Bitcoin Lending: From Crypto Innovation to Credit Architecture

Bitcoin lending has evolved from informal peer-to-peer arrangements into structured credit products, often routed through offshore special purpose vehicles (SPVs) and regulated intermediaries. At its core, bitcoin lending allows a borrower to access liquidity either in fiat or stablecoins, against a promise to repay with interest—sometimes with bitcoin involved as collateral, sometimes as the loan asset itself.

For Indian lenders, fintechs, and compliance teams, the key question is no longer whether bitcoin lending exists, but how the risk is structured, where the enforceability sits, and whether it resembles credit or custody under Indian law.

Two Distinct Models:

A. Bitcoin-Backed Loans (Collateralised Model):

In a bitcoin-backed loan:

• The borrower pledges bitcoin as collateral;

• The lender disburses fiat currency or stablecoins;

• Bitcoin is typically custodied, escrowed, or controlled via smart contracts;

• Loan-to-Value (LTV) ratios, margin calls, and liquidation triggers apply

Legal character:
This structure closely resembles a secured lending arrangement, with bitcoin functioning as a non-traditional movable asset.

• Easier to explain as credit with collateral;

• Risk is concentrated in custody, valuation, and enforcement, not in asset issuance.

B. Bitcoin Loans (Asset-Denominated Model):

In a pure bitcoin loan:

• The lender advances bitcoin;

• Repayment is in bitcoin (principal + interest);

• Exposure is directly to price volatility of bitcoin.

Legal character:

• Economically closer to asset lending or speculative finance; Raises questions of crypto asset dealing;

• Harder to map onto traditional “loan” concepts under Indian law.

• Balance sheet, capital adequacy, and consumer protection issues multiply.

How Bitcoin Lending Differs from Traditional Finance?

Parameter	Traditional Loan	Bitcoin-Backed Loan	Bitcoin Loan
Asset risk	Low–moderate	High	Extreme
Collateral	Physical/ financial	Bitcoin	Often none
Enforcement	Courts/ statute	Contractual liquidation	Contract only
Regulatory clarity	High	Medium	Low
Suitability for regulated lenders	High	Conditional	Low

Bitcoin-backed loans approximate secured lending, while bitcoin loans sit at the outer edge of acceptable risk for regulated or compliance-conscious institutions.

Market Practice: Platforms vs. Legal Reality:

Industry comparisons (including global lists of crypto lending platforms) show:

• Heavy reliance on over-collateralisation;

• Aggressive margin call and auto-liquidation clauses;

• Jurisdiction-shifting to manage regulatory uncertainty.

However, contractual sophistication does not eliminate:

• Indian FEMA exposure;

• Consumer protection scrutiny;

• Tax and reporting ambiguity on crypto-linked interest.

This is particularly relevant in light of the cautious posture of the Reserve Bank of India, which continues to discourage regulated entities from direct crypto exposure, even without an express statutory ban.

Regulatory Caution:

India has not enacted a comprehensive crypto-asset law, but the supervisory stance of the Reserve Bank of India continues to emphasise:

• systemic risk,

• consumer protection, and

• institutional caution.

In practice, this means substance-over-form scrutiny. Structures designed to appear offshore or technical will still be examined for:

• who bears credit risk,

• who controls assets, and

• who interfaces with Indian borrowers.

Checklist Before Offering Bitcoin-Backed Loans:

1. Structural and Jurisdictional:

• Is the lending entity offshore or is any Indian entity exposed as lender in substance?

• Is the role of the Indian entity limited to non-lending support functions?

• Are governing law and dispute resolution clearly offshore?

Red flag: Indian entity signing loan or security documents, even “as agent”.

2. Collateral and Asset Characterisation:

• Is bitcoin clearly defined as collateral, not consideration?

• Is title pledged, transferred, or merely custodied?

• Are enforcement rights automatic on default without court intervention?

Red flag: Ambiguous custody or trust language.

3. Custody and Control:

• Who controls private keys at all times?

• Is custody independent, institutional, and insolvency-remote?

• Are cyber and custodian failure risks allocated?

Red flag: Lender bearing loss without fault for custodian failure.

4. Credit and Liquidation Mechanics:

• Conservative LTVs;

• Real-time valuation feeds and dispute buffers;

• Are borrower rights clearly subordinated on default? Consider, automatic margin calls and pre-agreed liquidation triggers;

• No delay in enforcement during market stress. Typically, can the lender unwind all positions within 72 hours?

• Are cross-border enforcement costs realistically budgeted?

Red flag: Approvals required to enforce.

5. Regulatory and Consumer Safeguards:

• Clear disclosures on volatility and no guaranteed returns;

• Express exclusion from deposit or investment schemes;

• Marketing language aligned to credit, not yield.

Red flag: Fixed-return or “income” representations.

Income-Tax Implications:

For Borrowers:

• Loan proceeds are not taxable income;

• However:

  • Liquidation of bitcoin collateral may trigger capital gains;

  • Forced sale timing may create tax leakage without cash liquidity.

For Lenders:

• Interest income:

  • Taxable as business income.

  • Source rules depend on borrower residency and payment structure.

• If lender acquires bitcoin on default:

  • Subsequent disposal taxed as virtual digital asset (VDA) gains;

  • Crypto losses cannot be freely set off under Indian law.

Withholding and Characterisation Risk:

• Cross-border interest may attract withholding tax;

• Misclassification can trigger disputes over crypto-specific TDS;

• Gross-up clauses are critical.

FEMA Considerations:

Key FEMA questions regulators will ask:

• Is this a capital account transaction in substance?

• Does bitcoin function as security or consideration?

Risk points:

• Indian residents pledging crypto to foreign lenders;

• Offshore liquidation proceeds not repatriated correctly;

• Loan structures mirroring ECB economics but avoiding ECB reporting.

Concluding Remarks:

Bitcoin lending does not replace traditional finance—it tests its outer limits.

For lenders:

• Bitcoin-backed loans may be treated as secured credit with exotic collateral;

• Bitcoin loans should be treated as high-risk financial exposure;

• Yield should never be allowed to outrun enforceability and exit certainty.

Until India adopts a clear crypto-asset framework, bitcoin lending will remain less about innovation and more about how risk is contractually displaced.