Is it ever worth the risk?
The cryptocurrency space is expected to reach 1 billion users by 2030. While some have been known to make a fortune from it, others have ruined their finances, chasing similar results, going as far as getting credit to buy crypto by setting up valuable assets, including their home, as collateral.
Borrowing to invest can make sense in very specific circumstances, but using a home equity loan is also extremely risky. For example, it means that an investor’s home is pledged as collateral for a loan.
Cryptocurrencies have delivered spectacular results for investors in the past, but have also seen them go through long, drawn-out bear market periods where many lost hope and sold at a loss, with those who managed to hold on reaping the biggest gains. As any analyst or financial advisor will say, past performance is not indicative of future performance.
When Bitcoin (BTC) was trading at $57,000, MicroStrategy CEO Michael Saylor suggested that investors should use all their money to buy Bitcoin and “figure out how to borrow more money to buy Bitcoin.” At one point Saylor suggests they should “mortgage the house” to get more BTC.
Never forget that Michael Saylor encourages unsophisticated investors to liquidate all the assets they own to buy Bitcoin with leverage.pic.twitter.com/Wvv3c2JpOZ
— Nate Anderson (@ClarityToast) 13 June 2022
At the time of writing, Bitcoin is changing hands near $23,000, meaning investors who followed Saylor’s words would now be deep under water. MicroStrategy has taken out loans from Silvergate Bank and raised capital by issuing debt to buy more Bitcoin, to the point that it now has 129,698 BTC.
While business lending differs from personal lending, it’s important to understand what can happen when investors borrow against their assets to buy more crypto and what awaits them.
Be careful in a high-risk environment
Mortgaging a home to buy cryptocurrency has been a strategy used by some investors, one that, if done at the right time, can lead to significant returns. However, it can have disastrous consequences if done at the wrong time.
Speaking to Cointelegraph, Stefan Rust, CEO of inflation-tracking platform Truflation, noted that it is “definitely a high-risk strategy” that is “always an option” as it is a “reasonable and cheap source of capital.” Rust added that if the house being mortgaged is paid off and there are “remaining assets available to be able to take out a mortgage, why not leverage that mortgage to buy Bitcoin.”
The CEO referenced fintech startup Milo, which offers 30-year crypto loans and allows users to leverage their cryptocurrency holdings to buy property as an alternative, adding:
“I personally wouldn’t go all out and ‘max out’ by putting all my income into Bitcoin. It’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 care for and bills to pay, mortgaging their property may not be the most advisable strategy. In his words, it’s “usually best to use common sense and appropriate risk management.”
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Elaborating on Rust’s words, Dion Guillaume, global head of PR and communications at crypto exchange Gate.io, told Cointelegraph that the “easiest way to mess up is to play with shitcoins and try to time the market” and asked investors to “never use excessive leverage ” and instead “reign in” their greed.
Guillaume said investors need to 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 rather than going all-in as Saylor suggested:
“We need to be more careful about how we spend our money. For all its greatness, crypto remains a high-risk asset. Are you a billionaire with seven houses? If so, you can probably pawn one to buy BTC. If not, 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 to never do with your finances,” as a “house is a great investment in long term and one of the most important ladders to increase wealth.”
O’Connell added that he has read “too many articles about broken families or about people who have tragically taken their own lives by doing exactly this.” He added that one should never take out a loan 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 almost double in a month and bear markets can see BTC lose over 80% of its value.
Expect the unexpected
Due to the inherent volatility of the cryptocurrency space, O’Connell noted that investors need to take into account that Bitcoin is affected by monetary policy in the same way that other assets are and has “not proven to be an inflation hedge” while being highly correlated with other risks. assets.
The portfolio manager suggested that investors must 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 may try to buy some protection by hedging perpetual futures (not yet legal in the US) to cover their risk.”
In his words, the volatility of risk assets seen amid rising interest rates makes it difficult to “justify borrowing against traditional assets or crypto and going to Bitcoin.” Regarding proposals that investors can borrow to buy crypto, O’Connell said they need to be “very skeptical and always question the motivation of the source” and tell them to borrow.
He added that the cryptocurrency space is known to be filled with scammers and is heavily influenced by investor sentiment, so caution must be exercised.
Thomas Perfumo, head of business operations and strategy at cryptocurrency exchange Kraken, told Cointelegraph that there are educational resources that “everyone should read” before using leverage to buy cryptocurrency.
Perfumo noted that leverage is generally a tool used to maximize the return on capital and, in some cases, utilize it in a tax-efficient manner while increasing the risk profile of transactions in which it is used. This means that it is “important for anyone who wants to use leverage to understand their risk tolerance and manage 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 advise people to consult with advisors to find the most appropriate investment strategies.”
These important financial decisions should also likely include the composition of investors’ potential crypto portfolios and their role in their overall investment portfolio. For investors putting in more than they can afford to lose, crypto exposure can seem like a nightmare.
It went wrong to react to raised positions
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 continue to hold onto it and hope for “their fortunes to turn around.”
Guillaume said leveraged traders should use a bull market to turn crypto into cash when they break even, so they can pay off debt and promise themselves they’ll never mortgage their house for crypto “ever again.”
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O’Connell said investors underwater in a leveraged position should “immediately seek the advice of a 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 that there is professional support both financially and mentally.”
At the end of the day, investors must 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 manage risk appropriately, which may mean their portfolios will be “boring” for a while. However, this “down time” can give them the break they need to heal mentally and improve their outlook.
