Why Bitcoin-backed loans require qualified custody and zero rehypothecation

The volatility of digital assets often obscures the risks inherent in the lending structures themselves. When a borrower uses Bitcoin as collateral, they are not merely taking a loan; they are entering a counterparty agreement where the safety of the underlying asset depends entirely on the lender's operational integrity. Sahay emphasizes that qualified custody—where assets are held by a regulated, third-party entity rather than the lending platform—serves as the primary barrier against the unauthorized movement of funds.

Equally critical is the prohibition of rehypothecation. In many historical failures, lenders treated customer collateral as a pool of capital to be deployed in secondary trades or loans, effectively over-leveraging the assets they were supposed to be safeguarding. By ensuring that collateral remains static and segregated, platforms can prevent the contagion effects that crippled firms like Celsius, BlockFi, and Genesis. However, Sahay cautions that these structural safeguards are not a panacea for market risk. Even with perfect custody, borrowers remain exposed to standard lending hazards, including interest costs, margin calls, and the risk of liquidation if Bitcoin’s market price dips below a predetermined loan-to-value threshold.