While traditional banks have yet to fully embrace Bitcoin as collateral for loans, that could change with a Spot Bitcoin ETF. If approved by the SEC, a Bitcoin ETF would grant legitimacy for Bitcoin to be used as collaterals for legacy financial players and open the door for banks to lend against it.
Why An ETF Is Necessary For Bitcoin Collaterals
Banks already allow clients to seamlessly borrow against gold ETFs, which provide exposure to gold prices without direct ownership. A Bitcoin ETF would function similarly – as a wrapper providing bitcoin price exposure without conveying ownership of the underlying coins. As the saying goes “not your keys, not your coins.”
Related reading: Custodying Your Bitcoin: Combating Institutional Control Over Your Finances
This shift toward embracing Bitcoin-based ETFs as viable loan collateral indicates a new openness in the banking sector. As digital assets and mainly Bitcoin become more mainstream, it is likely many banks would be happy to lend against them.
The problem is they do not have the infrastructure to handle collateralized loans against someone who holds the keys to their bitcoin. The approval of a Spot Bitcoin ETF would change this since the ETF would be a security. This would pave the way for more banks to lend against bitcoin without having to directly handle the asset.
What We Can Learn From Hal Finney
Hal Finney wisely wrote on the Bitcoin talk forum:
“Actually there is a very good reason for Bitcoin-backed banks to exist, issuing their own digital cash currency, redeemable for bitcoins. Bitcoin itself cannot scale to have every single financial transaction in the world be broadcast to everyone and included in the block chain. There needs to be a secondary level of payment systems which is lighter weight and more efficient.”
Likewise, the time needed for Bitcoin transactions to finalize will be impractical for medium to large value purchases. Bitcoin backed banks will solve these problems. They can work like banks did before nationalization of currency.
Different banks can have different policies, some more aggressive, some more conservative. Some would be fractional reserve while others may be 100% Bitcoin backed. Interest rates may vary. Cash from some banks may trade at a discount to that from others.
George Selgin has worked out the theory of competitive free banking in detail, and he argues that such a system would be stable, inflation resistant and self-regulating. I believe this will be the ultimate fate of Bitcoin, to be the “high-powered money” that serves as a reserve currency for banks that issue their own digital cash.
The Collateral of Tomorrow
Bitcoin is often touted as the ultimate form of collateral, yet its potential remains underutilized. The current landscape presents a prime opportunity for accumulation, especially considering its finite supply and the growing interest from affluent investors.
The Virtuous Cycle of Bitcoin Collateral
Using Bitcoin as collateral to obtain a cash loan allows you to unlock the liquidity of your bitcoin without having to sell it. This enables you to benefit from Bitcoin’s potential for continued appreciation while also meeting your current cash flow needs. Unlike selling bitcoin, taking out a loan against it is not a taxable event, providing another advantage over liquidating your position.
As Bitcoin rises in value, you can potentially repeat this cycle of holding hard money while taking out loans for weaker currencies which you need to use to buy things. However, it is critical to manage the risks. Bitcoin’s volatility could lead to under collateralization if its price severely drops. With prudent loan-to-value ratios and proactive liquidation risk management, the virtuous cycle of Bitcoin collateral can be a compelling wealth management technique for HODLers.
The Ultimate Financial Backbone
Envisioning Bitcoin as the backbone of the global financial system isn’t far-fetched. Its inherent qualities make it an unparalleled form of collateral, potentially underpinning the financial industry and offering a glimpse into the future Hal Finney predicted.
Just as Warren Buffett advises to buy excellent companies and never sell them, Bitcoin encourages a similar ‘buy and hold’ philosophy. For believers in Bitcoin’s future, using it as collateral can be a strategic complement to simply buying and holding bitcoin, which of course is also not a bad strategy.
That said, it is anticipated that bitcoin may become a premier form of collateral, providing flexibility for its holders to either keep it passively or leverage it to secure funding. It’s crucial to exercise caution when using this potent financial instrument, yet the opportunities it presents are quite intriguing.
