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Ok it's Friday, and with lending coming to @avalacheavax with @traderjoe_xyz and @BenqiFinance, I thought I'd drop a thread about why lending is a big deal.
This thread will start off as a ELI5 primer. Later threads will get gradually more big brained.
Anyways, let's start.
Ok it's Friday, and with lending coming to @avalacheavax with @traderjoe_xyz and @BenqiFinance, I thought I'd drop a thread about why lending is a big deal.
This thread will start off as a ELI5 primer. Later threads will get gradually more big brained.
Anyways, let's start.
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Let's begin by describing how lending works in TradFi aka normie world.
Banks are usually the place you goto get a loan. Users deposit their cash into bank accounts and earn interest (if they're lucky) - we call them lenders or suppliers.
Let's begin by describing how lending works in TradFi aka normie world.
Banks are usually the place you goto get a loan. Users deposit their cash into bank accounts and earn interest (if they're lucky) - we call them lenders or suppliers.
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The bank then uses that cash and loans them out to borrowers.
Borrowers pay interest over time to borrow and the interest they pay is higher than the interest earned by the suppliers.
Supplier interest < Borrower interest
The difference is the profit made by the bank.
The bank then uses that cash and loans them out to borrowers.
Borrowers pay interest over time to borrow and the interest they pay is higher than the interest earned by the suppliers.
Supplier interest < Borrower interest
The difference is the profit made by the bank.
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To borrow, a bank will first access your credit score to determine the risk. If you pass all the checks, then you have to deposit collateral before you're allowed to borrow.
The amount you're able to borrow is determined by the collateral factor, which is expressed as a %.
To borrow, a bank will first access your credit score to determine the risk. If you pass all the checks, then you have to deposit collateral before you're allowed to borrow.
The amount you're able to borrow is determined by the collateral factor, which is expressed as a %.
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In TradFi, the collateral factor is usually over 100%. We call this an undercollateralised loan. This means you can borrow MORE than the collateral you deposit.
For example, if the collateral factor is 400% and you deposit $100 of collateral, then you can borrow $400.
In TradFi, the collateral factor is usually over 100%. We call this an undercollateralised loan. This means you can borrow MORE than the collateral you deposit.
For example, if the collateral factor is 400% and you deposit $100 of collateral, then you can borrow $400.
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If you've ever taken a loan whether it be a student loan, car loan or a mortgage, then you'll be familiar with this.
So how does it differ in DeFi?
If you've ever taken a loan whether it be a student loan, car loan or a mortgage, then you'll be familiar with this.
So how does it differ in DeFi?
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Well for starters, loans in DeFi are permissionless.
That means anyone can take a loan in DeFi regardless of your credit score. It doesn't matter if you're unemployed student or a billionaire oligarch - loaning in DeFi is blind to that.
But there's a caveat.
Well for starters, loans in DeFi are permissionless.
That means anyone can take a loan in DeFi regardless of your credit score. It doesn't matter if you're unemployed student or a billionaire oligarch - loaning in DeFi is blind to that.
But there's a caveat.
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Let's say you borrow $400 with $100 collateral (i.e. a collateral factor of 400%).
If you happen to degen that $400 away, then you won't be able to pay back your loan and you simply lose the $100 collateral.
Not a bad trade off to be honest, right?
Let's say you borrow $400 with $100 collateral (i.e. a collateral factor of 400%).
If you happen to degen that $400 away, then you won't be able to pay back your loan and you simply lose the $100 collateral.
Not a bad trade off to be honest, right?
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Not paying back your loan is called defaulting on your loan.
And it means the financial institution (e.g. bank) giving out the loan has to bear this risk.
If many borrowers end up defaulting on their loans, then well, you have a 2008 crisis on your hands.
Not paying back your loan is called defaulting on your loan.
And it means the financial institution (e.g. bank) giving out the loan has to bear this risk.
If many borrowers end up defaulting on their loans, then well, you have a 2008 crisis on your hands.
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For this reason, lending protocols in DeFi only allow undercollateralised loans.
For example, on @CreamdotFinance, you can borrow $ETH with a collateral factor of 75%.
Riskier assets, like $HEGIC for example, has a collateral factor of 40%.
For this reason, lending protocols in DeFi only allow undercollateralised loans.
For example, on @CreamdotFinance, you can borrow $ETH with a collateral factor of 75%.
Riskier assets, like $HEGIC for example, has a collateral factor of 40%.
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So why offer borrowing if you can only do undercollateralised loans?
Well it still opens many opportunities.
For starters, let's say you're bullish on $AVAX and you plan on HODLing that for a while.
So why offer borrowing if you can only do undercollateralised loans?
Well it still opens many opportunities.
For starters, let's say you're bullish on $AVAX and you plan on HODLing that for a while.
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Well at the moment you have a few options:
1. You let it sit in your wallet, idly doing nothing.
2. You stake it as a delegator.
3. You LP it with another token.
Let's breakdown the options.
Well at the moment you have a few options:
1. You let it sit in your wallet, idly doing nothing.
2. You stake it as a delegator.
3. You LP it with another token.
Let's breakdown the options.
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Option 1: You let it sit in your wallet.
This is akin to putting your cash in the bank. Good if you know you need to sell your AVAX at a short moment's notice to pay the bills.
But you're also not maximising the time it's sitting there doing nothing.
Option 1: You let it sit in your wallet.
This is akin to putting your cash in the bank. Good if you know you need to sell your AVAX at a short moment's notice to pay the bills.
But you're also not maximising the time it's sitting there doing nothing.
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Option 2: You stake it as a delegator.
This provides great returns with little risk. The issue is that you have to lock it up for at least two weeks. And as we know in crypto, the price of AVAX can literally change by the minute.
Option 2: You stake it as a delegator.
This provides great returns with little risk. The issue is that you have to lock it up for at least two weeks. And as we know in crypto, the price of AVAX can literally change by the minute.
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Option 3: You LP it with another token.
Good because if AVAX tanks, then you can quickly unstake your LP and sell off your AVAX.
But bad because you gotta pair it with another token at a fixed ratio and also because of IL.
Option 3: You LP it with another token.
Good because if AVAX tanks, then you can quickly unstake your LP and sell off your AVAX.
But bad because you gotta pair it with another token at a fixed ratio and also because of IL.
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Enter option 4: You supply your AVAX to a lending protocol like @traderjoe_xyz.
You don't suffer from IL AND you can quickly withdraw to react to the market.
This is basically like single-sided staking with sustainable tokenomics.
Enter option 4: You supply your AVAX to a lending protocol like @traderjoe_xyz.
You don't suffer from IL AND you can quickly withdraw to react to the market.
This is basically like single-sided staking with sustainable tokenomics.
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A win-win for people who to earn yield whilst maintaining liquidity on their tokens.
And if you're in the degen mood, you can simply deposit your AVAX as collateral to borrow some USDT to buy some other coins you're feeling bullish on.
A win-win for people who to earn yield whilst maintaining liquidity on their tokens.
And if you're in the degen mood, you can simply deposit your AVAX as collateral to borrow some USDT to buy some other coins you're feeling bullish on.
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This presents a new way to put your cryptocurrencies to good use.
And if the protocol is managed well, then the risk you incur is minimised significantly.
This presents a new way to put your cryptocurrencies to good use.
And if the protocol is managed well, then the risk you incur is minimised significantly.
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However, there's no such thing as risk-free in crypto!
Collateral factor is one parameter that needs to be managed well. Another factor is LIQUIDATION.
However, there's no such thing as risk-free in crypto!
Collateral factor is one parameter that needs to be managed well. Another factor is LIQUIDATION.
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In the next thread, we'll talk about liquidations and how they're absolutely necessary in maintaining the health of a lending protocol.
If you enjoyed this thread, please give it a like and a RT.
And also, check out our lending whitepaper: bit.ly/3fXuK2C 🙂
In the next thread, we'll talk about liquidations and how they're absolutely necessary in maintaining the health of a lending protocol.
If you enjoyed this thread, please give it a like and a RT.
And also, check out our lending whitepaper: bit.ly/3fXuK2C 🙂
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