The crypto lending market has been experiencing an increasing interest in the past 12 to 18 months. More and more HODLers are using their digital asset holding as collateral for fiat currency loans.
While the reasons to take out loans are myriad, one of the biggest arguments for taking out a crypto-backed loan is that it can help investors reduce their crypto tax bill.
In this article, you will learn how you can reduce your capital gains tax burden by leveraging crypto lending platforms.
What are crypto-backed loans?
As the name indicates, crypto-backed loans are loans that are backed by collateral in the form of cryptoassets.
Borrowers are, therefore, able to receive fiat currency without having to sell their crypto holdings.
Unlike traditional loans, however, no extensive documentation or credit checks are required to borrow.
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Instead, the crypto collateral is held in smart contracts once a loan is agreed. In the case that the value of the collateral drops below a certain level, the borrower receives a margin call to provide more cryptoassets as collateral.
Benefits of crypto-backed loans
Crypto-backed loans come with a number of benefits over traditional loans, which explains why the crypto lending space has been getting more attention in the past twelve months.
The key benefits of crypto-backed loans are as follows:
- Loans can be taken out almost instantly
- Borrowers are not required to undergo credit checks
- Little to no personal documentation is required to borrow
- Crypto-backed loans come with lower interest rates than bank loans
- Blockchain technology provides more transparency and security
- The value of your collateral could increase and generate a return on investment
- Access to cash without creating a taxable event
How to take out a crypto-backed cash loan to save on taxes
There are multiple crypto lenders such as BlockFi, Celsius Network, Nexo, EthLend, and others.
BlockFi, explains in a blog post: “Selling crypto is a taxable event. Exchanging crypto-for-crypto is a taxable event.
But borrowing money against your crypto is NOT a taxable event. This makes lenders [...] a great way to gain access to USD without having to sell your crypto investments.”
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Let’s use the Switzerland-based crypto lending platform Nexo as an example how the process looks like.
To take out a (fiat currency) cash loan, you first need to select the crypto asset (bitcoin, ether, XRP etc.) that you want to place as collateral. Next, you enter the amount of money (in one of 45 fiat currencies) that you would like to borrow in exchange for your crypto collateral.
The platform will then show you the amount of crypto collateral you will need to place, how much interest you will pay each day and then prompts you to create an account to secure the credit line.
Next, you will need to confirm your registration via a confirmation email, and then, you will be taken to your account dashboard.
Here, you can deposit and manage your collateral, and complete the loan agreement to acquire your first crypto credit line. The fiat currency is then deposited to your bank account.
Arguably the best part of a crypto-backed credit line is that it enables you to get your hands on cash without having to sell cryptoassets, which means no taxable event takes place.
While borrowing cash against cryptocurrency collateral is not a risk-free venture, by all means, it can be another way to save on taxes as a crypto investor.