A crypto trader thought he had found a loophole. Why sell Bitcoin, ETH, or altcoins and hand over 30% tax when you could simply borrow against them instead? Buy crypto, move it into DeFi, earn some yield, use the assets as collateral, take out a loan, and cash out the borrowed money. No sale, no disposal, no tax. At least, that was the theory.
The idea is so popular in crypto circles that it has its own unofficial slogan, “borrow, don’t sell.”
When the trader posted his strategy online, he wanted to know whether anyone had actually done it and whether it helped avoid taxes in practice. His proposed roadmap was
- Buy crypto on an Indian exchange.
- Move it to Binance and then to a self-custody wallet.
- Use DeFi protocols to provide liquidity and earn rewards.
- Deposit the assets as collateral and take out a loan.
- Convert the borrowed funds into cash.
The assumption was that since the final step involved a loan rather than a sale, the entire strategy might sidestep crypto taxation. But the reality is more complicated.
The loan itself is generally not a taxable event. But by the time a trader reaches that stage, several earlier steps may have already created tax obligations. In many cases, the tax exposure begins long before the loan is taken out. That is what makes the “borrow, don’t sell” strategy one of the most misunderstood tax ideas in crypto.
Where the Taxable Events Begin
Buying crypto is an acquisition and is therefore not taxable. No VDA left the trader’s possession, so no taxable event occurred.
Even the next step of transferring to Binance is not taxable if the wallet belongs to the trader. Moving crypto from one account to another that the same person controls is an internal transfer. No disposal occurred, so no tax. This step adds complexity to the recordkeeping, though. Every transfer between wallets needs to be documented so the original acquisition cost follows the coins correctly. If the cost basis is lost in transit, which happens when traders do not track cross-platform movements, the tax calculation at eventual disposal becomes harder.
The third step of DeFi strategies is where tax events start to accumulate that the original post did not account for.
Providing liquidity to a DeFi pool: When a trader deposits crypto into a liquidity pool, they typically receive LP (liquidity provider) tokens in return. Under Section 115BBH, depositing crypto into a pool in exchange for LP tokens is a disposal of the original crypto and an acquisition of LP tokens. If the original crypto had appreciated, the disposal creates a taxable gain.
Action | Tax event? |
Deposit ETH into a liquidity pool, receive LP tokens | Yes, disposal of ETH, acquisition of LP tokens |
Hold LP tokens while pool earns fees | No, holding is not a taxable event |
Receive trading fees as income | Yes, fees received are income at fair market value on date of receipt |
Withdraw from pool, receive ETH and fees back | Yes, disposal of LP tokens, acquisition of ETH
|
Earning fees from the liquidity pool: Every time trading fees accumulate and are credited, those fees are income. The INR equivalent of the fees on the date they are received is taxable as income from other sources at the applicable slab rate. This is the same treatment as staking rewards or funding fees: income at receipt, then Section 115BBH at disposal.
So Step 3 alone, if it involves providing liquidity, creates at a minimum two taxable events: the initial deposit (disposal of the original crypto) and the fee income (income on receipt). Any appreciation between deposit and withdrawal creates another taxable disposal when the LP tokens are redeemed.
The next step, using the altcoins as collateral to borrow against them, works differently. Borrowing against crypto is generally not treated as a taxable event because the trader retains ownership of the collateral and receives a loan rather than proceeds from a disposal.
Depositing collateral to a DeFi protocol: When crypto is deposited as collateral, the legal and economic question is whether ownership has transferred. In most DeFi lending protocols, the collateral remains in a smart contract controlled by the lender. The trader retains beneficial ownership of the asset, subject to the liquidation terms. The deposit itself is not a sale.
However, some protocols issue a receipt token (such as cTokens on Compound or aTokens on Aave) in exchange for the collateral deposited. If that receipt token is a separate VDA, the exchange may be treated as a disposal of the original asset and an acquisition( of the receipt token, similar to the liquidity pool situation. This depends on the specific protocol and is a grey area without explicit C guidance of the CBDT (Central Board of Direct Taxes).
Taking out the loan: The loan proceeds are borrowed funds, not income. Borrowing money in INR, in USDT, or in any currency is not a taxable event in any jurisdiction, including India. You receive cash or stablecoins that must be repaid. You have not sold anything. No disposal occurred. This step genuinely creates no tax.
Cashing out the loan proceeds: If the loan is in USDT and the trader converts USDT to INR, that conversion is a disposal of USDT, a VDA. If the USDT was received at a different value than it is converted at (which is usually minimal for a stablecoin), any gain is taxable. But the principal amount of the loan itself does not create income.
What the “Borrow, Don’t Sell” Strategy Really Does
The strategy successfully defers the tax on the appreciation of the crypto for as long as the loan remains outstanding. The trader accesses liquidity without selling the underlying asset, so the unrealised gain on the collateral does not crystallise into a taxable event. When the loan is eventually repaid, and the collateral is retrieved, no disposal has occurred on the collateral itself.
The gain on the collateral becomes taxable only when the collateral is eventually sold or swapped, which the strategy is designed to push into a future year, or potentially indefinitely if the loan is rolled over repeatedly.
This is a legitimate tax deferral strategy. It is not tax avoidance. The gain will eventually be taxable when the collateral is disposed of. It is simply deferred.
The strategy’s limitations are just as important as its benefits. Borrowing against crypto can defer tax on the collateral’s unrealised gains, but it does not eliminate the tax consequences of providing liquidity to DeFi pools, earning fee income, or redeeming LP tokens. It also introduces a new risk that does not exist when simply holding the asset: liquidation.
The Liquidation Risk
The real vulnerability in the borrow-don’t-sell approach is liquidation risk. If the collateral value falls far enough, the position can be liquidated automatically, forcing a disposal that the trader was trying to defer in the first place. When a DeFi protocol liquidates a position, it sells the collateral to recover the loan. Under Section 115BBH, liquidation is a disposal of the collateral at the liquidation price. The gain from the original acquisition cost to the liquidation price is taxable, exactly as if the trader had sold.
The trader who was trying to defer tax by never selling now has a forced sale at a potentially unfavourable price, creating both a capital loss on the trade and a tax event on whatever gain existed between acquisition and liquidation.
Scenario | Tax consequence |
Collateral value rises, loan repaid, collateral retrieved | No tax on collateral, gain is deferred to eventual sale |
Collateral value drops below liquidation threshold | Protocol sells collateral, disposal at liquidation price, taxable gain or loss |
Loan repaid using new crypto that has appreciated | Repayment crypto disposal is taxable if it has gained value
|
Mapping every step:
Step | Taxable event? | What triggers it |
1. Buy on Indian exchange | No | Acquisition only |
2. Transfer to hot wallet | No | Internal transfer |
3a. Deposit into liquidity pool (receive LP tokens) | Yes | Disposal of original crypto |
3b. Earn trading fees from pool | Yes | Income on receipt at slab rate |
3c. Withdraw from pool | Yes | Disposal of LP tokens |
4a. Deposit collateral to DeFi protocol | Possibly | Depends on protocol; receipt token issuance may be a disposal |
4b. Borrow against collateral | No | Loan is not income |
4c. Convert USDT loan to INR | Minimal | USDT disposal, negligible gain if stable |
5. Eventual collateral disposal or liquidation | Yes | Section 115BBH on disposal gain
|
The borrow-don’t-sell approach avoids tax on steps 4b and 4c, which is the loan itself. It does not avoid tax on steps 3a, 3b, 3c, and 5.
Recordkeeping Is The Real Challenge
Sign up on KoinX to simplify DeFi tax reporting.
When you are done, your tax-relevant. The Indian exchange has the original purchase. Binance has the transfer. The DeFi protocol has the liquidity deposits, the fee credits, and the withdrawal. And if the loan was taken on a separate protocol, that is a fifth system. None of them produces an India-compliant tax report.
Trying to reconstruct this manually
By the time the process is complete, the trader’s tax-relevant activity is scattered across multiple platforms. While the Indian exchange records the original purchase, Binance records the transfer. The DeFi protocol records the liquidity pool deposits, fee accruals, and withdrawals. If the loan was taken through a separate lending protocol, that creates yet another source of transaction data. None of these platforms produces an India-compliant tax report that brings the entire transaction history together.
The challenge emerges at tax-filing time. The trader must reconstruct the full chain of events across every platform and determine which transactions were taxable disposals, such as exchanging crypto for LP tokens or redeeming LP tokens on withdrawal; which were taxable income events, such as liquidity pool fees; and which were not taxable at all, such as transfers between self-owned wallets or the loan proceeds themselves.
Each of these transactions must then be converted into its INR value based on the exact date and time it occurred. For a DeFi strategy involving multiple pools, recurring fee credits, and several entry and exit transactions, the number of reportable events can quickly run into the dozens or even hundreds. At that point, manual recordkeeping becomes less of an accounting exercise and more of a reconstruction project.
Import your wallets and track every taxable DeFi event on KoinX.
This is exactly the kind of chain that KoinX was built to handle. Connect the Indian exchange, the Binance account, and the DeFi wallet addresses, and the platform traces the full transaction history across all the exchanges, classifying the internal transfers as non-taxable moves, the liquidity pool deposit as a VDA disposal with the correct acquisition cost, the fee income at the INR value on each receipt date, and the loan receipt as a non-taxable event. The Schedule VDA output already excludes the loan proceeds from the income calculation because the platform identifies the event type correctly rather than treating every USDT receipt the same way.
For anyone who has used a crypto-backed lending strategy and is approaching filing time without a consolidated record, importing your wallets into KoinX is the starting point. It surfaces the taxable events you may not have counted, and confirms the ones that genuinely are not taxable.
