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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 f

by 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.
        bhupy 6y ago
        > 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. You need to make a slight tweak to this statement. Currently, the smart contract enforces a "collateral ratio" of at least 150%. This means that if the underlying collateral appreciates, you can skim off and take whatever appreciation even before repaying. The only invariant that the contract enforces is that the value of the collateral has to be equal to 150% of the remaining principal. And yes, if they fail to pay back the loan, the shares are confiscated; but the borrower isn't left with "nothing"; rather they're left with 2/3 of their original collateral in cash + any appreciation from the original collateral (minus the principal, of course). For a lot of people, this is a manageable worst-case scenario. > That sounds enormously risky for most people. So basically: It's enormously risky for people that are in grinding poverty. This should obviously not be used as a pay-day loan of sorts. But for people that are in the middle or upper-middle class, this has the potential to be a solid financial instrument that can be used as one of many tools we have at our disposal in financial markets. > What’s the advantage over traditional finance? You can already get an asset backed loan at a bank for which you pay interest. Have you tried to do this? It requires a lot of time, process, and paperwork. The interest rates vary depending on the risk rules of the bank, and banks often charge a percentage of principal just for this service, sort of like what happens when you refinance a home loan. With DeFi, I was literally able to lend and borrow at the click of a button, and that transaction was processed by a network of robots where the transaction fee was flat/fixed. There's a lot of room for improvement to bring down that transaction fee, but it's too early to throw our hands up in concede that we are forever doomed to $80 transaction fees to process these kinds of contracts. Now, does this mean that everyone should move off of traditional finance? Absolutely not, traditional finance can still work out to be better for some people. But the key phrase there is "some people". With DeFi, you now have more options on the market, and that strikes me as a good thing.
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

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.
      - bhupy 6y ago
        > 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. You need to make a slight tweak to this statement. Currently, the smart contract enforces a "collateral ratio" of at least 150%. This means that if the underlying collateral appreciates, you can skim off and take whatever appreciation even before repaying. The only invariant that the contract enforces is that the value of the collateral has to be equal to 150% of the remaining principal. And yes, if they fail to pay back the loan, the shares are confiscated; but the borrower isn't left with "nothing"; rather they're left with 2/3 of their original collateral in cash + any appreciation from the original collateral (minus the principal, of course). For a lot of people, this is a manageable worst-case scenario. > That sounds enormously risky for most people. So basically: It's enormously risky for people that are in grinding poverty. This should obviously not be used as a pay-day loan of sorts. But for people that are in the middle or upper-middle class, this has the potential to be a solid financial instrument that can be used as one of many tools we have at our disposal in financial markets. > What’s the advantage over traditional finance? You can already get an asset backed loan at a bank for which you pay interest. Have you tried to do this? It requires a lot of time, process, and paperwork. The interest rates vary depending on the risk rules of the bank, and banks often charge a percentage of principal just for this service, sort of like what happens when you refinance a home loan. With DeFi, I was literally able to lend and borrow at the click of a button, and that transaction was processed by a network of robots where the transaction fee was flat/fixed. There's a lot of room for improvement to bring down that transaction fee, but it's too early to throw our hands up in concede that we are forever doomed to $80 transaction fees to process these kinds of contracts. Now, does this mean that everyone should move off of traditional finance? Absolutely not, traditional finance can still work out to be better for some people. But the key phrase there is "some people". With DeFi, you now have more options on the market, and that strikes me as a good thing.

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