If you're a Coinbase (COIN) user, you may be able to use the bitcoin (BTCUSD) you own as collateral to get a loan.

The cryptocurrency exchange announced a new service Thursday that will allow its users to raise funds in stablecoin USD Coin (USDC) against their bitcoin holdings.

"You can also convert USDC to USD 1:1 for free to cover major expenses like buying a car or making a downpayment on your mortgage," Coinbase said.

While the service is integrated into the Coinbase app, the loan will be serviced by a decentralized finance (DeFi) platform known as Morpho, which is deployed on the Coinbase-created Base blockchain.

How Does Borrowing Against Bitcoin Work on Coinbase?

While using this service, Coinbase's U.S. clients—except those who live in New York state—can pledge their bitcoin to borrow up to $100,000 in USDC using the company's app.

Unlike a regular loan from a financial services company, your ability to borrow in this case is linked to how much bitcoin you have to offer as collateral instead of your credit score or creditworthiness. Your interest rate will depend on the going market rate, and will be visible to you when you're making the loan transaction. There are no required due dates or fixed monthly payments, and you can choose to repay the loan entirely or partially.

When you decide to get a loan against your bitcoin, it first gets converted to Coinbase Wrapped BTC (cbBTC) token, which is a bitcoin-backed token issued by Coinbase. This cbBTC will then be incorporated into a Morpho smart contract on the Base blockchain.

Should You Be Borrowing Against Your Bitcoin?

Borrowing against bitcoin holdings has been a key financial service in crypto for a number of years in terms of both DeFi apps and centralized financial institutions. It has its benefits as well as risks.

If you need money and sell your bitcoin for a profit to raise funds, you'd be on the hook to pay taxes on that sale. A loan against your bitcoin could help you raise money without selling your crypto, but its tax treatment remains unclear as some worry that conversion from bitcoin to cbBTC may be considered a taxable event.

Also, one big risk is that if the price of bitcoin faces wild swings, the value of your collateral could get affected, leading to a liquidation of some of your bitcoin holdings.

Pros of Loans With Bitcoin as Collateral

• Raise money without selling your bitcoin: Not unlike other assets used as collateral, this service allows you to get immediate liquidity by pledging your bitcoin without having to sell it.

Risks of Loans With Bitcoin as Collateral

• Liquidation of bitcoin holdings: According to Coinbase, a loan's health is determined by its loan-to-value (LTV) ratio. If you borrow $500 against a $1,000 collateral, your LTV would be 50% (500/1000). If you've borrowed against your bitcoin using Coinbase, you need to have an LTV of less than 86%. "If your loan accrues enough interest or the value of your collateral drops, and that causes the LTV of your loan to reach 86%, then your collateral will be liquidated to repay the loan plus the penalty fee," Coinbase said. An executive from the crypto exchange told Coindesk that the company will set up "liquidation warnings" to inform consumers.
• Risk of losing bitcoin: The risks associated with crypto lending more generally came to light in 2022 when several crypto lending services, including BlockFi and Genesis, went bankrupt or halted withdrawals. That said, the use of a DeFi platform such as Morpho should offer greater transparency and avoid at least some of those issues—albeit while also introducing risks associated with the use of smart contracts, which have been subject to countless bugs and hacks over the years.