Former Wall Street trader Edgar Fernandez used some of his Bitcoin as collateral to borrow nearly $100,000, a move that let him keep his cryptocurrency and avert a tax bill on the newly acquired cash.
The tax perk stems from a longstanding principle that assets aren’t taxed until sold, much like borrowing against stock holdings. Yet digital currency carries far greater risks, from price volatility, to hacks and thefts that can make the collateral disappear, to sometimes shadowy players without long track records in the field.
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Since last fall, when the value of digital money plummeted, lenders have been pushing people who have paper profits to leverage them into cash by borrowing against their cryptocurrencies. And the fact that there’s no tax bill on the transactions is a big selling point. The Internal Revenue Service treats crypto money as a capital asset like stocks or property, not as a currency.
Genesis Capital, a cryptocurrencies lender in Jersey City, New Jersey, an affiliate of Genesis Trading, says it handed out more than $1.1 billion in cash loans and borrowed virtual cryptocurrencies in 2018. That total volume doubled in the last quarter of 2018 from the volume of the previous two quarters. Other lenders have also said they are doing more transactions, including Nexo, a cryptocurrencies lender that says it has loaned $330 million since launching last April.
Experts call the digital-currency lending world a “Wild West” environment, because many of the lenders seem to pop up out of nowhere, have sprawling overseas affiliates, and can sometimes be opaque about where or how they store a borrower’s digital currency to keep it safe from hacking.
Even the lenders acknowledge it’s a risky bet.
But creditors are willing to accept this risk because that would bring them a fair amount of money in the future.
Borrowers give the lender about 20 percent to 50 percent more cryptocurrency than the cash they want. Loan amounts range roughly from $500 to $2 million for as long as a year, with interest rates varying from a few percentage points to around 16 percent.
If prices plummet and the borrower doesn’t put up more collateral, the pledged coins could be forcibly sold, or the borrower could have to buy more virtual currency to make up the shortfall, all while shouldering the loan balance.
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