Double your Bitcoin with a 4% carrying costs

1. Bitcoin The Complete Guide

With annual inflation at 6.8% in November 2021, many continue to look towards bitcoin as an inflation hedge. According to experts, true inflation is even higher, due to the outdated CPI basket measurements. Bitcoin advocate, Michael Saylor has leveraged his company, MicroStrategy, by issuing corporate bonds to increase its Bitcoin position. While the retail investor can’t issue bonds, we can borrow on Defi using the Aave lending/ borrowing protocol at a 4% variable APY.

What is Aave?

Aave is a peer-to-peer finance platform that connects lenders and borrowers without the need of a centralized intermediary, like a bank. Currently the platform has 25 billion dollars of liquidity deposited. Lenders deposit their assets to earn passive income. Borrowers can borrow assets at different interest rates depending on the asset. Borrowers need to deposit an asset as collateral, which is returned when the loan is paid back. For example, you can borrow USDC (USD stable coin — pegged to the US dollar) at a 4% variable interest rate, at a 70% LTV of deposited assets. The liquidation point is 75% so it would be unwise to borrow 70% given the market’s volatility. Personally, I am borrowing at an LTV of 50%, which effectively allows me to achieve double leverage. For every 1 bitcoin, I can own a second Bitcoin with a 4% carrying cost interest rate. The following table illustrates that using USDC loan proceeds at 50% LTV to buy more Bitcoin will lead to a double leverage position. You will notice that the LTV always remains at 50%, and after 8 transactions, the Asset Multiplies to 99.61%.

This can be achieved quicker with two loans, one at 70% and the second 42.86%.

Is Aave Trustworthy?

Aave is a decentralized platform governed by its thousands (maybe millions) of Aave token holders around the globe. The software is open source and has been vetted by many programmers and continues to operate as intended. The protocol functions via smart contracts which ensures depositors security. If a borrower’s LTV exceeds the 75% threshold, the collateralized assets are liquidated, and the loan is repaid. This is all executed autonomously via smart contracts. While there is no official customer service department for Aave, you can reach out to the developers on discord, where you will be assisted with any issue. Aave operates on the Ethereum, Polygon and Avalanche Networks.

When does the loan mature?

The loan is open ended as long as the LTV does not exceed 75% — the liquidation threshold. The variable interest rate carrying cost, is added to the loan balance, increasing the LTV over time. This incremental loan balance increase will have a small effect on the LTV. The most significant contributing risk factor is, if the underlying asset used as collateral decreases in value, causing the LTV % to climb. This is common in Crypto as asset prices can swing 5–40% in a short period of time. It’s important to calculate at what price your collateralized asset can fall prior to getting liquidated. It’s imperative to understand this relationship between asset price and liquidation since poor management can result in losing your deposit by liquidation. In addition, it is also important to periodically watch the APY, since it’s a variable rate. If it were to increase drastically the LTV ratio would increase at a faster pace over time. This scenario is less likely and can be foreseen by paying attention to market trends. If achieving leverage manually sounds too risky, there are double leverage tokens available which automates the rebalancing. Index Coop has a the BTC2xFLI token which achieves a 1.7–2.3 leverage of Bitcoin.

The table below illustrates the volatility tolerance for a double leveraged (borrowed at 50%) Bitcoin position. This example assumes one bitcoin costs 50,000. By predefining and calculating the concerned, warning and liquidation thresholds, you can be prepared for any swing and act accordingly before getting liquidated.

Additional utilities Aave borrowing offers.

You can borrow money against your assets, to buy an entirely different token, achieving broader crypto exposure. If unexpected expense occurs, instead of selling your asset which may generate a tax liability, borrow against the asset, and repay it back later. If the asset value appreciates at a similar rate to the APY or even slightly lower, the LTV ratio will remain the same. Technically, the loan can remain open in perpetuity under these conditions.

Here are a few reasons Aave loans are attractive to use.

1. The loan proceeds are instantly deposited into your wallet.

2. Doesn’t require a credit check.

3. Borrowers are automatically approved (assuming LTV under 70%)

4. Zero borrowing discrimination

5. Open 24/7

6. No borrowing or repayment fees (besides APY and gas for transaction)

Web3 and decentralized finance continues to grow daily but has plenty to overcome before mainstream adoption. I am looking forward to the day when all ~7 billion people are using Defi for their personal finances. This innovation will dramatically improve the quality of life for billions around the globe.

I hope this article brought you some value.

Navigating the intricate world of DeFi, especially with platforms like Aave, underscores the need for professional cryptocurrency accounting. OnChain Accounting specializes in managing the complexities that come with such advanced financial tools. Utilizing Aave for borrowing or lending involves careful tracking and reconciliation of transactions to ensure financial accuracy and compliance with tax regulations. Our expertise in cryptocurrency accounting, combined with advanced tools like cryptocurrency tax software and crypto tax calculators, equips us to handle the nuances of bitcoin accounting and other crypto transactions. This is crucial for maintaining an accurate record of financial activities and understanding the tax implications of borrowing and lending in the crypto space. Our role is to provide clarity and precision in these complex transactions, ensuring our clients’ financial health and compliance in the ever-evolving landscape of crypto finances.