Yesterday, I spent the day working out a way to satisfy a margin call on a loan from Celsius. The deep market dip caused my LTV ratio to spike from 50% to about 68%. If it had reached 80%, they would have automatically liquidated. Fortunately, I was able to put together enough BTC, along with a gradual rise in the price of BTC, to satisfy the margin call. It was a close call. I'll discuss what saved me and my Bitcoin. We will also discuss cash and credit.
About Margin
One way to make use of your cryptos without selling them is to use them as collateral for loans. Just as everybody is a genius during a bull market, loans are great during a bull market. Borrowing on your crypto, also called a margin loan, has risk that you may have to liquidate your holdings. Much of the market dip in recent days has been driven by weak hands who were overleveraged. When they get a margin call, they don't have any way to pay the loan. So, the exchange sells their crypto at the worst price to pay off the debt. This is great for exchanges because they get investor crypto at bargain prices.
Margin loans are useful in that interest rates are generally lower than credit card debt. They also tend to be simple interest. And, they are flexible on payments, unlike installment loans. They also help the borrower avoid paying capital gains taxes from selling their holdings. Loans are not taxed. It is popular to take a margin loan to buy more of the asset. Let's say you have 1 BTC. With a 50% LTV (loan to value ratio), you can borrow up to 0.5 BTC value in cash. Some exchanges allow you to leverage 1X, 2X, and up to 10X for trading. That means that for every 1 BTC, you can get up to 10 BTC in credit. This is great when the market is in your favor. This can wipe you out if the market coughs, sneezes, or farts. You walk away with zero.
If you have a margin loan, you can avoid getting wiped out in two ways. One way is to add more collateral. If the loan is 50% LTV, you need to add more BTC to bring it back to ratio and the new market dip price. Another way to avoid getting wiped out is to pay off the loan. Ultimately, this means that you can't be all in on your investment. You need a little extra on the side that isn't being used as collateral. Or, you need extra cash.
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Avoiding Liquidation
In our situation, I was able to avoid liquidation of my BTC to satisfy the loan by coming up with extra BTC to deposit. This was cobbled together by a combination of spare cash in our checking accounts, spare BTC that was uncommitted, some DAI savings, and by a small rise in the price of Bitcoin. Fortunately, there was enough slack in my personal financial system that I could squeeze out some cash to satisfy the margin call. This slack is by design.
In previous posts, we mention that we intend to start moving towards stablecoin accumulation once the crypto market starts getting hot. This is because there is no point accumulating when price is reaching new highs. We could start accumulating again on the other side of the bull market, when prices are coming down. But, also, there is the possibility that Bitcoin rises significantly enough that we can get a reverse margin call, which releases some collateral. In this case, we could borrow even more money. However, knowing that a bear market is on the way, we would also need spare cash to either pay off loans, or buy more BTC to satisfy the margin calls that would surely come.
The Value of Cash
Many investors and financial pundits will tell you that you should not keep cash because it loses value. It's a melting ice cube when you factor inflation. They're right that cash is a rotten investment because it continuously loses value, guaranteed. However, it is also important to have cash or credit readily available because these can be deployed quickly to fix many problems. For example, if you want to buy the dip, yet have no cash, then you have to miss the opportunity. Cash helps out with margin calls to either buy more collateral or to pay off the loan. Cash prevents you from taking on debt for consumer purchases. There are so many way in which having a cash reserve, which includes stablecoins, benefits your personal financial system.
The Value of Credit
Credit is the equivalent of cash, in many respects. The value that cash gives is purchasing power. You can use cash to make things happen. Credit allows you to use somebody else's cash, temporarily, to achieve some end. The value of credit is that, your cash is not melting away, it's your creditor's cash. Thus, you can use your credit line as a form of cash savings. The only drawback is that you eventually need to pay it back. So, you either need the cash flow or an asset you can sell to pay the debt.
Margin loans are great in that there is no drawn out process for getting them. The only question asked is, "how much?". Unfortunately, there is at least a day of lead time to have access. Credit cards are great for instant purchases without having to get approvals. However, they are only good for purchases. They are less useful for investing. Lines of credit are a great resource in that your access to cash has been pre-approved. However, lines of credit aren't the easiest to get, depending on your finances and credit rating.
Time to Replenish
It was handy to have the cash available to avert a margin call. However, now that the reserve is depleted, it is necessary to replenish it rather than focus solely on buying the dip. Any additional disaster puts us at risk of having to liquidate our cryptos. This means we need to accumulate cash or equivalents, which includes paying back the loans too. This is a much faster remedy than building up collateral. When you save a dollar, you have 1:1 access to it. When you buy crypto for collateral, it's between a 1:4 or 1:2 ratio of credit to dollars. That is, I'd need to put in between $2 and $4 of BTC to borrow $1. Whereas each dollar paid off is a dollar I can reuse. Each dollar or stablecoin I save can be used at face value too. The slower, long-term way to approach it is to keep building collateral. However, the faster , short-term play is to replenish the reserves so that our investing can resume unimpeded by more emergencies.
Investing is the plan. Reserves are the backup plan. It is dangerous to operate the plan without the backup. Much of personal finance involves that management of risk. So, now our attention is in getting the backup plan fit for duty.
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Thanks for this. I've been wondering how borrowing against crypto to avoid tax works. This is really helpful information.
!LUV
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Glad you found it helpful. I would caution that UK tax rules might be different. I'd double-check to be sure.
Thanks for the luv.
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Good point. I remember it being talked about in a UK cypto tax discord but I wasn't paying attention. I need to check that out before I start making plans.
!ENGAGE 10
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ENGAGEtokens.These are some very important concepts for crypto amateurs... too few people know about this #DeFi side of things, and how it can help them progress their fiat finances as well. Thank you for detailing your experience, and for trying to impart the lessons you're learning. Cheers! :)
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I hope some reader out there finds it useful. Experience is the best teacher. However, getting wiped out is a high tuition cost for anybody.
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