4 ms·

What happens with these loans if the recipient defaults on repayment?

by benwad 6y ago

nootropicat 6y ago
Loans are overcollateralized and collateral is automatically liquidated once the collateral ratio falls below the liquidation threshold. Eg. for eth as collateral the liquidation threshold is 75%, meaning $75 borrowed for $100 in collateral. Compound itself has survived multiple violent price crashes and lenders didn't lose anything.
- hiq 6y ago
  To be clear, you mean that I can borrow $75 by giving $100 first, then pay back the $75 with interest and get back my $100? Why don't I use my $100 directly instead? There are a few cases outside the blockchain where you get loans although you already have the cash (e.g. for tax reasons), but I don't understand how it makes financial sense in this case, if everything happens on the blockchain with no other incentive. Maybe another direct question would be: as a lender, for which risk are you getting paid some interest?
  - nootropicat 6y ago
    >Why don't I use my $100 directly instead? Because it's not $100 in dollars, but $100 worth of eth or something else. Borrowed dollars can be used to buy something else, hoping the price of that something rises. >as a lender, for which risk are you getting paid some interest? It's theoretically possible for prices to fall fast enough so that the liquidated value of the collateral isn't enough to pay the debt. I don't think rewards are risk adjusted at all. More like same people that could provide dollars are likely to speculate on cryptocurrencies themselves, or take part in more risky and active yield generating schemes.
    - hiq 6y ago
      Ok I guess I was missing the basics on overcollateralization, https://www.investopedia.com/terms/o/overcollateralization.asp https://www.investopedia.com/terms/o/overcollateralization.a... answers my question, it was actually not blockchain-specific.
Acrobatic_Road 6y ago
As another commented pointed out, the collateral is seized. Default risk is very low because there is more collateral than debt. There's also special loans with 0% collateralization which amazingly have even less risk than the type described above. Those are called flash loans and take advantage of ethereum behavior that allows mini-rollbacks in the time before a block is finalized. So you borrow millions of dollars in the span of about ten seconds, and if it doesn't get payed back then it gets reverted. Very powerful if you're smart enough to use it properly.

What happens with these loans if the recipient defaults on repayment?

by benwad 6y ago

What happens with these loans if the recipient defaults on repayment?

Loans are overcollateralized and collateral is automatically liquidated once the collateral ratio falls below the liquidation threshold. Eg. for eth as collateral the liquidation threshold is 75%, meaning $75 borrowed for $100 in collateral. Compound itself has survived multiple violent price crashes and lenders didn't lose anything.

hiq 6y ago
To be clear, you mean that I can borrow $75 by giving $100 first, then pay back the $75 with interest and get back my $100? Why don't I use my $100 directly instead? There are a few cases outside the blockchain where you get loans although you already have the cash (e.g. for tax reasons), but I don't understand how it makes financial sense in this case, if everything happens on the blockchain with no other incentive. Maybe another direct question would be: as a lender, for which risk are you getting paid some interest?
- nootropicat 6y ago
  >Why don't I use my $100 directly instead? Because it's not $100 in dollars, but $100 worth of eth or something else. Borrowed dollars can be used to buy something else, hoping the price of that something rises. >as a lender, for which risk are you getting paid some interest? It's theoretically possible for prices to fall fast enough so that the liquidated value of the collateral isn't enough to pay the debt. I don't think rewards are risk adjusted at all. More like same people that could provide dollars are likely to speculate on cryptocurrencies themselves, or take part in more risky and active yield generating schemes.
  - hiq 6y ago
    Ok I guess I was missing the basics on overcollateralization, https://www.investopedia.com/terms/o/overcollateralization.asp https://www.investopedia.com/terms/o/overcollateralization.a... answers my question, it was actually not blockchain-specific.

Acrobatic_Road 6y ago

As another commented pointed out, the collateral is seized. Default risk is very low because there is more collateral than debt. There's also special loans with 0% collateralization which amazingly have even less risk than the type described above. Those are called flash loans and take advantage of ethereum behavior that allows mini-rollbacks in the time before a block is finalized. So you borrow millions of dollars in the span of about ten seconds, and if it doesn't get payed back then it gets reverted. Very powerful if you're smart enough to use it properly.