Vastly oversimplified (and possibly wrong), but if you want to know more, do some searching for "yield farming".
The point is that they want to keep their BTC because they think it's going to go up, so they take out a loan with their BTC as collateral rather than directly spend their BTC.
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?
Pray tell of these new cars whose value does not plummet the moment they are driven off the lot.
E: woah! .06 seconds to the first downvote to a Dow thread comment on a two day old post! I’m out.
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.
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.
If it happens, it's not a black swan event.
Black swans are rare but actually exist.
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]
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.
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.
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.