All loans are overcollateralized, and basically used for leverage: put up your bitcoins as collateral, borrow stablecoins, buy more bitcoins.

So the risk is limited as long as the loans can be liquidated in time in case of a price crash.

The rates are determined the ratio of all stablecoin liquidity provided vs the amount actually borrowed. Liquidity providers can remove liquidity at any time, and so the smaller the remaining liquidity buffer gets, the higher the fees gets.

Most of the rates are dynamic: i.e. the interest rate on your existing loan can increase drastically if there is a liquidity crunch. In practice your interest is charged as though it was extra borrowing and so lowers your liquidiation threshold.

On the flip side, the dynamic rate also means that as the liquidity gets thinner, the interest rate paid to liquidity provider gets higher, meaning it incentivizes liquidity deposits when they are most needed.

> put up your bitcoins as collateral, borrow stablecoins, buy more bitcoins

Nothing could possibly go wrong with this, right? Tether is found to not have the reserves they claim and it plunges, and the artificial demand for bitcoin disappears and it plunges as well.

DeFi loans are over-collatoralized usually by 1.5-2x.

If you want to borrow $100k, you put up $200k in collateral.

Sorry I don't get it. Why would you lock up 200k in order to borrow 100k? Why not just use part of the 200k you already have?!

If you believe that the value of Bitcoin is going to go up, it makes sense to lock is as a collateral and spend the borrowed fiat instead of selling the Bitcoins.

Is there a part of the system that keeps working even if the value of bitcoin stops (being believed to keep) going up all the time?

If ETH or some other new token takes more and more mindshare from btc isn’t that a big inflationary pressure on the crypto ecosystem as a whole? More tokens = less valuable tokens.

At some point buy the dip will turn into cash out.

If the value of Bitcoin stops going up, sooner or later your debt grows larger than the amount you were allowed to borrow and your collateral gets liquidated by someone who implemented the fastest liquidator bot.

https://docs.aave.com/developers/guides/liquidations

To lever gains. Now you can "own" 300k worth of bitcoin gains with only 200k worth of bitcoins. Of course the downside is that loses are levered too.

Different tax treatment. Locking up to buy something with the loan doesn't expose you to gains.

To retain the price exposure of the asset worth 200k while avoiding selling or spending it.

You gotta pay the upline!

> So the risk is limited as long as the loans can be liquidated in time in case of a price crash.

If I may guess, it seems unlikely there are too many folks in DeFi circles who have ever heard acronym LTCM.

(TL;DR: A bunch of actual Nobel laureates (no kidding, or at least as much as Nobel price in economics is an actual Nobel) founded a huge and famous hedge fund with a trading strategy assuming they can liquidate their position at market prices. At this point you may guess that it ended tits up and was kind of a mess. Time will tell if DeFi folks were smarter than that.)

Collateral is sold off automatically once they breach some threshold (varies, but it's always > 100%), and there are bots that compete to do this as quickly as possible. This is in no means perfect, but it is quite responsive, and did survive crypto's March 2020 price crash.

There were some denial of service issues that on Ethereum during the March 2020 crash that caused Maker DAO to have some Zero bid liquidations and the protocol had to mint and sell off some of Maker's token to keep all the issued DAI properly backed. This did not happen again in the crash in May, which was nearly as steep, but the protocols all kept functioning as expected.

It really sounds like fun and games until it all comes crashing down...

Then again if it's all crypto and everything goes down at once, I suppose there isn't too big issue. Apart from losing some fiat, but they who cares about that in cryptoworld...

Loans are overcollateralized, so you need to put in the same or more amount of capital that you're loaning out. That may not seem useful at first, but it allows you to have exposure to multiple assets. For example, you may want to use ETH temporarily, but you only have BTC. But you want to keep your BTC investment for the long term. So you're putting up BTC to borrow ETH. You keep your exposure to BTC, but you have liquid ETH.

It's the same concept as putting up your house as collateral. You don't want to sell your house just because you need some liquid cash temporarily.

> It's the same concept as putting up your house as collateral.

The crucial difference is in a mortgage loan the borrower keeps the collateral and gets to use of it, e.g. live in it, while they pay off the loan, whereas in a DeFi "loan" the lender has to keep the collateral the whole time.

The borrower does keep the collateral in that it's only use to them is the gains it provides. Those gains still belong to the borrower.

Surely the DeFi loan should be a "smart contract" that just locks the asset from transfer until either default or repayment.

Yes, the "smart contract" keeps it. The point is the borrower doesn't get to keep the collateral. This makes DeFi loans unsuitable for a large number of purposes.

What's an example of something you'd want to "do" with your crypto asset while using it as collateral? Obviously you can't spend it, give it away, use it as collateral for another loan etc as that would conflict with the first loan.

But you can do other stuff. For example you could covert ETH to one of the many tokens that represent staked ETH (rocketpool rETH for example) and use that as collateral. Now you are have collateral and staking revenue with the same funds.

Well, that's the point, 1) you need 100% collateral, 2) the collateral needs to be in the form of digital tokens and 3) it needs to be kept in custody by a third party (the "smart contract"). Yes, you can still do useful things despite these limitations, but at the same time be aware that 99% of the borrowing/lending activity that goes on in the real world is not possible with this technology.

This really sounds most like gambling. And not a financial instruments that is very supportive for economy. Like let's say company loaning money to purchase equipment.

Yes, these loans can't be used to fund investment or consumption in the real economy. The only use-case of crypto-loans, as far as I know, is making leveraged bets on the prices of crypto-currencies.

Why not? One can easily borrow USDC or another stablecoin with crypto collateral, withdraw to USD and use it for non-crypto investments..

Because if I already have $10,000 to put as collateral, to get a $10,000 loan to buy a $10,000 car, it means I didn't have a need for borrowing funds to begin with. I can go straight to buying the car without borrowing money. Whereas if I need to borrow the funds, I won't be able to get the loan because I don't have the 100% collateral required.

Using the BTC as collateral lets you stay long BTC and get the car. You also avoid paying capital gains since you aren’t selling.

The positions are fundamentally different. If you take the loan you are long BTC and short dollars. If you sell BTC for the car you have zero of both.

Yes, we had already established that. The point is that requiring 100% collateral does not allow the borrower to trade future consumption for present consumption, which is the whole point of borrowing as far as consumer and businesses are concerned. This is why DeFi loans are unsuitable when it comes to funding consumption or productive investment.

Uncollateralized lending in DeFi is very nascent (right now primarily targets crypto businesses, and are typically ran by centralized companies who have launched a protocol on chain).

TrueFi, Maple Finance, and Goldfinch are the biggest and primarily have permissionless lenders and kyc'd borrowers. Some of those borrowers may make consumer loans (Goldfinch is like this).

Permissionless uncollateralized borrowing has yet to take off (even though contracts for this already exist and are live), but I suspect it will once decentralized stablecoin on chain supply gets decoupled from current centralized stablecoin supply (decentralized credit based stablecoins built on top of incentivized permissions management of on <-> off chain flows [via over collaterlized decentralized stablecoins and centralized stablecoins alike] and on/off chain risk [via derivatives]). Decentralized derivatives protocols will be key to permissionless uncollateralized lending growth imo, but we are not there yet (I think we need to continue to see global markets break down more in OTC/CCP IRD's and tradfi counterparties continue to lose trust with one another in derivative transactions for this to grow faster in DeFi).

I can see that in the next 10-20 years, 20% of the eurodollar system with be contained within (multichain) permissionless DeFi protocols as HNW individuals and tradfi institutions outside of the US abandon CCPs and typical OTC derivatives txs.

I won't have to argue with folks at ihsmarkit like I do now for making EOD CDX data public (like it was before they were acquired by shit & pee global), when I can pull it from on chain contracts in real time.

I think you're not understanding the fundamental problem that uncolletarelised DeFi lending faces, which is the fact that the borrower can simply walk away with the money. None of the companies that supposedly offer uncollaterilised borrowing do what they claim to do. This is obvious if you read the fine print. And it's to be expected, because if they did, borrowers would borrow all the available funds and walk away, never to be seen again. That's not a sustainable business model.

> I think you're not understanding the fundamental problem that uncolletarelised DeFi lending faces, which is the fact that the borrower can simply walk away with the money.

I understand it very well, that's pretty much the risk to be mitigated (or not) by who the loans are extended to on the protocol level (when not trying to do it in the KYC/ofchain legal agreement way which is how its done now for the most part). Pools of capital can be lent to specific actors in a non permissioned way that can be governed by the the protocols users or on/off by the on chain contracts themselves automatically when certain on chain conditions are met.

Also, for the non corporate uncollateralized lending in defi now through flash loans (i.e. via Aave), it is impossible for the borrower to walk away from borrowing the funds because the loan must be paid back in the same transaction or entire transaction reverts. However this isn't appropriate for typical consumer loans.

Currently, a lot of the centralized companies with their protocols on chain mitigate the risk just by restricting the pool of borrowers to those who they can legally go after to recoup any losses in the event of a default (just like in tradfi, but still the risks remain).

In the case of a derivatives protocol, writers can borrow against buyers deposits (instead of having to put up their own stablecoin deposits to back the writing) to open positions with the expectation that the writers can write enough volume to net out the delta most of the time while capturing a spread. If/when they (the writers in the derivative liquidity pools) can't and if enough addresses choose to withdraw the decentralized overcollateralized/centralized stablecoins from the protocol (rather than transferring/swapping their protocol credit to another address who wants to buy or write derivatives, or use as a unit of accounting outside of the protocol) and there is a shortfall, decentralized overcollateralized/centralized stablecoin yielding debt tokens can be issued by the protocol automatically (as well as raising decentralized overcollateralized/centralized stablecoin collateral requirements across the board for writers who haven't been cleared by protocols risk management contracts or by some kind of on chain governance) to those trying to withdraw who can sell it on a dex at a premium or discount to par value of the stablecoin yielding debt token.

The risk doesn't go away in tradfi with all the uncollateralized lending now, it gets spread throughout all the actors of the system in various ways, much of which isn't very transparent to all actors in the system (and even for those in the know, it is not in real time). The same (spreading risk through various actors that engage with the protocol) can be done in a DeFi context minus the opacity we have now (we all can see what addresses have/done what, regardless of whom/what is behind the address).

There isn't going to be a one size fits all approach to uncollateralized lending in DeFi. Protocols will do it differently based on what the users see fit to do with their funds and will manage the risks in many different ways (some of which will be better than others).

Thanks for the information, but none of that addresses the problem I described earlier. All these pseudo-decentralised lending platforms that you mentioned happen to rely on a central party that "approves" borrowers. Once a borrower gets "approved" they sign a loan agreement with the central party. In the case of default, the central party can initiate legal action against the borrower. This is how these "decentralised" loans work. The only reason they work is because they aren't decentralised at all. They're conventional loan agreements that are enforced by courts of justice. The pseudo-decentralised platform plays the same exact role as a financial intermediary in conventional finance. Decentralised lending platforms where borrowers can get uncollateralised loans DO NOT exist. The technology does not allow it. There are no mechanisms through which make the borrower repay the loan.

> Decentralised lending platforms where borrowers can get uncollateralised loans DO NOT exist. The technology does not allow it. There are no mechanisms through which make the borrower repay the loan.

They do exist, Aave allows for this, there is no one to approve the flash loan. Just that you can only borrow the funds for specific context that I described and the borrower will have to pay off the loan or the loan wont be made and will fail. You can't do this at all in tradfi.

> They're conventional loan agreements that are enforced by courts of justice.

And even if these happen traditionally, no defi involved, the borrower many not be able to pay of the loan. Risk will be eaten by someone. Courts of justice can't squeeze blood from stone. But Aave doesn't face this risk. Maybe other protocols will, but thats the risk people have to accept when they engage with the different protocols.

As a curiosity, a "flash loan" is a loan in which the principal is received and repaid simultaneously and therefore has little practical utility, other than facilitating wash trading and other forms of market manipulation, which are prohibited in regulated markets.

I guess there's those like yourself that would deem it of little practical utility for anyone to borrow permissionlessly and without a large pool a capital of their own to take advantage of arb opportunities that arise in markets (and make those markets more efficient for those that use it). Luckily, defi participants are not bounded by your opinions.

It's unclear whether these flash loans can even be used to exploit arbitrage opportunities. Arbitrage involves simultaneous transactions in different markets, whereas flash loans only allow simultaneous transactions in the same blockchain. Anyway, arbitrage is not a sufficient condition for market efficiency. There's plenty of evidence showing that crypto-markets are rife with fraud and are anything but efficient.

I recommend reading Compounds white paper. They are a big player and have a decentralized protocol which establishes money markets with algorithmically set interest rates based on supply and demand.

https://compound.finance/documents/Compound.Whitepaper.pdf

CeDeFi (Centralized Decentralized Finance, websites like Coinbase, Nexo, Blockfi, Celsius. Registered companies with licenses that will often advertise as being the same as onchain DeFi services) offer fixed rates to customers, while they earn much greater variable rates in DeFi platforms, they pocket the difference. Just like TradFi (traditional finance) lenders we are all familiar with, the spreads are just much bigger right now, as expected in growing economies.

DeFi platforms are offering variable rates based on how many farmers and how much value is deposited that is trying to earn the same fixed amount of tokens, and those tokens current exchange rate. They are using present/historical data, as well as current exchange rates. These are not projections. Also do notice that APY, and APR are used interchangeably and inaccurately and not in any uniform way across platforms. Platform developers typically just choose whichever number shows the greater percentage.

Some DeFi platforms are just diluting their own token for some time, or indefinitely, and people earn that and hope the exchange rate support the greater supply long enough to convert out. Some DeFi platforms are successful at building a demand model and utility to offset the supply. Other DeFi platforms are doing something monetarily productive that earns the platform money which is distributed to stakers or farmers.

Hope that helps. There is no one way to evaluate or dismiss all defi products with a yield, but there are some patterns to look for and to understand why they attract so much capital on deposit so quickly. Much of the capital comes from CeDeFi looking for yield that won't cause them to loose all the customer money.

Small nitpick but CeDeFi is a term coined by Binance to make them appear more palatable and competitive. Binance is a centralized network so it's a CeFi foundation with all the controls that come with that, but with a DeFi coat of paint.

Coinbase is a centralized exchange (Cex, not a Dex) so it has little to do with DeFi in general.

a) who cares who coined it, it is a classification used by many and quickly conveys the shared concept that matches that classification, which is the overall point of language

b) Coinbase is many products. Coinbase Staking is the one that matches what was described above. Don't conflate the front facing CEX for everything they offer. No different than Amazon not being a bookstore, nor just an ecommerce platform. It is many products. The context was solidified amongst several other products with similar offerings. Coinbase's various CEX products have nothing to do with their Staking product (or the Lending one they were going to try, of Vault or several others)

a) it does matter because despite what you think CeDeFi is only there to create confusion in the industry. Centralized decentralized finance. Which is it?

b) staking has nothing to do with DeFi

so for anyone passing by (this isn't a response to you any more I no longer care what you think but I do care what others think)

Banks and brokers that offer exposure to the defi market are called CeDeFi because you could interact with DeFi yourself with no restrictions but the organizations that help you are just banks and brokers so it is a centralized company layer on top of the defi market. Those come with restrictions.

Their staking products allow you to provide them with liquidity, similar to a deposit at a bank or certificate of deposit (CD) at a bank, where they take your balance and put it in DeFi products to make a better yield for themselves.

Borrowing money in exchange for a promise to pay it back isn't really a thing in defi (and I'm not sure it ever could be?) All DeFi i'm aware of is based on borrowing less than the value of some asset you stake to assure your repayment. It's definitely a different thing than most people think of when they think 'loan'