When someone borrows dollars against their Bitcoin, two things happen at once: cash flows toward the borrower, and collateral flows away from them. A balance displayed in an account tells you
When someone borrows dollars against their Bitcoin, two things happen at once: cash flows toward the borrower, and collateral flows away from them.
A balance displayed in an account tells you one of those stories. The other is where the Bitcoin actually goes, who can use it, and what determines whether it comes back.
Galaxy Research reported $56.16 billion in crypto-collateralized lending outstanding at the end of Q2 2026, spanning both centralized lenders and decentralized protocols.
That's a large pool of assets sitting somewhere other than the owner's wallet, under terms that vary widely depending on the lender.
Related: Ledn identifies massive turning point for crypto lending markets
Ledn, a centralized Bitcoin-backed lender, offers what it calls Custodied Loans.
When a borrower posts Bitcoin, Ledn may re-post that collateral to an institutional USD funding partner, such as a bank, credit fund or other corporate entity, or to a Ledn-sponsored financing vehicle, including a Bitcoin-backed asset-backed security, according to the company's documentation.
The collateral moves, but the rules around it are specific. It remains in verifiable custody, legally ring-fenced from the funding partner's own assets or held in a bankruptcy-remote vehicle. Neither Ledn nor the funding partner nor any financing vehicle has the right to lend it out for interest, Ledn says.
Posting Bitcoin as security for a dollar loan is not the same as lending Bitcoin itself. In the first case, the collateral backs a specific obligation. In the second, it becomes someone else's asset to deploy, and the borrower's return depends on a chain of counterparties each performing their obligations.
Not all lenders operate this way. In a different model, used by some centralized platforms, the lender receives Bitcoin as collateral and may contractually reserve the right to lend it onward to another counterparty for interest.
The original borrower still owes dollars, but the lender now also depends on the onward borrower returning the Bitcoin.
This creates an additional source of revenue for the lender but introduces repayment dependency. If the onward borrower defaults, the original borrower's collateral may not be readily available for return.
The collapses of Celsius, BlockFi and Voyager in 2022 demonstrated what happens when these chains break, borrowers who believed their collateral was safely held discovered it had been deployed in ways that left them as unsecured creditors in bankruptcy proceedings.
A third model works differently again. Coinbase's cbBTC is a token backed 1:1 by native Bitcoin held by Coinbase. The token currently has a circulating supply of roughly 95,900 cbBTC, worth approximately $8.1 billion, according to CoinGecko.
When someone holds cbBTC, the native Bitcoin sits with Coinbase as custodian while the token itself trades freely on blockchain networks.
That token can then enter a lending protocol, creating two distinct layers of custody and risk: the native Bitcoin with Coinbase, and the cbBTC token inside a smart contract.
How the token is treated depends on which protocol it enters. On Aave, the largest DeFi lending protocol with roughly $19.5 billion in total value locked according to DeFiLlama, supplied tokens enter liquidity pools where they can serve as collateral and are available to borrowers, earning supply interest for the depositor.
On Morpho, which holds approximately $11.1 billion in TVL per DeFiLlama, the design separates collateral from loan assets, collateral posted by borrowers is not lent out to other borrowers and does not earn supply interest by default, according to the protocol's documentation. Lenders earn interest by supplying the loan asset, not the collateral.
Someone acquiring cbBTC on a secondary market does not need to personally wrap Bitcoin through Coinbase, they simply buy the existing token. But they inherit the custodial arrangement underneath it, including any terms Coinbase sets for redemption back to native BTC.
For each model, the path back to the borrower's Bitcoin depends on what happens next.
In Ledn's Custodied Loan structure, repaying the loan in full triggers the release of collateral back to the borrower. If the value of the collateral drops significantly, Ledn may issue margin calls or liquidate a portion to maintain the loan-to-value ratio, as with any collateralized lending arrangement.
In centralized models where collateral may be lent onward, the borrower's ability to recover their Bitcoin depends not only on their own repayment but on the lender's ability to recall collateral from wherever it was deployed.
In DeFi, repayment releases collateral from the smart contract, but for wrapped tokens, the borrower then holds cbBTC, not native Bitcoin. Redeeming that token for BTC requires going through Coinbase's unwrapping process, which carries its own terms and conditions.
If a liquidation occurs in the DeFi protocol, the collateral is sold to cover the debt, and the borrower loses it entirely, the same outcome as any margin loan.
The lending market offers more options than ever, but the range of custody and risk models underneath them has also widened. Before posting Bitcoin as collateral, four questions cut through the complexity:
Who holds the asset? Who can use it, and for what purpose? What evidence, attestation reports, onchain records, contractual terms, verifies the arrangement? And what specific conditions determine whether you get your Bitcoin back?
The answer differs on lender, protocol and the structure, which is exactly why they are worth asking before the Bitcoin leaves your wallet.
Related: Trump's new AI czar left the SEC a day after it declared war on crypto
