DeFi risks and the decentralisation illusion
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Re: DeFi risks and the decentralisation illusion
#2What I dont understand is how they calculate rates for loans. I dont know much about DeFi and just consider it as scammy as NFTs, but for me a lending rate is always function of a default risk: too high, no loan, high, high rate, low, low rates.
I've worked in fintech and am in a bank now and we've always had our proprietary mapping table with field studies of default stats and long attribute lists (age, immigration status, salary, number of other loans, number of past default, other assets and so on), and the key was to either religiously stick to these or take strategic decisions to open the valves if needed (say to fit a quota, we let the younger people in for a while).
How is DeFi doing lending rates ?
Edit: got it, over collateralized with valuable collateral confiscated rather than promised so not fit for the same purposes as normal consumer loan. You wont pay your daughter's sweet 16 mega party in mexico or your son's wedding in Singapore or your first car in France with a DeFi loan :D So it's not exactly decentralized finance, it's more decentralized leverage, I guess. At least you cant default a DeFi loan, which sounds reassuring on paper.
Re: DeFi risks and the decentralisation illusion
#3What I dont understand is how they calculate rates for loans. I dont know much about DeFi and just consider it as scammy as NFTs, but for me a lending rate is always function of a default risk: too high, no loan, high, high rate, low, low rates. I've worked in fintech and am in a bank now and we've always had our proprietary mapping table with field studies of default stats and long attribute lists (age, immigration…
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.
Re: DeFi risks and the decentralisation illusion
#4What I dont understand is how they calculate rates for loans. I dont know much about DeFi and just consider it as scammy as NFTs, but for me a lending rate is always function of a default risk: too high, no loan, high, high rate, low, low rates. I've worked in fintech and am in a bank now and we've always had our proprietary mapping table with field studies of default stats and long attribute lists (age, immigration…
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.
Re: DeFi risks and the decentralisation illusion
#5The decentralisation illusion argument seems weak. One could have claimed the same about the early internet: Early internet wasn't truly decentralized as there were still ISPs, and you still need to register your domain with a centralized entity.
This misses that the big change is one of access. Content creators were able to reach a large audience without playing ball with the big publishers or newspapers.
With defi, the same can happen with finance. Marketplaces, exchanges and new financial instruments can be created by anyone that follows programmatic rules. Complex & expensive relationships with legacy banks are no longer required.
Re: DeFi risks and the decentralisation illusion
#6What I dont understand is how they calculate rates for loans. I dont know much about DeFi and just consider it as scammy as NFTs, but for me a lending rate is always function of a default risk: too high, no loan, high, high rate, low, low rates. I've worked in fintech and am in a bank now and we've always had our proprietary mapping table with field studies of default stats and long attribute lists (age, immigration…
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.
Re: DeFi risks and the decentralisation illusion
#7What I dont understand is how they calculate rates for loans. I dont know much about DeFi and just consider it as scammy as NFTs, but for me a lending rate is always function of a default risk: too high, no loan, high, high rate, low, low rates. I've worked in fintech and am in a bank now and we've always had our proprietary mapping table with field studies of default stats and long attribute lists (age, immigration…
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 l…
> 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.
Re: DeFi risks and the decentralisation illusion
#8The comparison to banks as shock absorbers is pretty rich. It has been only 12 years since banks caused global recession due to secrecy and greed. At least the decentralized options are more open, despite any flaws, which would be shared by centralized finance anyways.
A mix of centralized and decentralized seems the safest.
Re: DeFi risks and the decentralisation illusion
#9Earlier quoted context omitted.
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 l…
> 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.
Surely the DeFi loan should be a "smart contract" that just locks the asset from transfer until either default or repayment.
Re: DeFi risks and the decentralisation illusion
#10What I dont understand is how they calculate rates for loans. I dont know much about DeFi and just consider it as scammy as NFTs, but for me a lending rate is always function of a default risk: too high, no loan, high, high rate, low, low rates. I've worked in fintech and am in a bank now and we've always had our proprietary mapping table with field studies of default stats and long attribute lists (age, immigration…
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.