The true cost of wrapping Bitcoin

As borrowing against Bitcoin becomes more mainstream, most borrowers begin their journey the same way: by looking at the most recognizable names in the space. Some are drawn to the seamless, app-driven experiences of centralized lenders like Milo, Ledn, or Nexo, while others prefer the decentralized, permissionless nature of DeFi platforms like Coinbase’s Base, Aave, or Compound.

That preference often comes down to how someone thinks about crypto itself. The DeFi experience appeals to those aligned with the original ethos of crypto: autonomy, transparency, and code over intermediaries. You don’t need to speak to a representative, go through KYC, or wait days to get access to your funds. For many, that’s the whole point of holding Bitcoin in the first place.

But while DeFi offers flexibility and control, what many borrowers don’t realize is the hidden cost of that decision. Specifically, when borrowing against wrapped Bitcoin (WBTC), which is required in DeFi, U.S.-based borrowers could be triggering a taxable event without knowing it. And that cost can significantly affect the real price of borrowing, even if the interest rate looks the same on the surface.

What does it mean to wrap Bitcoin?

Wrapped Bitcoin (WBTC) is a tokenized representation of Bitcoin that exists on other blockchains, primarily Ethereum. It was created to solve a core limitation: native Bitcoin is not compatible with Ethereum-based smart contracts. This means BTC holders can’t interact directly with DeFi protocols unless they convert their Bitcoin into a token that the Ethereum network understands.

The process works like this: you send your BTC to a trusted custodian (commonly BitGo), who locks it in secure custody and issues you an equivalent amount of WBTC—1 WBTC for every 1 BTC locked. That WBTC is now an ERC-20 token you can use across Ethereum-based apps, including Aave, Compound, Uniswap, and others.

This conversion unlocks a wide range of utility, but it also comes with trade-offs. First, your original BTC is no longer in your control—it’s held by a third party. Second, you now hold a different asset entirely (WBTC), which may look the same in price but has different regulatory, technical, and tax implications. Wrapping Bitcoin introduces custodial risk, and it creates the potential for taxable events, especially in U.S. jurisdictions.

How BTC-backed loans work: DeFi vs Bitcoin-Native

Borrowing against your Bitcoin is possible through two fundamentally different paths: DeFi and Bitcoin-native lending.

In a DeFi loan, the process starts by wrapping your BTC. That wrapped BTC (WBTC) is then deposited into a smart contract platform such as Aave or Compound. These protocols allow you to borrow stablecoins like USDC or DAI in real time, typically without providing identification. The entire process is on-chain, automated, and often completed in minutes. The experience feels fluid and self-directed, core to the DeFi ethos.

But with that flexibility comes complexity. You're not just using your BTC, you're converting it, managing smart contract exposure, and holding a synthetic version of the original asset.

In contrast, Bitcoin-native lending through a provider like Milo allows you to pledge your original BTC directly, without any conversion. Your BTC is held in secure custody, typically offline, and the loan is issued in fiat or stablecoins. The onboarding process may take longer and include KYC, but the structure is familiar to traditional finance and far more tax-efficient. Your BTC remains unaltered, and you avoid the need to interact with third-party token wrappers or on-chain protocols.

The Hidden Tax Impact of Wrapped BTC

The IRS treats crypto-to-crypto swaps as taxable events. This includes wrapping Bitcoin into WBTC, because you are exchanging one crypto asset (BTC) for a fundamentally different one (WBTC). That swap is considered a disposition of property. If the BTC has increased in value since you acquired it, you will owe capital gains tax at the time of wrapping.

Unwrapping WBTC back into BTC is also a taxable event. That’s a second disposition. If the value of WBTC has changed during the time you held it, that change will result in another taxable gain or loss.

According to official IRS guidance here, a crypto-to-crypto transaction triggers a reportable gain or loss, regardless of whether fiat is involved. This means that a borrower who wraps and later unwraps BTC may face two separate taxable events throughout one loan.

By contrast, pledging native BTC through a lender like Milo involves no sale, no swap, and no disposition. Your original Bitcoin remains intact, and no capital gains are realized. From a tax perspective, the structure is cleaner and more favorable for long-term holders.

Case study: How wrapped Bitcoin affects your true borrowing cost

To highlight the real impact of using wrapped Bitcoin, let’s walk through a side-by-side comparison of two borrowers using the same amount of collateral, under identical loan terms.

Both loans have:

• 50% LTV
• Same interest rate
• Same origination fee
• No early payoff penalty

The only difference is how the collateral is handled; one wraps BTC to use in DeFi, the other pledges native BTC with a Bitcoin-native lender.

Borrower Profile

• Collateral: 2 BTC
• BTC price at loan origination: $107,400
• Total collateral value: $214,800
• Loan amount (50% LTV): $107,400
• BTC appreciates 10% during loan term → New price: $118,140
• New total value of BTC: $236,280

Option 1: DeFi Lender (e.g., Coinbase Base, Aave)

• Borrower wraps BTC to receive 2 WBTC
• After BTC appreciates, borrower unwraps WBTC back into BTC
• Unwrapping is a taxable event
• Capital gain per BTC: $10,740
• Total gain: $21,480
• Estimated capital gains tax (15%): $3,222

Total additional cost = $3,222 in taxes

Option 2: Bitcoin-Native Lender (e.g., Milo)

• Borrower pledges BTC directly
• BTC is held securely, with no conversion
• After loan repayment, borrower receives BTC back unchanged
• No taxable event triggered
• Total additional cost = $0

Additional risk considerations

Both DeFi and Bitcoin-native lenders use trusted custodians such as BitGo to hold Bitcoin. The difference isn’t who holds the BTC, but how that custody is used.

In DeFi, once BTC is wrapped, it becomes WBTC and is moved into smart contracts. These contracts are programmable, which means they can be exposed to bugs, exploits, or unintended behavior. Even though the BTC is held by a custodian, the tokenized version is now part of a broader system that carries added technical risk.

With Bitcoin-native lending, the BTC stays in cold storage and isn’t wrapped or deployed into other protocols. It remains securely held, off-chain, and fully segregated. There’s no exposure to smart contract vulnerabilities or third-party interactions. Same custodian, very different levels of control and risk.

When does DeFi make sense for borrowing against Bitcoin?

DeFi can be a powerful option for borrowers who prioritize speed, anonymity, and access to on-chain liquidity. With no paperwork, approvals, or intermediaries, platforms like Aave or Compound offer near-instant loans using wrapped Bitcoin. This appeals to borrowers who want to stay entirely within the crypto ecosystem or actively participate in yield strategies and composable DeFi apps.

However, it’s important to understand that while DeFi offers permissionless access, it doesn’t mean full control over your BTC. Once Bitcoin is wrapped, it's held by a custodian, and what you control is a tokenized version (WBTC) that operates within a smart contract environment. That token can be exposed to protocol-level risks, including bugs, governance changes, or bridge failures.

If your goal is to access liquidity without triggering taxable events or exposing your collateral to added risk, a Bitcoin-native lender like Milo may be more appropriate. Your BTC stays in its original form, held in cold storage, not tokenized or deployed. The structure is simpler, more secure, and more aligned with long-term value preservation. Ultimately, the best option depends on what you value most: DeFi offers speed and flexibility, while Bitcoin-native lending offers tax efficiency, asset integrity, and peace of mind.

The takeaway Wrapping Bitcoin allows for a wide range of use cases in the DeFi ecosystem. But for borrowers in the U.S., the true cost of wrapping BTC often goes unnoticed until it’s too late.

Whether you go with a decentralized or centralized lender, understanding how your BTC is treated can make a five-figure difference in the outcome of your loan. Before choosing a platform based on brand recognition or user experience alone, be sure to factor in the full picture, including custody, tax exposure, and long-term value preservation.

Sometimes the smartest move is keeping your Bitcoin exactly as it is.

The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.