How Crypto Loans Work
How crypto-backed loans work in 2026 โ collateral ratios, liquidation risk, the difference between CeFi and DeFi lenders, and when they make sense.
Updated June 2026 ยท Reviewed by the PipeFlare team
A crypto loan lets you borrow cash or stablecoins by locking up crypto as collateral without selling it
Crypto loans let HODLers access liquidity without triggering a taxable sale โ but liquidation risk is real if prices drop
Read the official source โCategory
DeFi / lending
Difficulty
Intermediate
Where you'll see it
DeFi lending protocols (Aave, Compound), CeFi platforms, Bitcoin-backed loan services
First introduced
2018 (DeFi lending went live on Compound and early Aave)
About crypto loans
A crypto loan lets you borrow cash or stablecoins by locking up cryptocurrency as collateral without selling it. You keep exposure to your crypto's upside while accessing liquidity โ useful if selling would trigger a large capital gains tax. The risk is liquidation: if your collateral's price drops enough, the protocol or lender sells it automatically to cover the loan. Both decentralized (DeFi) and centralized (CeFi) lending platforms offer this product.
How it actually works
You deposit collateral โ typically BTC or ETH โ and borrow up to a set percentage of its value, called the loan-to-value (LTV) ratio. DeFi protocols like Aave use LTV ratios typically between 50% and 80%. If the collateral value falls and your LTV rises past a liquidation threshold, smart contracts automatically sell enough collateral to bring the LTV back to safe levels โ no human involved. CeFi lenders like centralized platforms work similarly but hold your collateral in their custody and may require KYC. Interest accrues on the borrowed amount. DeFi rates are variable and set by supply and demand in lending pools. CeFi rates may be fixed or negotiated. Some DeFi protocols offer flash loans โ uncollateralized loans that must be borrowed and repaid within a single blockchain transaction, used mainly by developers and arbitrageurs.
Start here
- 1Calculate how much you can safely borrow โ aim for an LTV well below the liquidation threshold, typically 50% or less of the collateral value, to give yourself a price buffer.
- 2On DeFi: connect a self-custody wallet to Aave or Compound, deposit collateral, and borrow in the same transaction flow.
- 3Set price alerts on your collateral. If the price drops toward your liquidation price, you need to add more collateral or repay part of the loan.
- 4Factor in the interest cost. If you borrow at 5% APR and your collateral drops 30%, you face both losses โ the math has to work.
Strengths
- Access liquidity without selling, which avoids a taxable disposal event in most jurisdictions.
- DeFi loans are non-custodial, instant, require no credit check, and are open 24/7 to anyone with a wallet.
- Stablecoin borrowing lets you dollar-cost average or cover expenses while staying long on the underlying asset.
Common misunderstandings
- Liquidation is automatic and irreversible โ a fast price drop can wipe your collateral before you can react.
- CeFi platforms hold your collateral in custody โ Celsius and BlockFi collapsed in 2022 with billions in customer funds locked.
- Interest costs compound, and a prolonged bear market can erode the value of holding the loan relative to just selling.
Common questions
What is an LTV ratio in a crypto loan?
LTV stands for loan-to-value. It is the ratio of what you borrowed to the value of your collateral. If you deposit $10,000 of ETH and borrow $5,000, your LTV is 50%. Most protocols liquidate your collateral if LTV rises past a liquidation threshold โ for example, 80% on Aave for ETH. Always keep a buffer below that threshold.
What happens if my crypto collateral gets liquidated?
If your LTV exceeds the liquidation threshold, the protocol (in DeFi) or the lender (in CeFi) sells enough of your collateral to bring the ratio back to safe levels. You lose that portion of collateral but keep the borrowed funds. DeFi protocols charge a liquidation penalty โ typically 5% to 15% of the liquidated amount โ on top of the loss. You may still owe tax on the collateral that was sold.
Is borrowing against crypto taxable?
In most jurisdictions, taking out a loan secured by crypto is not itself a taxable event โ you are borrowing, not selling. However, if the lender liquidates your collateral, that liquidation is treated as a disposal and triggers capital gains tax. The tax rules on this point are consistent in the US (IRS) and UK (HMRC), though it is always worth confirming with a local tax professional.
What is a flash loan?
A flash loan is an uncollateralized loan that must be borrowed and repaid within a single blockchain transaction. If the repayment is not included in the same transaction, the entire operation is reversed as if it never happened. Flash loans are used by developers for arbitrage, collateral swaps, and liquidations. They are not a consumer product โ they require custom smart contract code to use.
Is DeFi lending safer than CeFi lending?
DeFi lending has different risks from CeFi, not necessarily lower ones. DeFi is non-custodial โ the protocol cannot take your collateral for operational reasons โ but smart contract bugs and oracle manipulation can drain funds. CeFi is custodial โ Celsius and BlockFi both collapsed in 2022 โ but regulated CeFi lenders may offer some creditor protections. Neither is risk-free.
Sources
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