I've noticed a lot of talk about financing using Bitcoin as collateral and using that to live off Bitcoin. I just want to share my thoughts and findings, both to solidify what is in my head, but also in the hopes that it helps anyone trying to understand it as well.
I've looked around, focusing on collateral loans, and there are a few financial products. Living in the UK, my options are limited. Some lenders allow borrowing for up to 3 years, whereas some only allow borrowing for a few months. There was Nexo which has an interest only plan with no time limit for paying off the capital. This is interesting, but one thing to note, they have an interest rate of 11.9% whereas others have around 8%. So that's around 4% for the convenience. Nexo can also increase your loan value instead of taking interest payments allowing you to survive the loan without any income until your collateral doesn't cover the loan anymore and you lose your collateral.
Borrowing for a few months is not really suitable for much because if you can earn the money you need in a few months, you probably don't need that loan. So it's kind of like payday loan and it is designed to get you by rather than to help you grow your wealth. It can also be useful for short term speculation based trading. It gives you money to play with and if you're lucky, you made a bit of money, but for me personally, the risk is too high to justify.
Borrowing for 3 years might lead you into the next bear market, so you may need to add to the collateral before you get to the end of the loan. You will be paying off the loan over time, so there's also a reasonable chance that you may never need to add more collateral. So what can you get for your collateral? You can get up to 80% of your Bitcoin's worth in Fiat, but most lenders offer up to 50% which is sensible. The more you borrow, the higher the chance of being asked for more collateral or having your loan immediately payable.
What do you do with that money? You can't live off of it, because then you'd have no money to pay back the loan. If you pay off the loan with the Bitcoin, that is a taxable event and you will need to pay taxes on that. Consider also, that if you are trying to reduce your tax bill, giving $2,000 after investing $1,000 and seeing it rise to $4,000 today, will leave you paying tax on 75% of your $2,000 payment, but in a few years, lets say your Bitcoin investment rose to $8,000, you would now be paying tax on 87.5% of your $2,000 and this is after paying loan interest. So you're not saving on taxes, but you are "keeping" your Bitcoin as Bitcoin which is good. You have to project your expectations, compare the profits and losses and decide if the benefit is worth the risk. Part of that is knowing if the risk is something that could break you financially. If it is, don't go any further, it isn't worth any potential reward. A lot of people cite these loans as a way to avoid paying taxes, so I will assume they are not talking about this strategy.
Ok, so what do you do with the money? You re-invest it. I don't think investing into Bitcoin is great when trying to avoid taxes, because again, in order to pay the loan, you need to sell some of the Bitcoin and we're back to the previous scenario. So instead, maybe you can invest in property. You now have 2 loans, but you also have a source of income in the best case scenario. Buying a property for renting has its own risks to consider, but you can make some income if you do it responsibly. The key here is earning rent money. If you aren't doing that, you can't pay your loans. This is income and you will be taxed on that. You also might only get enough rent to cover the mortgage, if you're smart, you have excess to cover interest on your first loan and maybe even some collateral to protect against bear markets requiring you to add more Bitcoin to your collateral.
Let's talk about taxes on that rent. You earn $900, and you pay $500 on the mortgage, $100 of which is interest. So you get $400 to spend a month (although some of it should go towards your loan) but you pay tax on $800 of profit because they only allow you to offset the interest part of your mortgage. You also need to save a lot of that money for expenses like fixing the boiler and that means you still haven't got enough to live. You get multiple properties, but that's not living off Bitcoin as much as living off a real estate.
Can you re-invest the money into Bitcoin and earn income from that instead? Well yes, but when you cash out, you have to declare it for gains (unless you cash out immediately, some companies might help by paying your interest in fiat) and you'd pay income tax with no relief for the loan interest. Turns out the real estate guys figured out how to be special and get relief for their loans. Right off the bat, your interest will be lower than the interest on the loan. You usually can get about 6% but pay interest on the loan around 8% - 12%. Eventually, if Bitcoin becomes super valuable, your interest can overtake the loan interest because 6% of your Bitcoin is more than 12% of your original loan in fiat. That's a long term hope based on speculation, that's a high risk and you're making losses in the short term.
On top of all of that, you could have instead put the Bitcoin into an interest account instead of even doing anything with the loan and you'd get twice the interest since you put in twice the amount of Bitcoin, and no debts to pay.
If your Bitcoin was worth millions, you could put your coins into something like Nexo and take small loans over time to spend on living. This should give you plenty of space for adding more collateral on margin calls during bear markets, and you can even have the interest pile up on the collateral. This might last for a while and you can live the life, but eventually, you will owe a large amount to Nexo and they may have a limit to how much you can borrow with this strategy (it would seem dumb not to) so you will then have a bill to pay. If Bitcoin is constantly rising, then you could have lived the life for a while and even borrowed millions when you started with just a million dollars of Bitcoin and when you go to pay it all off, you might still only give up a fraction of your Bitcoin. In this case, you did well, but for the sake of taxes, you still have to pay taxes on the amount you pay back (which is the amount you borrowed* plus interest) but by then, you've already let that money work for you. You have deferred the taxes enough that pretty much used inflation to your advantage, but you didn't completely avoid taxes. There's some maths to do to see how much that benefit is because the difference may influence your decision.
*The amount you borrowed minus the price you purchased that much Bitcoin for, but by then it's probably so small its negligible.
The last option is probably the best option, but you have to start with a substantial amount of Bitcoin and then you might want to diversify your assets in case Bitcoin crashes enough to put you in trouble, then your other asset might prevent you from bankruptcy. You also have more risk than just the price of Bitcoin; you have your Bitcoin in someone else's custody and that is also a pretty big risk. There's also still a lot of controversy around Bitcoin and governments are still allowed to govern the companies that you service with.
Ultimately, maybe if I get millions in Bitcoin, I might look into the risks again to see if they are reduced by then and possibly look into this then. But for now, it seems like the risk reward ratio for these loans are just not sensible.
I also think that even if I did take this strategy, I would want to use half of the money I borrow to invest in another asset so the risk is diversified. That asset will give me time to sort everything out if it all goes south and I need to get a job after all.
Oh, and then there's inheritance tax. Guess they get the last laugh!
I'll end with a question: What are people's thoughts? Did I get something wrong? Has it helped you? Do you have a different strategy in mind?
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