Crypto-Backed Loans: LTV Ratios and Liquidation Risk

A crypto-backed loan lends you cash or stablecoins in exchange for crypto locked as collateral, and the loan-to-value (LTV) ratio measures how close you are to losing that collateral. LTV is the debt divided by the collateral's current market value, so it rises every time the price falls. Once it crosses the lender's liquidation line, the collateral can be sold without any further say from you.

Key takeaways

LTV = loan balance / collateral value. A $20,000 loan against 0.5 BTC at an assumed $80,000 starts at 50%, and under the hypothetical 83% liquidation line it fails after a 39.8% price drop.
On Aave v3, a position becomes eligible for liquidation when its health factor drops below 1; the liquidator receives the repaid debt value plus a bonus taken from the borrower's collateral.
In FRED's daily Coinbase bitcoin series, the price fell 48.9% from peak to trough over the 12 months from October 19, 2025 to October 19, 2026, and 53.0% from the October 5, 2025 high. Both falls are bigger than the drop needed to liquidate the hypothetical loan.
At a centralized lender, the bigger danger can be the lender itself. A court held that Celsius's Earn customers had only unsecured claims, Celsius's terms warned that Borrow collateral might not be recoverable, and FDIC insurance does not cover crypto company failures.
The IRS digital asset FAQs treat digital assets as property and cover sales and exchanges; they do not address loans or collateral, so the tax result of borrowing or being liquidated needs separate confirmation.

How a crypto-backed loan works

The borrower deposits crypto, receives a loan worth some fraction of its value, pays interest, and gets the collateral back on repayment. The borrower usually keeps the price exposure, which is the appeal and also the risk: the loan is a fixed dollar amount while the collateral moves with the market.

Two lender types differ in who controls the collateral and who enforces the rules.

Centralized (CeFi) lenders are companies. Terms sit in a loan agreement and terms of use, margin-call and liquidation procedures are whatever that contract says, and the company holds or controls the deposited coins.
Decentralized (DeFi) protocols such as Aave are smart contracts. Collateral sits in the protocol, risk is tracked with a health factor, and the position becomes eligible for liquidation when it falls below 1. Any network participant can carry out the liquidation.

Neither type has a published, universal rulebook. The thresholds below are hypothetical unless a source is named, and a real lender's numbers differ by asset and can change.

LTV and its three thresholds

LTV = loan balance / market value of collateral

Price that hits a given LTV = loan balance / (units of collateral x LTV level)

A loan agreement may name up to three LTV levels. The names vary, so read the agreement for the exact terms.

Level	What it means	Hypothetical value used here
Initial LTV	The ratio when the loan starts; sets how much you can borrow against the collateral	50%
Margin-call LTV	The ratio at which the lender asks for more collateral or a partial repayment	70%
Liquidation LTV	The ratio at which the lender or protocol may sell collateral	83%

These values are illustrations, not any lender's published terms. Aave's documentation describes no margin-call stage: once the health factor falls below 1, any participant can liquidate.

Worked examples with 0.5 BTC

Illustrative example 1. A borrower pledges 0.5 BTC when bitcoin is assumed to trade at $80,000 and borrows $20,000. Interest and fees are ignored.

Collateral value: 0.5 x $80,000 = $40,000. LTV: $20,000 / $40,000 = 50%.
Margin-call price at 70%: $20,000 / (0.5 x 0.70) = $57,142.86, a drop of 28.6%.
Liquidation price at 83%: $20,000 / (0.5 x 0.83) = $48,192.77, a drop of 39.8%.

Illustrative example 2. The price falls 25% to $60,000, so the collateral is worth $30,000 and LTV is $20,000 / $30,000 = 66.7%. That is below the 70% margin-call line but close to it. To restore 50% the borrower has two routes.

Repay debt: the loan must fall to 50% x $30,000 = $15,000, so repay $5,000.
Add collateral: the collateral must reach $20,000 / 0.50 = $40,000, so add $10,000, or about 0.1667 BTC at $60,000, taking the pledge to 0.6667 BTC.

Adding collateral takes twice as many dollars as repaying, because at a 50% target every $1 of debt repaid removes $2 of collateral that would otherwise be needed. In general, the collateral to add equals the repayment divided by the target LTV. Added collateral stays yours but stays exposed to the price, while a repayment spends cash and permanently lowers the debt.

How far bitcoin has actually moved

The question is whether a 40% drop is plausible. Computed in Python from the FRED series CBBTCUSD (Coinbase bitcoin in US dollars, one price a day taken at 5 p.m. Pacific, updated October 19, 2026), the 366 daily prices from October 19, 2025 to October 19, 2026 show:

A peak of $114,548.09 on October 25, 2025 and a trough of $58,585.96 on June 30, 2026, a 48.9% fall.
The worst single day was February 5, 2026, at -12.4%, and the best was +9.5% the day after.
The 30 days to October 19, 2026 were calmer: the largest peak-to-trough fall inside that window was 5.9%.

This window starts two weeks after the series high of $124,720.09 on October 5, 2025; measured from that high to the same June 30 trough, the fall is 53.0%. Either way, the drop exceeds the 39.8% needed in example 1. A once-a-day price also hides intraday lows, so a lender watching live prices could see a lower price than the series shows. The figures describe the past and do not predict anything.

How Aave v3 liquidates a position

Aave's help pages (the liquidations page dated August 9, 2024 and the FAQ) give the mechanics.

Health factor = (collateral value x weighted average liquidation threshold) / total borrow value

Liquidation threshold is set by Aave Governance for each collateral asset. A health factor below 1 makes the position eligible for liquidation, and it moves with collateral and debt values, which include accrued interest.
Liquidation bonus (the borrower's penalty) depends on the collateral asset. The liquidator repays debt and receives that value plus the bonus from the borrower's collateral. The FAQ's examples use 5% for ETH and 15% for YFI.
Close factor limits how much debt one liquidation can repay. The help page and FAQ allow up to 50% only when the health factor is above 0.95 and both collateral and debt are worth at least $2,000. Up to 100% is allowed when the health factor is 0.95 or below, or when either value is under $2,000. The developer page for the pool contract still says the close factor is 0.5, so check the live rules for your market.

Illustrative example 3 (hypothetical numbers; the 80% threshold and 5% bonus are assumptions modelled on the FAQ's ETH example, since real values are set per asset and change). A borrower supplies $20,000 of ETH and borrows $11,000 in stablecoins. Interest is ignored.

Start: LTV = 55%, health factor = 20,000 x 0.80 / 11,000 = 1.45.
Liquidation becomes possible once collateral falls below $11,000 / 0.80 = $13,750, a 31.25% drop.
Collateral falls to $13,500 (-32.5%): health factor = 13,500 x 0.80 / 11,000 = 0.98. That is above 0.95, and collateral and debt are both above $2,000, so at most 50% of the debt can be repaid: $5,500.
The liquidator receives $5,500 x 1.05 = $5,775 of ETH. The $275 difference is the bonus, paid from the borrower's collateral.
Result: $7,725 of collateral and $5,500 of debt remain, a health factor of 1.12 and an LTV of 71.2%.

The loan was not closed, but the borrower lost $5,775 of collateral to clear $5,500 of debt and is left only slightly above the line. If the collateral had instead fallen to $13,000, the health factor of 0.945 would have allowed 100% of the debt to be repaid: $11,550 of ETH seized, $1,450 left.

Custody risk at centralized lenders

With a CeFi lender, price risk sits next to counterparty risk. Rehypothecation means a firm re-lends or otherwise uses assets customers handed over. Whether a borrower's collateral is pledged or transferred, and whether it can be reused, depends on the loan agreement. The two cases below mainly involve interest-earning accounts, but they show what happens when the terms give a firm that control.

BlockFi. On February 14, 2022, the SEC announced that BlockFi Lending LLC agreed to pay a $50 million penalty, with another $50 million to 32 states, $100 million in total. The SEC found that its interest accounts were securities it had failed to register, and that BlockFi had operated as an unregistered investment company, noting that more than 40% of its assets, excluding cash, were investment securities, including loans of crypto assets to institutional borrowers. BlockFi neither admitted nor denied the findings.
Celsius. Celsius filed for Chapter 11 in July 2022, and in a January 4, 2023 opinion, Chief Bankruptcy Judge Martin Glenn held that crypto in Earn accounts became Celsius's property under its terms of use, which granted Celsius "all right and title" to the assets, including the right to rehypothecate them. About 600,000 Earn accounts held crypto worth about $4.2 billion as of July 10, 2022, and their holders were left with unsecured claims; the same terms warned that assets "used in the Earn Service or as collateral under the Borrow Service may not be recoverable" if Celsius went bankrupt. The opinion expressly did not decide who owned the assets in Celsius's Borrow Program.

Deposit insurance does not fill the gap. The FDIC's July 28, 2022 fact sheet says it insures deposits in insured banks and that insurance does not protect against the default, insolvency or bankruptcy of non-bank entities, nor does it apply to crypto assets.

Regulation of banks has moved separately. The OCC's March 7, 2025 Interpretive Letter 1183 reaffirmed that certain crypto activities, such as custody, are permissible for national banks, and the FDIC's FIL-7-2025 of March 28, 2025 let FDIC-supervised banks engage in permissible crypto activities without prior approval, provided they manage the risks. Neither adds deposit insurance to crypto held as loan collateral.

Taxes: borrowing versus liquidation

The IRS's digital asset FAQs (page reviewed June 29, 2026) say digital assets are treated as property, that selling them for dollars produces a capital gain or loss, and that exchanging them for other property generally does too. The page does not address borrowing against digital assets or pledging them as collateral, and it does not say how a seizure is treated.

Taking out a loan is a loan rather than a sale of the asset, which is the usual reason borrowing is described as non-taxable, but that rests on general property rules and not on a statement in these FAQs.

A liquidation is different: collateral is sold to repay debt, and a sale is the type of disposition the FAQs describe. The closest general rule is in IRS Publication 544, which treats a foreclosure or repossession of property as a sale or exchange, with gain or loss measured against your adjusted basis. The IRS has not published crypto-specific guidance on liquidations, but on that logic a liquidation after a price rise could create a tax bill and a lost position together. An agreement that transfers ownership of the coins to the lender, as Celsius's terms did, may be treated differently, so a tax professional should review the specific contract.

Frequently asked questions

Can a small Aave position be liquidated in full?

Yes. Under Aave's help page and FAQ, if either the collateral or the debt is worth less than $2,000, up to 100% of the debt can be liquidated even when the health factor is above 0.95. A partial liquidation must also leave at least $1,000 of both collateral and debt. In example 3 both remainders clear that bar and the health factor rose to 1.12, though a further price fall could push it below 1 again.

Can interest alone trigger a liquidation?

Yes. Aave's documentation says the health factor moves with collateral and debt values, and debt value includes accrued interest. A position with a flat collateral price can drift toward 1 as interest accumulates.

Who receives the liquidation bonus?

The liquidator. Aave's FAQ says the liquidator receives the repaid debt value plus a bonus from the borrower's collateral, so the borrower bears the cost. The bonus depends on the collateral asset.

Why do bitcoin drawdown figures differ between sources?

The answer depends on the window. In the FRED series, the 12 months to October 19, 2026 show a 48.9% fall because they start after the October 5, 2025 high. From that high of $124,720.09 to the June 30, 2026 trough of $58,585.96, the fall is 53.0%. Intraday data and other exchanges give different numbers again.

Where do the prices that trigger liquidation come from?

On Aave v3, the overview page says collateral and debt values use prices from oracles, which are external price feeds. A centralized lender uses whatever price source its contract names, so that clause is worth reading.

Checklist before you pledge

Write down the margin-call and liquidation LTVs, and convert each into a price using the formula above.
Compare that price with recent drawdowns: the 48.9% fall in the 12 months to October 19, 2026 would have crossed an 83% liquidation line from a 50% start.
Decide in advance whether you would repay or add collateral, and keep that reserve outside the loan.
For a protocol, check the live liquidation threshold, bonus and close factor for your asset; for a company, read who holds the collateral and whether it can be reused.
Keep records of collateral, loan dates and any forced sale for tax reporting.