4 ms·

Because the only way to get a loan is to put up collateral that is locked into a contract. And that collateral can only be extracted if you pay back the loan. S

Because the only way to get a loan is to put up collateral that is locked into a contract. And that collateral can only be extracted if you pay back the loan. So, if you value the collateral less then your debt, then, sure, walk away. But if the value of that collateral falls to less then the liquidation threshold (an amount some percentage greater then the value of your debt), your debt will be paid back by a liquidation bot and the the liquidator will take your collateral for themselves.

UncleMeat 5y ago
There is a huge problem with the collateral model: liquidity. If you put up $X in FOO_COIN as collateral and FOO_COIN starts tanking in value, the contract is supposed to auto-liquidate once it hits a certain point. But there is absolutely no guarantee that this can find a buyer. So the "guaranteed" collateral recovery is not exactly guaranteed.
- bhaak 5y ago
  How is that different to traditional finance? Evergrande almost went belly-up as the prices of their real state fell sharply because they sold so much of it to cover their credits. The financial crisis from 2007 was because the collaterals were nowhere as sound as they were sold for. Don’t get me wrong I think it’s mostly a house of cards but crypto finance is just traditional finance on steroids IMO.
  - UncleMeat 5y ago
    > How is that different to traditional finance? There are a lot more backstops. Traditional finance can have this problem, but we can install human systems to limit the blast radius of things. As you say, it is traditional finance on steroids. Crypto enthusiasts seem to think it is the opposite. People tell me that defi loans are "zero risk" because of the automatic collateral systems and I just laugh and laugh.
    - bhaak 5y ago
      Crypto finance and especially DeFi is tiny compared to traditional finance. The blast radius is still small without the regulations. But the regulations will come. Crypto finance is going down the same path that traditional finance did just in a period of a few years than a century. Everybody who claims there's "zero risk" is either lying or blind to the risks. You can't get those large yields with zero risk.
- yokem55 5y ago
  That's why you can only borrow up to 80-ish% of your collateral, and that's getting very risky for the borrower. It also means that the sane lending protocols are somewhat stingy with what they take as collateral and then set the borrowing limits and liquidation thresholds fairly conservatively. When the market starts making big moves downward the liquidation bots have a keen eye on which positions are at risk, watching and predicting the oracle updates, and within a block or 2 (~30 seconds) of a position being vulnerable have the deal all closed out. It can even be all done in a single transaction bundle that calls the liquidation function, pays back the debt, takes the collateral, and sells it on a dex, all in one go. The market price for the collateral would have to drop more then 20% in the span of that 30-seconds for it to not be profitable for the liquidator. That's not to say it's impossible for this to fail, the biggest and sharpest dumps happen during liquidation cascades. But a failure is in the category of 'black swan event', and not something that is seen with regularity.
  - wizzwizz4 5y ago
    > That's not to say it's impossible for this to fail, the biggest and sharpest dumps happen during liquidation cascades. If it happens, it's not a black swan event.
    - TomSwirly 5y ago
      This is a wrong use of the term. Black swans are rare but actually exist. https://en.wikipedia.org/wiki/Black_swan_theory https://en.wikipedia.org/wiki/Black_swan_theory
      - wizzwizz4 5y ago
        It's actually a correct use of the term. A “black swan” is something that is believed not to be possible – or, in retrospect, something that was believed impossible but happened anyway. The term predates the discovery of black swans; > However, in 1697, Dutch explorers led by Willem de Vlamingh became the first Europeans to see black swans, in Western Australia.[9] The term subsequently metamorphosed to connote the idea that a perceived impossibility might later be disproven. Taleb notes that in the 19th century, John Stuart Mill used the black swan logical fallacy as a new term to identify falsification.[10]
lottin 5y ago
Yeah, but the whole purpose of a loan is to fund something, and to be able to fund something the amount loaned out needs to be larger than the collateral. Otherwise, there's no financing going on. It's simply a bet on the relative value of the principal vs the collateral. Calling this "a loan" is misleading.
- pdonis 5y ago
  > the whole purpose of a loan is to fund something, and to be able to fund something the amount loaned out needs to be larger than the collateral Um, what? If I take out a mortgage to buy a house, the loan amount is not going to be larger than the value of the collateral (the house). If I take out a loan to buy a car, the loan amount is not going to be larger than the value of the collateral (the car). What kind of loan are you thinking of?
  - throwawaygh 5y ago
    > If I take out a loan to buy a car, the loan amount is not going to be larger than the value of the collateral (the car). Pray tell of these new cars whose value does not plummet the moment they are driven off the lot.
    - pdonis 5y ago
      Which is why car loan providers usually require a substantial down payment so the loan is not underwater. (And why home mortgage providers usually require a LTV well under 100 percent--and make you pay mortgage insurance even then unless the LTV is even lower.)
      - throwawaygh 5y ago
        What the hell are you taking about? I have never made a down payment for a car and have never paid interest on a car loan. Ever. And I’ve purchased many cars. E: woah! .06 seconds to the first downvote to a Dow thread comment on a two day old post! I’m out.
    - 5y ago

UncleMeat 5y ago

There is a huge problem with the collateral model: liquidity. If you put up $X in FOO_COIN as collateral and FOO_COIN starts tanking in value, the contract is supposed to auto-liquidate once it hits a certain point. But there is absolutely no guarantee that this can find a buyer. So the "guaranteed" collateral recovery is not exactly guaranteed.

bhaak 5y ago
How is that different to traditional finance? Evergrande almost went belly-up as the prices of their real state fell sharply because they sold so much of it to cover their credits. The financial crisis from 2007 was because the collaterals were nowhere as sound as they were sold for. Don’t get me wrong I think it’s mostly a house of cards but crypto finance is just traditional finance on steroids IMO.
- UncleMeat 5y ago
  > How is that different to traditional finance? There are a lot more backstops. Traditional finance can have this problem, but we can install human systems to limit the blast radius of things. As you say, it is traditional finance on steroids. Crypto enthusiasts seem to think it is the opposite. People tell me that defi loans are "zero risk" because of the automatic collateral systems and I just laugh and laugh.
  - bhaak 5y ago
    Crypto finance and especially DeFi is tiny compared to traditional finance. The blast radius is still small without the regulations. But the regulations will come. Crypto finance is going down the same path that traditional finance did just in a period of a few years than a century. Everybody who claims there's "zero risk" is either lying or blind to the risks. You can't get those large yields with zero risk.
yokem55 5y ago
That's why you can only borrow up to 80-ish% of your collateral, and that's getting very risky for the borrower. It also means that the sane lending protocols are somewhat stingy with what they take as collateral and then set the borrowing limits and liquidation thresholds fairly conservatively. When the market starts making big moves downward the liquidation bots have a keen eye on which positions are at risk, watching and predicting the oracle updates, and within a block or 2 (~30 seconds) of a position being vulnerable have the deal all closed out. It can even be all done in a single transaction bundle that calls the liquidation function, pays back the debt, takes the collateral, and sells it on a dex, all in one go. The market price for the collateral would have to drop more then 20% in the span of that 30-seconds for it to not be profitable for the liquidator. That's not to say it's impossible for this to fail, the biggest and sharpest dumps happen during liquidation cascades. But a failure is in the category of 'black swan event', and not something that is seen with regularity.
- wizzwizz4 5y ago
  > That's not to say it's impossible for this to fail, the biggest and sharpest dumps happen during liquidation cascades. If it happens, it's not a black swan event.
  - TomSwirly 5y ago
    This is a wrong use of the term. Black swans are rare but actually exist. https://en.wikipedia.org/wiki/Black_swan_theory https://en.wikipedia.org/wiki/Black_swan_theory
    - wizzwizz4 5y ago
      It's actually a correct use of the term. A “black swan” is something that is believed not to be possible – or, in retrospect, something that was believed impossible but happened anyway. The term predates the discovery of black swans; > However, in 1697, Dutch explorers led by Willem de Vlamingh became the first Europeans to see black swans, in Western Australia.[9] The term subsequently metamorphosed to connote the idea that a perceived impossibility might later be disproven. Taleb notes that in the 19th century, John Stuart Mill used the black swan logical fallacy as a new term to identify falsification.[10]

lottin 5y ago

Yeah, but the whole purpose of a loan is to fund something, and to be able to fund something the amount loaned out needs to be larger than the collateral. Otherwise, there's no financing going on. It's simply a bet on the relative value of the principal vs the collateral. Calling this "a loan" is misleading.

pdonis 5y ago
> the whole purpose of a loan is to fund something, and to be able to fund something the amount loaned out needs to be larger than the collateral Um, what? If I take out a mortgage to buy a house, the loan amount is not going to be larger than the value of the collateral (the house). If I take out a loan to buy a car, the loan amount is not going to be larger than the value of the collateral (the car). What kind of loan are you thinking of?
- throwawaygh 5y ago
  > If I take out a loan to buy a car, the loan amount is not going to be larger than the value of the collateral (the car). Pray tell of these new cars whose value does not plummet the moment they are driven off the lot.
  - pdonis 5y ago
    Which is why car loan providers usually require a substantial down payment so the loan is not underwater. (And why home mortgage providers usually require a LTV well under 100 percent--and make you pay mortgage insurance even then unless the LTV is even lower.)
    - throwawaygh 5y ago
      What the hell are you taking about? I have never made a down payment for a car and have never paid interest on a car loan. Ever. And I’ve purchased many cars. E: woah! .06 seconds to the first downvote to a Dow thread comment on a two day old post! I’m out.
  - 5y ago