How to Use Bitcoin as Collateral to Secure a Loan

Bitcoin owners who want access to liquidity in the form of stablecoins don’t need to sell their BTC. Instead, they can take out a stablecoin loan using their bitcoin as collateral. 

In this guide, we’ll explain what bitcoin-collateralized loans are, how they work, and how you can take advantage of the Zero protocol available on Sovryn. Finally, we’ll show how you can provide liquidity to the protocol, thereby earning yield on your idle BTC.

Bitcoin-collateralized loans are loans in which you offer BTC as collateral, which guarantees that you’ll return the amount you’ve borrowed. 

Bitcoin-backed loans usually let borrowers access fiat currency or stablecoins.

Collateralized loans, regardless of collateral type, tend to offer higher maximum loan amounts compared to their uncollateralized counterparts. This is because the security from the collateral ensures there is no significant cost risk in case of a liquidation.

Bitcoin-backed loans rely upon borrowers providing BTC to receive a loan, either in fiat or in stablecoins. The two options are the result of a choice between centralized and decentralized finance.

Centralized lending platforms, as part of a wider centralized finance (CeFi) environment, are able to offer fiat loans backed by BTC. Generally, these platforms are similar to traditional financial institutions: they rely upon a central authority and both the stability and the security that stems from it. They tend to be somewhat easier to use as well but at the cost of the borrowers’ privacy and autonomy.

Decentralized finance (DeFi) lending platforms use protocols that ensure the whole borrowing process and all its potential outcomes remain non-custodial and handled through smart contracts. In return, they usually only provide stablecoin loans.

In general, when you take out a loan and leave BTC as collateral, the amount of BTC will usually be higher than the amount of the loan. 

This is referred to as overcollateralization, and it ensures that the lenders are at a lower risk in case the price of bitcoin moves unfavorably compared to the stablecoin. Once you return the borrowed amount, you receive your collateral back. 

In case you can’t return the loan, the collateral is liquidated, and, unfortunately, you have no right to any amount. Instead, it’s used to reimburse any lenders providing the liquidity from which the loan was secured.

Although bitcoin is one of the most popular choices for collateral, it comes with its own considerations. Here, we take a look at both sides of the coin.

Advantages 

Using bitcoin as collateral means that you don’t need to sell your BTC when you need stablecoins or fiat quickly. 

These loans tend to be processed very quickly, meaning you can get the required funds in a very short time.

Finally, bitcoin is almost universally available: there are very few geographical restrictions on BTC-backed loans.  

Limitations & Considerations 

Bitcoin’s price swings can lead to a loan liquidation before the borrower is ready to repay their debt. This may require you to create risk management strategies to ensure you’re able to return the debt in time.

Furthermore, quoted interest rates may change over the life of the loan. Borrowers may not know in advance what interest rate they’ll be paying over time.

Additionally, different lending platforms can charge different interest rates on loans, requiring users to compare rates carefully. 

This amount is usually percentage-based, so a higher loan amount will incur a higher interest fee, sometimes severely limiting the amount you can borrow and the time you’ll need to repay the debt. An exception to this is Sovryn, which offers BTC-backed stablecoin loans with 0% interest.

Sovryn has introduced Zero, a decentralized protocol that lets you borrow the stablecoin with a zero interest rate, using BTC as collateral. 

Loans are overcollateralized, with the ratio of collateral and debt required to be 110%. This is a relatively low collateral ratio, considering that most cryptoasset loans require significant overcollateralization to ensure liquidity in every circumstance. 

Additionally, with no interest and a stablecoin backed by bitcoin and redeemable for dollar value, the Zero protocol is an excellent choice for any borrower.

For lenders, the protocol also features a stability pool, which is its first line of defense to maintain solvency. It contains the required liquidity to repay any debts incurred by liquidated lines of credit (LoCs). An LoC is a ledger where you take out and maintain your loan, similar to vaults on other platforms. 

When an LoC is liquidated, the debt is paid from the Stability Pool, and the corresponding amount is burned. Meanwhile, the collateral from that LoC is siphoned into the Stability Pool.

Liquidity providers in the Stability Pool receive rewards in SOV, Sovryn’s native token, at a current rate of 5% APR. The rewards are liquid; they can be claimed and sold at any time. Another earning possibility is holding and/or staking SOV to receive additional rewards.

Zero borrowing is currently only available on the Rootstock (RSK) chain, which means you will need to switch from BOB if that’s your preferred chain when using Sovryn. 

Additionally, you’ll need to provide collateral in RBTC, the RSK-bridged version of bitcoin.

Sovryn’s zero-interest loans, collateralized with BTC, are an excellent opportunity for borrowers and lenders alike. Borrowers can secure loans for a low one-time fee, while lenders can provide liquidity to earn a yield on their digital assets.

Connect your wallet to Sovryn to start borrowing at 0% interest today!

Can you get a loan with bitcoin as collateral?

Yes, you can get a loan with bitcoin as collateral, which can be in the form of a bitcoin-backed cash or crypto loan. The DeFi platform Sovryn, for example, offers zero-interest loans. You only pay a one-time fee and receive a stablecoin loan in return. Once you repay the loan, you receive your collateral back; if you don’t, the collateral simply remains locked.

How much can I borrow against my bitcoin?

At Sovryn, the collateral ratio is 110%, which means you need to provide 1.1x the amount you want to borrow. In other words, your loan will always be slightly lower than the amount of BTC you’re providing as collateral. This practice is called overcollateralization and is very common in DeFi. If the collateral ratio is not maintained at 110% or higher, Sovyrn’s stability pool pays out the debt and receives your collateral in return.