell something you think will increase in value when you can borrow money in return? When comparing Bitcoin loans to mortgage financing on real estate, both types of loans operate on the assumption that these assets will appreciate in value over the long term; Why sell something you think will increase in value instead of borrowing instead?

Bitcoin and real estate financing

Because physical property is a finite resource, it almost always maintains or increases in value. The same can be said for Bitcoin as it has a limited supply. This scarcity is what makes mortgage loans an important tool in real estate investment, and Bitcoin-backed loans offer a similar proposition.

However, Bitcoin offers unique advantages that differentiate it from traditional securities.

With $40 billion in daily transaction volume and a 24/7 global market, Bitcoin is incredibly liquid. This significant and relatively untapped liquidity allows large positions to be liquidated within minutes at any time, significantly reducing credit risk by ensuring that lenders using it as collateral can recoup their funds with minimal delay or loss. Moreover, Bitcoin’s low correlation with traditional asset classes makes it an attractive diversification tool for institutional investors. Compare this to mortgage financing, where selling a property can take weeks or months and involves a complex process of multiple steps. In real estate, the cumbersome liquidation process means lenders face greater risk of recovering value in the event of default, as they may face delays, market fluctuations and potential losses.

Structural parallels: Bitcoin loans and equity financing

Although Bitcoin-backed loans are built around the same logic as real estate financing, they are actually structurally more similar to equity financing. When investors enter into equity financing, they are subject to margin calls. For example, if the stock price falls, the bank may ask the investor to deposit cash or sell some of his shares to cover the loan. Bitcoin-backed loans work the same way but offer several advantages.

An important advantage is that Bitcoin is borderless. Unlike traditional assets, which can vary significantly in quality due to differences in regulation and exchange by jurisdiction, Bitcoin is the same for everyone and everywhere. It remains the same regardless of geography. This means that lending against Bitcoin is not affected by the complexities of various jurisdictions or property rights that often complicate traditional lending. Whether the borrower is in Canada or Argentina, the Bitcoin used as collateral is the same, greatly simplifying the lending process and eliminating many of the geographic risks associated with traditional cross-border financing.

Institutional investors: Attractive returns in a falling interest rate environment

The economics of Bitcoin-backed loans are particularly attractive in the current financial environment. Bitcoin-backed loans are offering significantly higher interest rates, typically in the 12-14% range, as investors become concerned that traditional fixed income products may struggle to provide meaningful returns in a falling interest rate environment. This premium exists in the digital asset sector due to perceived risk, but we can expect this premium to decrease over time as more traditional institutions enter this space.

Looking ahead, we can foresee the development of a secondary market for syndicated Bitcoin-backed loans, similar to traditional financing. Additionally, a securitization product similar to the mortgage-backed securities market may also develop. This will further professionalise the sector, increase liquidity and potentially lead to more attractive products and rates for both lenders and borrowers.

For institutional investors, Bitcoin-backed loans offer an attractive alternative to traditional fixed-income investments such as money market funds and treasury bonds, especially in an environment where interest rates are falling. Although the price of Bitcoin can be volatile, the over-collateralized structure and the ability to liquidate collateral almost instantly provide significant security for the preservation of capital.

It is important to note that the Bitcoin lending industry is still in its early stages, comparable to the early beginnings of home mortgages. Currently, only an estimated 2% of Bitcoin has leverage, compared to roughly 60% of American households. As Bitcoin continues to grow and stabilize and people become more comfortable using it as collateral, the market size of Bitcoin-backed loans is poised to grow tremendously.

It is clear that Bitcoin-backed loans are moving from the fringes of finance into the mainstream as traditional financial institutions begin to enter the space. However, it is currently the established digital asset firms that have the expertise and experience in this unique market.

Ultimately, Bitcoin-backed loans represent a significant evolution in the world of finance. It combines the best aspects of traditional lending with the unique features of Bitcoin, offering unparalleled liquidity, global accessibility and potentially higher returns. As the market matures and becomes more regulated, we can expect increased participation from institutional investors, further legitimizing and expanding this exciting new frontier in lending.

Combined with the advantages of an inherently digital currency and always-on market, financing through Bitcoin loans is becoming an increasingly attractive option for many businesses.

As the financial landscape evolves, Bitcoin-backed loans are likely to become a major player in the future of finance as more businesses realize the unique opportunities these regulations can offer.

Man Reeds

Adam Reeds is the co-founder and CEO of Ledn, a global company regulated in the Cayman Islands focused on creating financial products that help people grow their digital wealth. Before founding Ledn, Adam spent a decade at Dream Asset Management; where it developed, built and financed a $1.5 billion portfolio of renewable energy projects. What brought Adam to Bitcoin mining was Bitcoin’s connection to energy; he and his co-founder identified a gap in the financing of digital assets. Today, Ledn is a broad financial services platform with customers in more than 120 countries and over $6 billion in digital asset-backed loans since its founding. Adam is a graduate of the Richard Ivey School of Business’ HBA program and also holds a Bachelor of Science in Engineering from the University of Western Ontario.