Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Ultra-Wealthy Families Use Crypto-Backed Lending for Liquidity
Transcript
- Lucas: Luna, let me ask you something. If you had a hundred million dollars in Bitcoin — not that you do, but hypothetically — and you wanted to buy a beach house in Malibu, would you sell some Bitcoin to do it? Luna: I mean, I'd think about capital gains tax. If I've held that Bitcoin for years, selling would trigger a huge tax event. So probably not. Lucas: Right, and that's exactly the problem wealthy families face with concentrated crypto positions. Selling means realizing gains, and in many cases, those gains are massive. So instead, they're increasingly turning to crypto-backed lending. Luna: Crypto-backed lending — so borrowing against your crypto rather than selling it. Like a margin loan but with digital assets as collateral. Lucas: Exactly. And it's not just a niche thing anymore. We're seeing family offices and ultra-high-net-worth individuals using platforms like Genesis, BlockFi, or even decentralized protocols like MakerDAO to get liquidity without triggering a taxable event. The loan proceeds are not income, so no capital gains tax. Luna: Right, because borrowing isn't a sale. The IRS treats it as debt, not realization. So you get cash, keep your Bitcoin, and hope it appreciates further. Lucas: That's the play. But there are nuances. Let me give you a concrete example. I spoke with a family office last month — they manage about $800 million in assets. Roughly 15 percent of that was in Bitcoin and Ethereum. They wanted to acquire a commercial property in Denver, priced at $12 million. Instead of selling crypto, they took out a loan from a private crypto lender at 8.5 percent interest, using Bitcoin as collateral at a 50 percent loan to value ratio. Luna: Fifty percent LTV — so they had to put up $24 million in Bitcoin to get $12 million in cash. That's a lot of collateral. Lucas: It is. But they were comfortable because they believed Bitcoin would appreciate over the loan term. And they structured it as a one-year interest-only loan, so they only paid interest monthly, not principal. At the end, they could either repay with cash from the property's cash flow or roll it over. Luna: What happens if Bitcoin drops? If the value falls below a certain threshold, the lender can liquidate the collateral. That's the big risk. Lucas: Exactly. Most crypto-backed loans have a liquidation threshold — typically around 70 to 80 percent LTV. If your collateral value drops and your LTV exceeds that, the lender can sell your Bitcoin to cover the loan. That's called a margin call in crypto land. In this family's case, they set up a buffer: they only borrowed at 50 percent LTV, so Bitcoin would have to drop more than 40 percent before they faced liquidation. Luna: Still, a 40 percent drop isn't out of the question in crypto. We've seen 50, 60 percent drawdowns before. So it's a real risk. Lucas: Absolutely. And that's why wealthy families don't just blindly borrow. They often set up multiple tranches, use stablecoins as collateral, or even hedge with options. But the key takeaway is: crypto-backed lending is becoming a legitimate tool for liquidity without tax consequences. Luna: And it's not just Bitcoin. Other digital assets like Ethereum, or even tokenized real estate, can be used. But the lending terms vary widely. Lucas: Right. Ethereum loans might have a lower LTV because it's more volatile. Some lenders accept only Bitcoin. Others accept a basket. The interest rates can range from 6 to 12 percent depending on the lender and the LTV. And there are two main types: centralized lenders like BlockFi or Galaxy Digital, and decentralized protocols like Aave or Compound. Luna: Centralized vs decentralized — what's the difference for a wealthy family? Lucas: Centralized lenders offer more personalized service, often with a relationship manager, and they can negotiate terms. But you have counterparty risk — if the lender goes under, your collateral could be stuck. Decentralized protocols are code-based, so no counterparty risk, but you need to manage your own wallet and understand smart contract risk. Plus, the terms are non-negotiable. Most family offices prefer centralized for larger loans, but they diversify. Luna: So they might split their crypto across a few lenders to spread risk. Smart. Lucas: Exactly. Now, the tax angle is crucial. The IRS has issued guidance — Notice 2014-21 — saying that borrowing against crypto is not a taxable event as long as you don't default and the lender sells. If the lender liquidates your collateral, that's a sale, and you realize gain or loss. So families need to monitor that carefully. Luna: And what about the interest? Can they deduct it? Lucas: It depends. If the loan is used for investment purposes, the interest might be investment interest expense, deductible against investment income. If it's for personal use, like that Malibu beach house, it's not deductible. So families often structure loans for business or investment use to maximize tax benefits. Luna: That's a key distinction. So the intended use of the loan proceeds matters for tax planning. Lucas: Right. And that's why you see wealthy families using crypto-backed loans for things like real estate acquisitions, private equity investments, or even funding a family office operating budget. They're not borrowing to buy yachts — well, some might — but the tax-efficient play is to use the cash for income-producing assets. Luna: Let's talk about the elephant in the room: regulation. Crypto lending has faced scrutiny from the SEC and state regulators. A few years ago, BlockFi had to pay a $100 million fine for offering unregistered securities. How do families navigate that? Lucas: They work with lenders who are registered or operate within regulatory frameworks. Some lenders are now registered investment advisers or have state lending licenses. And for very large loans — say $50 million plus — families often use private, bespoke lending arrangements with a single counterparty, which can be structured as a private placement. That avoids some regulatory hurdles. Luna: So it's like the Wild West, but with lawyers. Lucas: Pretty much. Every family office I talk to has a dedicated crypto legal counsel. They're not going in blind. And the due diligence process is intense — you're looking at the lender's balance sheet, their custody arrangements, insurance, and audit history. Luna: Custody is another big one. If a lender holds your crypto and gets hacked, you could lose everything. So how do families protect against that? Luna: And insurance policies often have exclusions for certain types of attacks. So you have to read the fine print. Lucas: Exactly. Now, one interesting trend I'm seeing is families using crypto-backed loans to avoid selling during bear markets. In 2022, when Bitcoin dropped from $68,000 to $16,000, many families who needed liquidity would have been forced to sell at the bottom. Instead, those who had set up credit lines earlier could borrow against their crypto at a lower LTV and wait for the recovery. Luna: That's the classic 'don't sell at the bottom' strategy. But it requires foresight and a good relationship with a lender before the crisis hits. Lucas: Right. You can't get a crypto loan overnight when the market is crashing. Lenders will tighten terms or halt new loans. So families pre-arrange credit lines when conditions are favorable. Luna: That's a great point. So it's a tool that needs preparation, like a home equity line of credit. Lucas: Exactly. And the amounts are getting larger. I've heard of individual loans exceeding $100 million. One family office I know used a Bitcoin-backed loan to finance a $200 million real estate portfolio. They put up $400 million in Bitcoin as collateral at 50 percent LTV. The loan was arranged through a private bank that also offers crypto services. Luna: Private banks are getting involved? That's a shift. A few years ago, they wouldn't touch crypto. Lucas: It's changing fast. Banks like Goldman Sachs and Morgan Stanley are starting to offer crypto-backed lending to their ultra-high-net-worth clients, though with higher rates and strict eligibility. But it adds a layer of credibility and regulatory comfort. Luna: What about the tax reporting? If you take a crypto loan, do you have to report anything to the IRS? Lucas: Generally, no. The loan itself is not a taxable event. But the interest paid may need to be reported if deductible. And if you default and the lender liquidates, that's a sale. Also, if the loan is in a foreign jurisdiction, there might be FBAR or FATCA reporting. So it's not as simple as just getting cash. Luna: So you need a good tax advisor. Speaking of which, you know, this conversation reminds me of something. If listeners find these kinds of deep dives useful — and I know many of you do — there's a way to support the show that keeps it ad-free. Lucas: Yeah, we try to keep the podcast clean of commercial interruptions. And honestly, the way that works is through listener support. If you got something out of today's episode — maybe a new idea about how to think about liquidity or crypto strategy — you can show that at buy me a coffee dot com slash fexingo. Luna: It's a small gesture, but it really helps us keep doing what we do. And we appreciate every single one. Lucas: Alright, back to crypto lending. One more wrinkle I want to discuss: the use of decentralized finance, or DeFi, for these loans. Some tech-savvy families are using protocols like MakerDAO to create Dai — a stablecoin — by locking up Ethereum as collateral. That Dai can then be used for spending or investing, and it's essentially a loan without a traditional counterparty. Luna: But that requires managing a wallet, understanding gas fees, and dealing with smart contract risk. Not for everyone. Lucas: Not at all. Most families delegate that to a crypto-savvy family office staffer or an external manager. But it's gaining traction because the interest rates can be lower — currently around 4.5 percent on MakerDAO for a 150 percent collateralization ratio. That's cheaper than many centralized lenders. Luna: And you don't have KYC, which some families value for privacy. But that also opens up regulatory risk. Lucas: Exactly. Privacy vs. compliance is a trade-off. Some families are comfortable with the pseudonymity; others want everything above board. It really depends on their risk tolerance. Luna: So what's the bottom line? Is crypto-backed lending something every wealthy family should consider? Lucas: Not every family, but if you have a meaningful crypto allocation — say five percent or more of net worth — and you need liquidity, it's worth exploring. The key is to do it before you need it, work with reputable lenders, and have a plan for what happens if the market drops. It's not a set-it-and-forget-it strategy. Luna: And always consult your tax advisor and legal counsel. This isn't DIY territory. Lucas: Absolutely. So that's the world of crypto-backed lending for ultra-high-net-worth families. Next time, we'll look at another strategy: using crypto donations to donor-advised funds for tax efficiency. Luna: Looking forward to it. Thanks, Lucas. Lucas: Thanks, Luna. And thanks to our listeners. See you next time.