Crypto lenders push no-tax perk of leveraging bitcoin for cash

The tax perk stems from a longstanding principle that assets aren’t taxed until sold, much like borrowing against stock holdings and IRS treats crypto money as a capital asset like stocks or property, not as a currency


Former Wall Street trader Edgar Fernandez used some of his bitcoin as collateral to borrow nearly US$100,000 (RM410,000), 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.

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 Services (IRS) 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, said it handed out more than US$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 AG, a cryptocurrencies lender that said it has loaned US$330 million since launching last April.

Swiss-based Nexo, which said it has affiliates in Delaware, the Cayman Islands and Estonia, conducts its cash loans out of London, according to co-founder and managing partner Antoni Trenchev, an ex-legislator from Bulgaria.

Cryptocurrency lenders aren’t subject to oversight by the SEC or the CFTC

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.

Pat Larsen, the co-founder and CEO of ZenLedger, said the dangers should be obvious. “It’s always risky to get a loan with a highly volatile asset,” he said.

Cryptocurrency lenders aren’t subject to oversight by the US Securities and Exchange
Commission (SEC) or the Commodity Futures Trading Commission (CFTC). Those that claim to be “regulated” are governed by state agencies that oversee non-bank companies. While the SEC has flagged initial coin offerings by some lenders for scrutiny, it doesn’t mention their or others’ cash lending operations.

The IRS hasn’t addressed crypto-backed cash loans.

Bitcoin enjoyed a steep climb at the end of 2017, rising in value from about US$1,300 in April to US$19,100 in December 2017, so early investors have paper gains against which they could borrow. Since then, however, virtual currencies have hit their most protracted downturn ever. Bitcoin now trades at about US$4,100.

That’s one of the biggest risks, because the loan is tied to the borrower “betting on whether the market is going to go up or down”, said Andrew Kernosky, the owner of Archer Tax Group, which specialises in cryptocurrency taxes.

Borrowers give the lender about 20% to 50% more cryptocurrency than the cash they want. Loan amounts range roughly from US$500 to US$2 million for as long as a year, with interest rates varying from a few percentage points to around 16%.

The lenders’ pitch is that borrowing against cryptocurrencies lets borrowers unlock profits

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.

The lender could also secretly loan out the pledged collateral, a move that the IRS would likely deem a sale that’s taxable to the original borrower.

Some lenders hold the collateral at state-regulated custodians like Gemini, BitGo and PrimeTrust, but others have muddied the waters. SALT Lending, a cash loan provider, is being investigated by the SEC in relation to its sale of US$50 million of digital tokens to borrowers, the Wall Street Journal reported. A SALT Lending spokeswoman said the firm was unable to comment on the investigation.

The lenders’ pitch is that borrowing against cryptocurrencies lets borrowers unlock profits, while avoiding capital gains taxes that would come from selling them.

“It’s a way to remain invested and not create a taxable event and get access to liquidity,” said Fernandez, a former trader in Latin American debt at Barclays plc and Bank of America Corp who borrowed from BlockFi, an online lender whose backers include billionaire Mike Novogratz’s Galaxy Digital Ventures LLC and Fidelity Investments.

With bitcoin’s notorious price swings, he added, “there is definitely a risk”. But it may be on a small list of options for people who need cash, given that traditional banks don’t count holdings in digital tokens toward credit-worthiness.

Last January, a would-be borrower who uses the name Satoshi Junior — a nod to bitcoin’s mysterious founder Satoshi Nakamoto — wrote online that he needed cash to pay rent but didn’t trust online lenders not to steal or lose his cryptocurrencies because of the risk. He warned against the practice, writing that had he done so, it “would’ve meant risking my funds getting stolen or confiscated at some point during my loan”.

Kernosky said he had a client whose collateral was confiscated after he couldn’t make a margin call when the price of bitcoin plunged.

Michael Moro, CEO at Genesis, said the increasing number of loans tap into the tension investors face between not wanting to give up their dream of a digital currency yet wanting cash.

The tax benefit taps into those tensions as well. BlockFi said on its website that “borrowing money against your crypto is NOT a taxable event”, adding that the loans are “a great way to gain access to US dollar without having to sell your crypto investments”.

Lenders argue that the tax perk can work even for investors who bought at bitcoin’s highest price and now have paper losses.

Bitcoin enjoyed a steep climb at the end of 2017, rising in value from about RM5,330 in April to RM78,310 in December 2017

“If you’re still bullish, you’re better off from a tax perspective selling it, buying it back and then borrowing against it,” said Zac Prince, the CEO of BlockFi. Such a sale would trigger a deductible capital loss for the investor of US$3,000 a year. And a loan would allow the borrower to extract cash while holding onto new bitcoin long enough to get the 20% capital gains rate at a future sale.

There’s no credit score check. “It’s an alter-native to short-term credit,” Fernandez said.

Executives whose wealth is tied-up in stock in the companies they run have long leveraged that asset into cash without selling it and facing capital gains taxes.

Yet, that’s less risky because stocks aren’t as volatile as digital currencies.

Though some companies now prohibit executives from borrowing against stocks, crypto-backed lenders are taking a page from that book. “We give clients a tool that billionaires have had for decades,” Trenchev said. — Bloomberg