Using Bitcoin as loan collateral provides a clear advantage for asset holders: they obtain instant cash liquidity without needing to sell their coins, thereby avoiding capital gains tax liabilities in the United States. However, this tax-free cash avenue demands a high level of security behind the scenes, particularly regarding who controls the collateralized coins during the credit term.
Arch Lending CTO Himanshu Sahay emphasized that credit services with Bitcoin collateral absolutely require qualified custody and a zero rehypothecation policy. A zero rehypothecation policy means platforms are prohibited from touching or redeploying client collateral to seek additional profits in secondary markets.
LTV Limits and Price Drop Risks
While this loan scheme frees clients from tax liabilities, it places them face-to-face with market volatility. Borrowers face the risk of margin calls and forced liquidation if the market price of Bitcoin falls sharply below the Loan-to-Value (LTV) ratio agreed upon at the start of the contract. The Arch Lending platform itself sets the maximum LTV limit at 60%.
If price movements breach this ratio, clients must choose: immediately inject additional funds, add collateral, or allow their Bitcoin to be forcibly sold by the system. This is a measured risk that depends on market figures. However, there is another systemic risk that can wipe out client assets without a margin call warning.
Breaking the Chain of Counterparty Failures
That systemic risk stems from the practice of rehypothecation, which triggers counterparty risk. To prevent this, Arch Lending deposits all client collateral with Anchorage Digital Bank. The choice of this institution is based on Anchorage’s status as a US federally chartered custodian bank, ensuring that clients’ coins remain in place and will not be misused.
The history of the crypto market proves how costly negligence in this area can be. The practice of redeploying client collateral assets was the main trigger behind the domino effect that led to the mass collapse of lending platforms in 2022. At the time, collateralized coins were lent out again to other parties, so when one entity defaulted, a series of platforms collapsed alongside it, and clients lost all of their assets.
For Bitcoin owners, taking a loan from a platform without official custody protection means placing their coins on a secondary gambling table. Ensuring the existence of a zero-rehypothecation clause has now become an absolute necessity before signing any credit contract.
Reported from crypto.news.
Read also: What Is DeFi (Decentralized Finance)?
Disclaimer: This article is for informational and educational purposes only, not financial advice. Cryptocurrency assets are highly volatile and carry significant risk. Always do your own research (DYOR) and never invest more than you can afford to lose.
