A mechanical breakdown of bitcoin backed loans: over-collateralization math, wrapped BTC, oracles, liquidation triggers, and who holds your BTC.
Arkadii Kaminskyi
Arkadii Kaminskyi
Head of Operations at Sats Terminal
Head of Operations at Sats Terminal with 5 years of experience in crypto. Specializes in DeFi, yield farming, and borrowing — has reviewed 50+ crypto products.
Bitcoin holders who want dollars without selling face a simple trade-off: give up your BTC and pay capital gains, or use it as collateral and keep the upside. Bitcoin-backed loans solve that trade-off, but the mechanics underneath them are not simple. They involve wrapped tokens, over-collateralization ratios, oracle price feeds, liquidation thresholds, and a choice between smart contracts and custodial institutions holding your BTC. Most explainers stop at the surface. This one goes deeper. You will learn exactly what happens when you post BTC as collateral, how the math of over-collateralization protects lenders, how oracles decide when your position is unsafe, and what distinguishes wBTC from BTCB and cbBTC. By the end, the machinery behind a Bitcoin-backed loan should feel transparent rather than mysterious.
A Bitcoin-backed loan is a credit facility where you pledge BTC as collateral and receive cash or stablecoins in return. You keep ownership of the BTC economically — any appreciation still belongs to you — but the lender controls the collateral until the loan is repaid. When you pay back the principal plus interest, the lender releases the BTC. If the BTC price falls far enough that your loan becomes under-secured, the lender sells part or all of your collateral to recover their funds. That is the entire model.
The product has existed in traditional crypto finance for roughly a decade, first through centralized lenders such as the now-collapsed BlockFi and Celsius, then through decentralized lending protocols like Aave and Compound, and more recently through isolated-market protocols like Morpho Blue. What has changed over time is not the fundamental idea — collateralized lending is as old as finance itself — but the mechanics of how collateral is held, priced, and liquidated. Today, borrowers can choose between fully on-chain, non-custodial loans where smart contracts enforce the terms, and custodial loans where an institution holds the keys to the BTC.
The primary reason borrowers use these loans is to avoid a taxable event. In most jurisdictions, borrowing against an asset is not a disposal, so no capital gains are realized. Borrowers also use BTC loans to fund real-world expenses without giving up long-term exposure, rebalance portfolios without selling, or deploy stablecoins into other strategies. For a broader explanation of the mechanics, see what are bitcoin-backed loans. None of this is tax or legal advice — borrowers should consult a professional.
Collateral is the heart of the whole arrangement. Without it, there is no loan — only an unsecured promise, which crypto lenders do not extend because there is no credit bureau, no wage garnishment, and no enforceable identity layer to fall back on. Collateral replaces all of that with something simpler: an asset the lender can sell if the borrower defaults. In crypto, that asset is Bitcoin (or a tokenized representation of it), and the enforcement mechanism is either a smart contract or a custodian. For a full primer on the concept, see our glossary entry on collateral.
The critical number in any Bitcoin-backed loan is the loan-to-value ratio, or LTV. LTV measures how much you have borrowed relative to the current market value of your collateral. If you deposit $10,000 of BTC and borrow $5,000 of USDC, your LTV is 50%. As the BTC price moves, your LTV moves with it. A falling BTC price pushes your LTV up (because the denominator shrinks), while a rising price pushes it down. Every lender sets two LTV limits: a max LTV at origination (how much you can borrow against your collateral on day one) and a liquidation threshold (the LTV at which your position becomes eligible to be liquidated).
Imagine you deposit $10,000 of BTC as collateral into a non-custodial DeFi market with a 65% max LTV and an 80% liquidation threshold. You borrow $6,500 of USDC — the maximum allowed.
This is why the model is called over-collateralization: you post more value than you borrow, and the gap between the two numbers — the "buffer" — is what absorbs price volatility before the lender is exposed to loss. The wider that buffer (the lower your LTV), the more room the BTC price has to fall before you are in trouble. Experienced borrowers often deliberately under-use their max LTV. If the market lets you borrow at 65%, you might choose to borrow at 40% instead, trading some capital efficiency for a much larger volatility cushion. For strategies around setting a durable LTV, see our guide on optimizing your LTV ratio.
One final wrinkle in the worked example: interest accrues the whole time the loan is open. If you borrow $6,500 at a typical variable DeFi rate of 5% APR and hold the position for a year, your debt grows to roughly $6,834. That is a quiet 5% increase in your numerator without any change in BTC price — the kind of drift that moves long-held positions closer to the liquidation threshold even during calm markets. Borrowers who park loans for a year or more should budget for this drift explicitly rather than assume the starting LTV is the LTV they will have at month twelve.
Native BTC cannot move inside Ethereum, Arbitrum, or BSC smart contracts — it lives on the Bitcoin base chain. So when you take out a DeFi Bitcoin-backed loan, your BTC is either (a) custodied by an issuer who mints a wrapped token representing it on another chain, or (b) held by a centralized lender directly. In the wrapped case, the wrapped token — wBTC, BTCB, or cbBTC — is what sits inside the lending smart contract. It earns no yield while it sits there unless the lender explicitly offers a supply rate. In most cases, it simply waits. The BTC it represents is held by the wrapper's custodian (or bridged across chains), and it is generally not rehypothecated on the DeFi side: Aave and Morpho do not lend it out as a side business. On CeFi platforms, rehypothecation policies vary and have been the source of past failures — always check a lender's terms of service.
Bitcoin the network and Bitcoin the unit of account are not the same thing as Bitcoin the on-chain asset on Ethereum or Base. The Bitcoin blockchain uses its own scripting language and does not support the kinds of programmable vaults that DeFi lending protocols rely on. To use BTC as collateral in Aave or Morpho, you need a tokenized representation — a 1:1 claim on real BTC that lives on the destination chain. That representation is what the industry calls wrapped Bitcoin.
The three dominant wrapped-BTC variants today are wBTC, BTCB, and cbBTC. They serve the same purpose but differ in issuer, supported chains, and backing model. The table below summarizes the main differences at the time of writing.
| Wrapped BTC | Issuer | Supported chains | Backing model |
|---|---|---|---|
| wBTC | BitGo (custodian), multi-merchant minting network | Ethereum primarily; also on several EVM L2s via bridges | 1:1 BTC held in institutional custody; published proof-of-reserves addresses |
| BTCB | Binance | BNB Smart Chain (BSC) primarily | 1:1 BTC held by Binance; proof-of-reserves via on-chain attestation |
| cbBTC | Coinbase | Base, Ethereum | 1:1 BTC held by Coinbase; backed by Coinbase's own institutional reserves |
The important shared property is that each token is a custodial receipt: if you hold 1 wBTC, you hold a claim on 1 BTC sitting with BitGo's custody infrastructure. If that custodian fails, the peg is at risk — not because the smart contract is broken, but because the underlying BTC is no longer there to redeem against. This is a form of counterparty risk that sits one layer beneath the lending protocol itself. The wrapper's proof-of-reserves and the custodian's solvency are both inputs to the safety of any Bitcoin-backed loan that uses that wrapped token.
In practice, each lender tends to prefer a specific wrapper. Aave v3 on Ethereum leans on wBTC. Aave v3 on Base uses cbBTC. Lending markets on BNB Smart Chain use BTCB. When you route a loan through an aggregator, the wrapper choice is usually made for you based on the destination chain and protocol. The UX goal is to hide that complexity; the mechanical reality is that your BTC is being bridged and wrapped into the format the target market understands. Our guide on bridging and wrapping Bitcoin walks through the routing in more depth.
The conversion itself is not free — it costs gas on the destination chain, a potential bridge fee if you are crossing networks, and a small spread where the wrapper mints from BTC deposited with the custodian. These costs are usually small relative to the loan size, but on smaller loans they can meaningfully shrink the economics. A good aggregator surfaces the all-in cost up-front rather than letting borrowers discover it post-hoc. When your loan closes, the reverse process happens: the wrapped BTC is unwrapped, bridged back, and sent to a native Bitcoin address you control, incurring gas and bridge fees again in the other direction.
The single biggest structural distinction in Bitcoin-backed lending is who holds your collateral while the loan is active. There are two models, and they behave very differently in a crisis.
On Aave v3 and Morpho Blue, your wrapped BTC is supplied into a smart contract. The contract's code — publicly visible and audited — controls whether you can withdraw, whether you can be liquidated, and at what price. No human approves a liquidation, and no human can freeze a withdrawal. As long as your LTV stays below the liquidation threshold, the contract will release your collateral the moment you repay the debt. This is what "non-custodial" means: the custody logic is encoded in software that anyone can read.
The risks here are different from custodial risks. Instead of worrying about a company becoming insolvent, you worry about the smart contract having a bug, an oracle feed being manipulated, or governance making a change that affects your position. These are real risks, and they have caused losses on other protocols historically, but on mature markets they are generally bounded by multiple audits, significant bug bounties, and long production track records. For an introduction to the audit landscape, see smart contract security and audits.
On a CeFi platform, there is no smart contract enforcing your terms. The lender holds your BTC directly — usually in a combination of cold storage and operational hot wallets — and enforces the loan agreement through their internal systems and a legal contract you sign. If the lender is solvent, well-run, and honest, this works fine. If any of those assumptions break, the borrower has limited recourse. The failures of BlockFi, Celsius, and Genesis demonstrated that CeFi lenders sometimes take risks with customer collateral that are not visible to customers — rehypothecation into risky strategies, for example.
This does not mean CeFi is always a bad choice. Some borrowers prefer the handholding, fiat on-ramps, and support channels that only a custodial lender can offer. It does mean the risk profile is fundamentally different: in non-custodial DeFi, your main exposure is to code; in CeFi, your main exposure is to a company's solvency and integrity. A deeper comparison lives in custodial vs non-custodial lending.
A lending protocol has to know, continuously, what your collateral is worth. That number decides whether your position is healthy or liquidatable. But smart contracts cannot read the outside world on their own — they only know what other contracts tell them. The component that bridges that gap is called an oracle.
The dominant oracle network in DeFi is Chainlink, which aggregates prices from many exchanges and publishes a single consensus price on-chain. Aave v3 and Morpho Blue both use Chainlink-style feeds for BTC pricing, typically the wBTC/USD or BTC/USD feed depending on the market. The feed is updated either on a fixed heartbeat (for example, once per hour) or when the price moves beyond a deviation threshold (for example, 0.5% from the last published value), whichever happens first.
That update cadence matters because liquidation only triggers when the on-chain price crosses the liquidation threshold. In a fast-moving market, there can be a small lag between the real-world BTC price and the price the contract sees. For borrowers this is usually favorable — the oracle often catches up slightly after the spot market moves — but it also means you cannot assume the second-by-second price you see on TradingView is exactly what Aave thinks your BTC is worth. The difference is usually small, but it can matter in the minutes around a sharp drawdown.
Oracle design choices also affect the tail risks. A feed with too few data sources can be manipulated by pushing a handful of thin-liquidity venues around. A feed with too-lax deviation thresholds can stay stale long enough to miss a fast move. Mature markets mitigate both issues by using volume-weighted aggregation across many venues and by stacking a secondary fallback feed that the protocol can switch to if the primary stalls. Protocol governance tunes these parameters over time as market structure evolves, which is part of why the liquidation threshold you see today may not be the threshold in place a year from now.
When the oracle price crosses the liquidation threshold, the lending contract opens your position to a public liquidation mechanism. On Aave, anyone running a liquidation bot can call liquidationCall, repay up to 50% of your debt in the borrowed asset (USDC, for example), and receive an equivalent amount of your collateral plus a liquidation bonus of 5–10%. That bonus is what incentivizes anyone to step in and clean up unhealthy positions fast. It is also the single biggest cost of being liquidated — it is not merely that your collateral is sold, it is that it is sold at a discount.
The practical implication: liquidation is not a graceful downsizing of your position. It is a hard, automated action that costs you meaningfully more than simply repaying the loan yourself at the same price. The best defense is simply to never get close to the threshold in the first place, and the second-best defense is to have repayment capital or additional collateral ready when volatility spikes. Our dedicated guide on managing liquidation risk covers both defenses in depth, as does monitoring your loan health.
Over-collateralization is the reason Bitcoin-backed loans can exist without KYC, credit checks, or lender-by-lender underwriting. The lender does not need to trust you because the collateral is worth more than the loan. But the same property creates friction: you can only borrow a fraction of what you post. Understanding where that fraction comes from clarifies a lot of what seems arbitrary about the product.
Every market sets its max LTV based on the volatility and liquidity of the collateral. Stablecoin-collateralized loans have max LTVs above 90% because the collateral barely moves. Bitcoin, with historical 30-day volatility routinely in the 40–70% annualized range, has max LTVs much lower. On Aave v3, wBTC typically has a max LTV in the 70–80% range with a liquidation threshold of 75–85%. Those numbers are set through governance and change over time based on observed market conditions; check the live parameters before each loan.
DeFi lending markets use variable interest rates that reset block-by-block based on the pool's utilization rate — the ratio of borrowed funds to supplied funds in the pool. When utilization is low, borrow rates are low because lenders need to compete for borrowers. When utilization approaches 100%, rates rise steeply (the "slope 2" region of the curve) to encourage repayment and attract more suppliers. Interest accrues continuously into your debt balance, not in discrete monthly installments. There is no origination fee on Aave or Morpho; on CeFi platforms, fees vary.
Some Morpho Blue markets and select CeFi products offer fixed rates. Fixed rates are easier to reason about but typically carry a premium to compensate the lender for taking duration risk. For a comparison, see variable vs fixed interest rates.
The difference between max LTV and liquidation threshold is a buffer the borrower gets for free. On a market with 70% max LTV and 80% liquidation threshold, you are handed a 10-percentage-point cushion on day one. That is roughly equivalent to BTC being able to drop 12.5% before a fully-drawn loan faces liquidation. If you choose to borrow only at 50% LTV, your cushion expands to a 37.5% price drop. Borrowers who treat the buffer as a design choice, not an afterthought, survive volatility that liquidates borrowers who max out their LTV. For the full mechanical picture, see understanding collateral and LTV.
Borrow by Sats Terminal is a Bitcoin-backed stablecoin lending aggregator. It is not a lender itself. Instead, it surveys real-time offers across DeFi protocols (Aave v3, Morpho Blue) and CeFi providers, then presents the best-matching terms in a single interface. For each quote, the interface shows the lender, rate type (variable or fixed), estimated rate, max LTV, liquidation threshold, whether the lender is custodial, and the liquidation price implied by your chosen loan size.
The user flow is designed to hide the collateral-mechanics complexity described above while still letting an informed borrower inspect it. You sign up with email alone — no KYC — and a self-custodial Privy wallet is created automatically behind the scenes. You never touch a seed phrase, but you also never hand custody to Borrow; every state-changing action requires your wallet's approval. You configure a loan (BTC amount in or USDC amount out), Borrow compares offers, and you pick one. You deposit native BTC to a unique address. Borrow monitors the Bitcoin network for confirmations, then automatically bridges and wraps your BTC into the correct format for the selected lender (wBTC, BTCB, or cbBTC), supplies it as collateral, and disburses the stablecoins into your Privy wallet. Every step is visible and user-approved.
Throughout the life of the loan, the dashboard displays the same core numbers the underlying protocol uses: current collateral value, outstanding debt, effective LTV, accrued interest, and the liquidation price. Borrow does not auto-manage positions or auto-liquidate — risk management stays with the borrower — but the visibility layer makes it straightforward to spot a deteriorating position early. Supported collateral wrappers are wBTC, BTCB, and cbBTC, across BASE, Ethereum, Arbitrum, Polygon, Optimism, and BSC. Learn more in how bitcoin-backed loans work and what is Borrow by Sats Terminal.
Common Questions
There is no universal minimum — each lender sets its own max LTV and liquidation threshold, and those numbers vary by collateral and by market. On Aave v3 wBTC markets, the max LTV at origination is typically in the 70–80% range, which corresponds to roughly 125–143% collateralization. On Morpho Blue markets, parameters are set per isolated market and can be tighter or looser. On CeFi platforms, max LTVs often sit lower (50–60%) to give a wider volatility buffer. Always check the specific parameters of the loan you are quoting before borrowing, because protocol governance adjusts them over time.
