Cryptocurrency Lending And Borrowing

Would you believe if someone told you that you could take a loan at a cheap rate in the range of 5-15% without any requirement of documentation, processing fees or even any collateral in the form of your home or car? 
Yes, this is now possible if you have some cryptos in your digital wallet.

Latest updates – Clarification on proposed Section 115BBH in Budget 2022

1. Losses incurred from one virtual digital currency cannot be set-off against income from another digital currency. 
2. Infrastructure cost incurred on mining crypto assets will not be treated as cost of acquisition. 

Union Budget 2022 Outcome: 

1. Income from transfer of virtual digital assets such as crypto, NFTs will be taxed at 30%.
2. No deduction, except the cost of acquisition, will be allowed while reporting income from transfer of digital assets.
3. Loss from digital assets cannot be set-off against any other income.
4. Gifting of digital assets will attract tax in the hands of receiver.Losses incurred from one virtual digital currency cannot be set-off against income from another digital currency.

Introduction

Cryptocurrency gained immense popularity in the last year with a multi-fold increase in the investor’s count.

Many virtual currencies are volatile in the short term, for instance, Bitcoin has increased in value from $ 23,000 in 2022 to $ 75,000 in 2024. Such an increase is mainly due to the approval of Bitcoin ETF by the SEC in U.S Stock exchanges. This approval of the ETF has opened a gateway for institutional investors like Blackrock, Ark Invest, and Sovereign Wealth Funds to invest in this asset category. Within 2 months since the ETF was launched in Jan 2024 more than $10 billion in AUM under this ETF. 

Investors who had invested in this booming volatility during the last year may have gained or lost their money. While some investors are only interested in short-term gains, others are there because they firmly believe in the future of cryptocurrency.  

For investors who want to stay invested by holding their cryptocurrencies while spending physical currencies like INR, USD, CAD, EUR, etc. is now possible with the facility of crypto lending. Crypto investors can hold their crypto assets and keep them in a safe wallet until the price of their investment appreciates.

Crypto lending and borrowing have gained momentum recently, marking the start of a new financial era. Let us understand more about crypto-based financing.   

What Is Cryptocurrency Lending Or Borrowing?

Crypto-financing allows crypto investors to borrow loans in cash or cryptos by offering cryptocurrencies owned by them as collateral. Crypto lending enables the lender to remain the owner of the crypto asset. However, the crypto offered as collateral cannot be used for trading or transacting during lending tenure. 

Crypto investors who plan to HODL (a crypto term for Hold On for Dear Life) their crypto assets and have no plan to sell soon can lend the crypto assets and earn interest for that period. The interest earned is also called ‘crypto dividends’. It’s a simple way for crypto investors to generate passive income by lending their crypto assets.

A crypto loan is a collateralised loan that one can get from a crypto exchange or some crypto-lending platform. It functions similarly to a mortgage or a car loan, where you use car or house property as collateral, whereas in this case, you use your cryptocurrency to secure your loan funds.

Types Of Crypto-Lending Platforms

There are two types of lending platforms, as mentioned below:

• Automated platforms give you dividends as soon as you deposit assets in your crypto wallet.
• Manual platforms require the investor to manually stake (block for a certain amount of time) a certain amount of your crypto assets to generate dividends.

How Does Crypto Lending Work?

Lenders and borrowers in cryptocurrency financing are connected through a third party, usually an online crypto lending platform. So, for crypto loans, there have to be three parties involved: lenders, borrowers (crypto asset holders), and lending platforms (Or a smart contract in Defi) :

• The lenders are the ones who want to lend cryptos, stablecoins or cash and earn passive income from their crypto investments.
• The crypto lending platforms are the third-party platforms that connect borrowers and lenders and take care of these transactions. These can be autonomous, decentralised, or centralised platforms (a group of people or companies operating the platform). 
• The borrowers want funds for varied purposes and should use crypto or fiat assets as collateral to get funding.

Process Of Crypto Lending

The process of crypto lending is as follows:

• The borrower connects with the crypto lending platform requesting a crypto loan.
• The borrower offers crypto-assets as collateral for the loan. The crypto platform accepts the loan and attaches the collateral. The borrower will have to repay the entire loan before taking back the stakes in the collateral offered. 
• The lender funds the loan through the third party platform to the borrower.

Tax Implication On Cryptocurrency Lending And Borrowing

1. Cryptocurrency Lending 

Idle Crypto currency in your wallet can be lent out for Interest. This helps investors generate extra return over and above the capital appreciation in the asset class. Interest income generated from such lending is taxable under the head income from Other sources.

2. Cryptocurrency Borrowing

This involves keeping your crypto as a collateral security to take a loan usually in stablecoin. This is usually done by those investors who are in need of a short term fund and do not want to sell the assets. Loans taken in stablecoins are a non taxable transaction since it is required to be repaid after a certain time. As per section 115BBH, interest expense cannot be claimed as a deduction. Thus, Crypto borrowing has no tax implication. 

Example For Crypto-Lending

Let’s understand this with an example. 

Suppose you own 10 bitcoins and would like to earn a steady passive income with your investments in Bitcoins. You can deposit these 10 Bitcoins in your crypto lending platform’s wallet and receive monthly or weekly interest from it. The lending of Bitcoins offers interest rates in the range of 3%-7%; however, they can also be as high as 17% for more stable assets such as stable coins like USD Coin, Binance USD, etc. 

The interesting thing about crypto lending compared to other peer-to-peer lending is that the borrowers attach their cryptocurrency as collateral. Hence, in the non-repayment of loans, the investors can sell the cryptocurrency assets to cover the loss. Investment platforms generally ask to stake 25 to 50% of the loan in crypto and can usually recover most of the losses and avoid investors losing money.

Cryptocurrency financing allows you to borrow in stable coins like USDT and USDC, which can be liquidated into fiat currency.

Let’s take another example;

Mr A has 1 Bitcoin worth USD 15,000 and needs a loan of USD 5,000 against it at an 8% interest rate per annum. Mr B has USDT 5,000 stable coins and is ready to lend it to Mr A at an 8% interest rate by keeping 1 Bitcoin as collateral. Once Mr A pays off Mr B’s USD 5,000 and interest, Mr B will release the Bitcoin back to Mr A. This transaction has an LTV (loan to value) of 33.33%, i.e. USD 5,000/USD 15,000. Here, Mr B can liquidate the Bitcoin if Mr A does not repay the loan amount and refund the balance amount.

Crypto lending is always over-collateralised, and hence, it is more secure than other forms of lending, such as peer-to-peer lending.

Smart contracts using Ethereum L1 and L2 protocol are pre-programmed which allows such lending and borrowing of crypto without any counterparty risk involved. 

Conclusion

Crypto Lending is a rapidly growing sector within the broader cryptocurrency ecosystem. Even though it offers higher returns on assets and increased liquidity, it also has its risks - volatility, regulatory concerns and security vulnerabilities. Looking ahead to the future, crypto lending will be more secure, clearer regulations, technological advancements and the overall stability of the crypto ecosystem. 

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