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I've only just begun to wrap my head around all of this, and I tried playing with some of the DeFi lending platforms built on top of Ethereum. It has its kinks

by bhupy 6y ago

I've only just begun to wrap my head around all of this, and I tried playing with some of the DeFi lending platforms built on top of Ethereum. It has its kinks, but I think on the net it's a remarkably cool thing. I was able to lend $50 (overcollateralized) at 12% APY without any central institution. The only real wrinkle has been the insane transaction fees: it cost me about $80 to execute the "smart contract" for the $50 12% APY loan. That said, this is a flat cost, and I can very much see the value in paying $80 in transaction costs to be able to lend $50,000 or $500,000 at 12% APY. It also very much feels like "mainframe" days of computing where everything was expensive and impractical, but it was just the beginning. For the time being, I continue to keep my money safely parked in index funds, but one can get a first hand look at the potential for Eth/DeFi by testing small(ish) transactions out.

cwkoss 6y ago
Is the loan secured to anything? What is the incentive for the borrower to repay this loan?
- bhupy 6y ago
  Yeah it's "overcollateralized". The borrower has to put 150% of the principal into escrow (this is enforced by the smart contract). If the borrower decides to flake, the lender gets to take the collateral.
  - opportune 6y ago
    Just curious, from the perspective of the borrower, what is the purpose of an overcollateralized loan? If their collateral is just as liquid as their loan, why even take the loan at all?
    - bhupy 6y ago
      Super good question, I was perplexed by this myself. Basically what this financial instrument allows the borrower to do is maintain exposure to appreciating crypto assets while still leveraging its value for day to day spending. For example, suppose you owned $1500 worth of BTC. Suppose you’re also bullish on BTC and expect it to appreciate, say 2x in a year. If you liquidated the $1500 to buy a MacBook or something, you’d lose out on that appreciation. Instead, I can lend you $1000 in cash, and you can put your $1500 as collateral (150%). A year later, you pay me back $1120, and then take back your BTC collateral; except by then it may have doubled in value to $3000 (let’s say). In fact, as long as BTC appreciates by at least 12%, the loan pays for itself. As the lender, I am essentially enabling HODLers by providing them liquidity (in the form of stablecoins). Of course downside for the lender is that the buyer could bail AND the collateral could plunge in value.
      - graeme 6y ago
        What use case does that have other than crypto currency speculation though? Most loans serve some sort of function in the economy.
        bhupy 6y ago
        Right now, no other use case. Though I think your question bakes into it a premise which is itself debatable: that speculation doesn't serve some function in the real economy. Today, most rich people are able to collateralize their ownership in valuable assets to defer capital gains tax (guaranteed long term capital gain) and enjoy asset appreciation while still engaging in consumption and even levered investments in the real economy. Most billionaires live their lives like this: they take loans collateralized on their corporate ownership, and eventually pay them back while still enjoying value appreciation. These DeFi platforms essentially unlock the same for everybody else: if you have your entire savings in a deflationary asset like Gold (or perhaps even the S&P500), you might want to be able to collateralize that for daily spending while still enjoying its appreciation for the future. Cryptocurrencies (especially Bitcoin) are more or less equivalent to digital gold. And with the advent of pegged coins, you can now represent really anything as a cryptocurrency, even equities and derivatives. You could extrapolate this further and imagine a world where even equities and derivatives can be purchased as a tokenized coin on some blockchain; and you'd then be able to take collateralized loans for spending off of your index-fund-backed savings account. You'd eventually pay them back while still enjoying value appreciation. Asset speculation arguably serves a second order function to the real economy. Today, cryptocurrency is only one asset with very limited scope, but one might argue that it's just a start.
        graeme 6y ago
        That sounds enormously risky for most people. So basically: * Someone has $30,000 in S and P shares * With a smart contract they might put these in escrow for a $20,000 loan * If they pay back the loan they can get the shares back. If they fail to pay back the loan the shares are confiscated, no matter the value the shares are now at. What’s the advantage over traditional finance? You can already get an asset backed loan at a bank for which you pay interest.
  - graeme 6y ago
    What does the lender use as collateral? And doesn’t this defeat the point of most loans? People use houses as collateral for mortgages, but other than that aren’t most loans given with substantially less collateral, all the way to zero collateral? Even mortgages are usually less than 100% collateral. And the house isn’t in escrow! You use it. Am I missing something fundamental? How does it make sense to borrow $100 and lock up $150 for the lifetime of the loan?
    - bhupy 6y ago
      > Am I missing something fundamental? How does it make sense to borrow $100 and lock up $150 for the lifetime of the loan? Great question, I was just as dumbfounded as you are. Answered below in another sub-thread, which I believe you're also participating in: https://news.ycombinator.com/item?id=26162914 https://news.ycombinator.com/item?id=26162914

by bhupy 6y ago

cwkoss 6y ago

Is the loan secured to anything? What is the incentive for the borrower to repay this loan?

bhupy 6y ago
Yeah it's "overcollateralized". The borrower has to put 150% of the principal into escrow (this is enforced by the smart contract). If the borrower decides to flake, the lender gets to take the collateral.
- opportune 6y ago
  Just curious, from the perspective of the borrower, what is the purpose of an overcollateralized loan? If their collateral is just as liquid as their loan, why even take the loan at all?
  - bhupy 6y ago
    Super good question, I was perplexed by this myself. Basically what this financial instrument allows the borrower to do is maintain exposure to appreciating crypto assets while still leveraging its value for day to day spending. For example, suppose you owned $1500 worth of BTC. Suppose you’re also bullish on BTC and expect it to appreciate, say 2x in a year. If you liquidated the $1500 to buy a MacBook or something, you’d lose out on that appreciation. Instead, I can lend you $1000 in cash, and you can put your $1500 as collateral (150%). A year later, you pay me back $1120, and then take back your BTC collateral; except by then it may have doubled in value to $3000 (let’s say). In fact, as long as BTC appreciates by at least 12%, the loan pays for itself. As the lender, I am essentially enabling HODLers by providing them liquidity (in the form of stablecoins). Of course downside for the lender is that the buyer could bail AND the collateral could plunge in value.
    - graeme 6y ago
      What use case does that have other than crypto currency speculation though? Most loans serve some sort of function in the economy.
      - bhupy 6y ago
        Right now, no other use case. Though I think your question bakes into it a premise which is itself debatable: that speculation doesn't serve some function in the real economy. Today, most rich people are able to collateralize their ownership in valuable assets to defer capital gains tax (guaranteed long term capital gain) and enjoy asset appreciation while still engaging in consumption and even levered investments in the real economy. Most billionaires live their lives like this: they take loans collateralized on their corporate ownership, and eventually pay them back while still enjoying value appreciation. These DeFi platforms essentially unlock the same for everybody else: if you have your entire savings in a deflationary asset like Gold (or perhaps even the S&P500), you might want to be able to collateralize that for daily spending while still enjoying its appreciation for the future. Cryptocurrencies (especially Bitcoin) are more or less equivalent to digital gold. And with the advent of pegged coins, you can now represent really anything as a cryptocurrency, even equities and derivatives. You could extrapolate this further and imagine a world where even equities and derivatives can be purchased as a tokenized coin on some blockchain; and you'd then be able to take collateralized loans for spending off of your index-fund-backed savings account. You'd eventually pay them back while still enjoying value appreciation. Asset speculation arguably serves a second order function to the real economy. Today, cryptocurrency is only one asset with very limited scope, but one might argue that it's just a start.
        graeme 6y ago
        That sounds enormously risky for most people. So basically: * Someone has $30,000 in S and P shares * With a smart contract they might put these in escrow for a $20,000 loan * If they pay back the loan they can get the shares back. If they fail to pay back the loan the shares are confiscated, no matter the value the shares are now at. What’s the advantage over traditional finance? You can already get an asset backed loan at a bank for which you pay interest.
- graeme 6y ago
  What does the lender use as collateral? And doesn’t this defeat the point of most loans? People use houses as collateral for mortgages, but other than that aren’t most loans given with substantially less collateral, all the way to zero collateral? Even mortgages are usually less than 100% collateral. And the house isn’t in escrow! You use it. Am I missing something fundamental? How does it make sense to borrow $100 and lock up $150 for the lifetime of the loan?
  - bhupy 6y ago
    > Am I missing something fundamental? How does it make sense to borrow $100 and lock up $150 for the lifetime of the loan? Great question, I was just as dumbfounded as you are. Answered below in another sub-thread, which I believe you're also participating in: https://news.ycombinator.com/item?id=26162914 https://news.ycombinator.com/item?id=26162914