Borrowing to buy Bitcoin: Is it ever worth the risk?

The cryptocurrency space is expected to reach 1 billion users in 2030. While some have been known to make a fortune off of it, others have ruined their finances, chasing similar results, going as far as getting credit to buy crypto by putting up valuable assets, including their homes, as collateral.

Borrowing to invest can make sense under very specific conditions, but using a home equity loan is also extremely risky. For example, it means that an investor’s home is being put up as collateral on loan.

Cryptocurrencies have, in the past, delivered spectacular results to investors, but also saw them go through long drawn-out bear market periods in which many lost hope and sold at a loss, with those who managed to hodl on reaping the biggest rewards. As any analyst or financial adviser would say, past results are not indicative of future results.

When Bitcoin (BTC) was trading at $57,000, MicroStrategy CEO Michael Saylor suggested investors should use all of their money to buy Bitcoin and “figure out how to borrow more money to buy Bitcoin.” At one point, Saylor suggests they should “go mortgage their house” to get more BTC.

At the time of writing, Bitcoin is changing hands near $23,000, meaning investors who followed Saylor’s words would now be deeply underwater. MicroStrategy has taken out loans from Silvergate Bank and raised capital by issuing debt to buy more Bitcoin, to the point that it now holds 129,698 BTC.

While corporate lending differs from personal lending, it’s important to understand what may happen when investors borrow against their assets to buy more crypto and what’s in store for them.

Being prudent in a high-risk environment

Mortgaging a home to buy cryptocurrencies has been a strategy employed by some investors, one that, if done at the right time, could lead to significant returns. However, it could have disastrous consequences if done at the wrong time.

Speaking to Cointelegraph, Stefan Rust, CEO of inflation-tracking platform Truflation, noted it’s “definitely a high-risk strategy” that is “always an alternative” as it’s a “reasonable and cheap source of capital.” Rust added that if the house being mortgaged is paid off and there are “residual assets available to be able to take out a mortgage then why not leverage that mortgage to buy Bitcoin.”

The CEO referenced fintech startup Milo, which offers 30-year crypto-mortgages and allows users to leverage their cryptocurrency holdings to purchase real estate as an option, and added:

“I personally would not go all out and ‘maximize’ by putting all my earnings into Bitcoin. That’s basically putting all your eggs in one basket. This is a super high risk allocation of capital.”

Rust added that for investors with a family to take care of and bills to pay, mortgaging their property “might not be the most advisable strategy.” Per his words, it’s “typically best to deploy common sense and appropriate risk management.”

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Dion Guillaume, global head of PR and communications at crypto exchange, expounded upon Rust’s words, telling Cointelegraph that the “easiest way to ruin is to play with shitcoins and try to time the market” and told investors to “never use excessive leverage” and instead “reign in” their greed.

Guillaume said that investors must avoid falling for the hype, and while “this can be tough in crypto, discipline is key.” Commenting on leveraging assets to buy more BTC, he advised caution instead of going all-in as Saylor suggested:

 “We need to be more prudent with the way we use our money. Despite all its greatness, crypto is still a high-risk asset. Are you a billionaire with seven houses? If yes, then you can probably mortgage one to buy BTC. If not, then be smarter.”

Speaking to Cointelegraph, Dennis O’Connell, chief technology officer and portfolio manager at crypto portfolio company Peregrine Digital, noted that borrowing to buy crypto is a “textbook case of what never to do with your finances,” as a “house is a great investment over the long term and one of the primary ladders to grow wealth.”

O’Connell added he has read “too many articles of destroyed families or of people who have taken their lives tragically by doing this very thing.” He added one should never take out loans or use leverage to invest in Bitcoin if they cannot afford to lose.

Cryptocurrency markets are known to be extremely volatile and filled with significant ups and downs, where leading assets can nearly double in a month and bear markets can see BTC lose over 80% of its value.

Expect the unexpected

Because of the cryptocurrency space’s inherent volatility, O’Connell noted that investors need to take into account that Bitcoin is affected by monetary policy the same way other assets are and has “proven not to be an inflation hedge” while being highly correlated to other risk assets.

The portfolio manager suggested investors need to expect the unexpected, especially when using leverage:

“They should expect the unexpected. Market cycles in crypto are highly volatile. Depending on their local regulations they can try and buy some protection through hedging perpetual futures (not yet legal in United States) to off their risk.”

Per his words, the volatility in risk assets seen amid climbing interest rates make it difficult to “justify borrowing against any asset traditional or crypto and going to into Bitcoin.” Addressing suggestions investors could borrow to buy crypto, O’Connell said they must be “highly skeptical and always question the motivation of the source” telling them to borrow.

He added the cryptocurrency space is known to be filled with scammers and is heavily influenced by investor sentiment, and as such, caution must be exercised.

Thomas Perfumo, head of business operations and strategy at cryptocurrency exchange Kraken, told Cointelegraph that educational resources exist that “everyone should read” before using leverage to buy any cryptocurrency.

Perfumo noted that leverage is generally a tool used to maximize returns on capital and, in some cases, leverage it in a tax-efficient manner while also increasing the risk profile of transactions in which it’s being used. This means it’s “important for anyone looking to employ leverage to understand their risk tolerance and manage their risk effectively.”

With any risk asset, Perfumo said, investors should never invest more than they are willing to lose, concluding:

“When making important financial decisions, it is important for everyone to consider their personal risk tolerance and financial goals. We often recommend people consult with advisers to determine the most appropriate investment strategies.”

These important financial decisions should likely also include the composition of investors’ potential crypto portfolios and their role in their overall investment portfolio. To investors who put in more than they can afford to lose, crypto exposure may seem like a nightmare.

Reacting to levered positions gone awry

Guillaume stated that investors who have a leveraged position in the cryptocurrency space need to consider how much longer they can afford to maintain them, as given enough time, they can keep on holding onto it and hope for their “fortunes to turn.”

Guillaume said leveraged traders should use a bull market to turn crypto into cash when they break even so they can pay off their debts and promise themselves they will never mortgage their house for crypto “ever again.”

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O’Connell said that investors underwater on a leveraged position should “should immediately seek the advice of licensed financial planner and expert to structure a plan.” Mental health, he added, should not be set aside:

“They should also take care of their mental health and seek help from therapists or licensed mental health professionals. They should know there is professional support both financially and mentally.”

At the end of the day, investors need to recognize that cryptocurrencies are risky assets based on technological innovations. Things can change overnight, as the collapse of the Terra ecosystem and subsequent contagion to other firms made clear.

To stay safe, investors need to appropriately manage their risk, which may mean their portfolios will be “boring” for quite some time. However, this “downtime” can give them the break they need to heal mentally and improve their outlook.