Borrowing Against Crypto Holdings Example

I saw this tweet the oth­er day, did some quick math in my head, and won­dered if what “Dr. Satoshi” was doing made sense:

Just took out a 1000 USDC loan from @CelsiusNetwork. Took about 7 hours to be approved and funds in my account. Was able to with­draw and do what­ev­er I want­ed with it. I bought some @RealTPlatform. Loan was at 1%. RealT yields ~10%.

— Dr. Satoshi (@drsatoshi2) May 29, 2020

Let’s break this down.

Celsius is the “Unbank”. Their busi­ness mod­el is to be sit in between depos­i­tors and buy­ers of cryp­tocur­ren­cies, facil­i­tate loans, and reward depos­i­tors with high­er inter­est than a legacy/fiat bank. They do this all while hav­ing increased trans­paren­cy so you know what they’re up to.

Celsius are run­ning a spe­cial:

The impor­tant point for the sake of this break­down is that bot­tom line — 25% LTV. LTV stands for “loan to val­ue” and that means that you have to have 4x the amount of cryp­tocur­ren­cy on deposit against which can be bor­rowed.

“Dr. Satoshi” above bor­rowed 1,000 USDC (US dol­lar coins, essen­tial­ly $1,000), which means he has to have $4,000 worth of cryp­to on deposit in order to bor­row that $1,000.

Celsius pays inter­est on cryp­to hold­ings that are not used to secure a loan. It does not pay when the cryp­to is used to secure a loan. In a lat­er tweet “Dr. Satoshi” shares that they’re using BTC (bit­coin) to secure the loan, a quick glance at their cur­rent rates shows that s/he could earn about 4% on their hold­ings (Celsius rates vary week-to-week).

“Dr. Satoshi” is excit­ed to earn about 10% on their 1000 USDC loan. Rounding the rates to assume no com­pound­ing and that rates are the expect­ed annu­al yield… they’d earn about 100 USDC over the year.

However, they’re pay­ing 1% on the loan, which means they’re earn­ing 90 USDC (it’s 1% on the 1,000 USD bor­rowed).

And, they’re for­feit­ing 4% inter­est on $4000 worth of cryp­to that’s used as col­lat­er­al for the loan. That’s $160.

So, they’re for­feit­ing $160 in income to earn $90, while tak­ing on the risk that their loan gets called if their col­lat­er­al val­ue drops. A 25% loan to val­ue is kin­da con­ser­v­a­tive, but cryp­tocur­ren­cies are volatile; in any case it’s more risk than not tak­ing the loan.

With more risk, the investor should expect more reward. Only in this case, they’re los­ing mon­ey!

Obviously, “Dr. Satoshi” expects their invest­ment in RealT to increase more than the amount they’re los­ing in the inter­est arbi­trage.

Also, they might be doing this (as I would) to learn — how does a loan work? how does RealT work? and in that case… the small amount they’re “los­ing” is not a loss, but an invest­ment in edu­ca­tion. It’s how I would do it, because I learn by doing and through expe­ri­ence.

Or, they might be doing it to diver­si­fy their hold­ings. Now, instead of just the bit­coin they used as col­lat­er­al, they have two hold­ings: bit­coin and the tok­enized real estate.

Why would one take a loan against hold­ings then, instead of sell­ing? Not the point of this post, but here are some bul­lets:

1. Avoid cap­i­tal gains tax because there’s no sale of assets. Maybe you want to sell over a few sep­a­rate tax years to min­i­mize tax­es by stay­ing in a low­er brack­et, or sim­ply to pay tax­es over a cou­ple of dif­fer­ent years. (Disclosure: This is not tax advice!)
2. Continue to be exposed to upside while being able to cash out some to spend (you’d do this if you were long-term bull­ish and want­ed to keep the invest­ment in play, while at the same time increas­ing your qual­i­ty of life).
3. To diver­si­fy… maybe you hold BTC and it’s appre­ci­at­ed a lot, and you want to say, buy a home. You don’t want to sell (because of cap­i­tal gains and because you’re long-term bull­ish) but you need cap­i­tal as a down­pay­ment for the home.
4. And of course, my favorite (and some­thing I strong­ly rec­om­mend if you’re curi­ous about this space), they did it to learn some­thing new. What is it like to take a loan? How does it work? When I did it, was there any­thing that hap­pened that I did­n’t expect? What can I learn about RealT? Etc.

Anyways, not an exam­ple of my best writ­ing, but I hope a use­ful exam­ple of how to think through a deci­sion like this for your­self. Questions/comments are wel­come below, but please keep them positive/constructive.