By Anthony Diosdi
Cryptocurrency investors are turning to lending primarily for liquidity reasons- by putting up cryptocurrency as collateral, they can continue to invest in the digital currency market while obtaining access to cash. There are two main types of cryptocurrency as collateral, they can continue to invest in the digital currency market while obtaining access to cash. This article will take a closer look at cryptocurrency loans. There are two main types of cryptocurrency loans that are discussed below.
What is Cryptocurrency?
Cryptocurrency has grown in popularity and ubiquity in the past few years. Cryptocurrency is a type of digital or virtual currency that uses cryptography for security. Cryptography allows digital currency transactions to be pseudonymous and secure with no bank or other intermediary requirement. Although some major retailers accept cryptocurrencies like Bitcoin, cryptocurrency is not money. Money means coin and paper money that Congress declares is legal tender. Cryptocurrencies are extremely volatile, especially compared with conventional financial instruments like stocks and bonds. That volatility plays a central role in the appeal of virtual currency.
What is a Cryptocurrency Loan?
A cryptocurrency loan is a secured loan in which an individual pledges an asset to secure financing. In the case of a cryptocurrency loan, virtual currency is the asset offered to a lender. If the loan is not repaid, the lender will liquidate the cryptocurrency pledged as collateral. A cryptocurrency loan may be used by an individual who holds crypto assets and would like to use these crypto assets to invest in businesses or other assets without suffering the tax consequences of liquidating cryptocurrency.
As indicated above, there are two types of cryptocurrency loans. The first type of cryptocurrency loan involves one party (the borrower) borrowing virtual currency from another party (the lender) with the borrower posting collateral. The borrower agrees to return to the lender an identical amount of the same virtual currency at the end of the agreement and the lender agrees to return the collateral. These transactions are typically structured to resemble securities lending transactions. The borrower is free to sell or otherwise dispose of the cryptocurrency subject to the loan, and the lender is often allowed to sell or otherwise dispose of the collateral. If during the term of the agreement there is an airdrop or hard fork with respect to the particular virtual currency that was borrowed, the borrower transfers back to the lender units of virtual currency identical to those that were received in the airdrop or hard fork.
In brief, a hard fork represents a permanent change to the coding of a virtual currency’s underlying blockchain that necessitates the creation of a separate and distinct cryptocurrency. Another transaction unique to cryptocurrency is the airdrop. An airdrop involves the distribution of new cryptocurrency to a current or potential investor for free.
In the second type of transaction, a lender loans the borrower fiat currency and the borrower posts virtual currency with the lender as collateral. A principal objective of these transactions is for the borrower to monetize a virtual currency position without triggering a taxable sale. These transactions are relatively straightforward. When the loan matures, the borrower repays the lender the dollar amount of the loan plus interest, taking back identical virtual currency to that which the borrower had posted as collateral. If during the term of the loan there is an airdrop or hard fork, the lender must transfer to the borrower virtual currency units identical to what is received in the airdrop or hard fork.
The Risk of Cryptocurrency Loans
Cryptocurrency loans are not without risk. The volatility of cryptocurrency may result in a cryptocurrency pledged dropping below the threshold amount established by the lender. This may result in the borrower having to pledge additional crypto assets to the lender.
Conclusion
Overall, cryptocurrency loans is an emerging area. If you are considering borrowing against your crypto assets, you should consult with a tax attorney well versed in cryptocurrency to avoid triggering an unintended tax consequence.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on international and domestic tax planning. He advises multinational companies, closely held businesses, and individuals on a host of complicated tax matters. Anthony has authored numerous articles on international and domestic tax planning.
Anthony Diosdi is a frequent speaker at international tax seminars. Anthony Diosdi is admitted to the California and Florida bars.
Diosdi Ching & Liu, LLP has offices in San Francisco, California, Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises throughout the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.