September 29, 2023

The cryptocurrency space is expected to reach 1 billion users by 2030. While some have been known to make fortunes from it, others have destroyed their finances chasing similar results, going so far as to take credit for the crypto market, placing valuable assets , including their homes, as collateral.

Borrowing for investment can make sense under very specific circumstances, but using a home equity loan is also extremely risky. For example, it means that an investor’s house is given as collateral with a loan.

Cryptocurrencies have, in the past, delivered spectacular results for investors, but also seen them go through long bear market periods where many lost hope and sold at a loss, with those who managed to reap the biggest gains. As any analyst or financial advisor would say, past results are not indicative of future results.

When Bitcoin (BTC) was trading at $57,000, MicroStrategy CEO Michael Saylor suggested that investors use all their money to buy Bitcoin and “figure out how to borrow more money to buy Bitcoin.” At one point, Saylor suggests that 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 deep underwater. MicroStrategy has taken loans from Silvergate Bank and raised funds by issuing debt to buy more Bitcoin, to the point where it now holds 129,698 BTC.

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

Be prudent in a high-risk environment

Mortgaging a house to buy cryptocurrency has been a strategy used 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 that it is “definitely a high-risk strategy” that is “always an alternative” as it is a “reasonable and cheap source of capital.” Rust added that if the mortgaged home 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 cited fintech startup Milo, which offers 30-year crypto-mortgages and allows users to leverage their cryptocurrencies to buy real estate as an option, and added:

“I personally wouldn’t go all in and maximize by putting all my winnings in Bitcoin. This essentially means putting all your eggs in one basket. This is an extremely high-risk capital allocation.”

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

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

Guillaume said investors should avoid falling for the hype, and while “this can be difficult 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 judicious in the way we use our money. Despite its greatness, crypto is still a high-risk asset. Are you a billionaire with seven houses? If so, 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 holding company Peregrine Digital, noted that borrowing to buy crypto is a “textbook case of what you should never do with your finances,” as “The house is wonderful. investments for the long term and one of the key stepping stones to increasing wealth.”

O’Connell added that he has read “too many articles of devastated families or people who have tragically taken their own lives doing this very thing.” He added that no one should ever 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 full of major ups and downs, where top assets can almost double in a month and bull 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 should keep in mind that Bitcoin is affected by monetary policy in the same way other assets are, and has “proven itself not to be an inflation hedge,” while highly correlated with other risky assets.

The portfolio manager suggested that investors should expect the unexpected, especially when using leverage:

“They should expect the unexpected. Market cycles in cryptocurrencies are extremely volatile. Depending on their local regulations, they can try to buy some protection by hedging perpetual futures contracts (not yet legal in the United States) to avoid the risk.”

In his words, the volatility of risk assets seen amid rising interest rates makes it difficult to “justify borrowing against any traditional asset or crypto and moving into Bitcoin.” Addressing suggestions that investors could borrow to buy crypto, O’Connell said they should be “very skeptical and always question the motive of the source” telling them to borrow.

He added that the cryptocurrency space is known to be full of scammers and heavily influenced by investor sentiment and hence, caution should 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 any cryptocurrency.

Perfumo noted that leverage is generally a tool used to maximize returns on capital and, in some cases, leverage in a tax-efficient manner, while increasing the risk profile of the transactions in which it is used. This means it is “important for anyone who wants to use leverage to understand 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 recommend that people consult with advisors to determine the most appropriate investment strategies.”

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

Reacting to leveraged positions gone wrong

Guillaume stated that investors with a leveraged position in the cryptocurrency space should consider how much longer they can afford to hold it, as given enough time, they can continue to hold it and hope “their fortunes turn.” .

Guillaume said that leveraged investors should use a bull market to convert cryptocurrencies into cash when they crash so they can pay off their debts and promise themselves never to mortgage their house for crypto “ always again”.

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O’Connell said investors who find themselves underwater in a leveraged position should “immediately seek the advice of a licensed financial planner and plan structure specialist.” Mental health, he added, should not be sidelined:

“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 financial and mental.”

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 the subsequent contagion to other companies made clear.

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