HEATH MUCHENA | Why institutions are building credit markets around bitcoin

For years the dominant case for owning bitcoin was simple: buy it, secure it and wait.

That proposition is changing. Bitcoin is increasingly being used as collateral for loans, trading facilities and institutional credit, giving holders access to cash or stablecoins without requiring them to sell the underlying asset.

The appeal is obvious. An investor who believes bitcoin will appreciate may prefer to borrow against it rather than dispose of it. A company holding bitcoin in its treasury could obtain working capital while maintaining its long-term position. Traders and market makers can use bitcoin to secure financing for other activities.

But once bitcoin becomes collateral, a volatile investment becomes the foundation of a debt obligation. That changes the risk.

A borrower who pledges R500,000 worth of bitcoin for a R150,000 loan begins with a loan-to-value ratio of 30%. If the value of the bitcoin falls to R300,000, the ratio rises to 50%, even though the borrower has not borrowed any additional money. Interest charges increase the outstanding debt further, pushing the loan-to-value ratio even higher.

If the ratio reaches the lender’s liquidation threshold, some or all of the bitcoin may be sold automatically. The borrower can be liquidated even if the price later recovers. This is why the maximum amount a platform is prepared to lend should not be treated as a sensible target. It represents the outer limit of the product, not a prudent borrowing level.