What is Decentralized Finance (DeFi)? pt. 3 | Collateralized Borrowing/Lending
Did you know that you can lend out or borrow crypto without a bank?
Collateralized Borrowing/Lending
This is the 3rd issue of "What is Decentralized Finance (DeFi)?". If you missed the first 2, check them out below. This series will also be indexed under my master index of educational crypto content (at some point) - "Learn Crypto Stuff".
The idea with this series is to educate people that are new to cryptocurrency or new to DeFi on how it works. Decentralized finance can definitely be intimidating if you've never done anything with cryptocurrency before aside from just holding or trading it. Another reason that people can find it intimidating, or confusing, is that it does require a little bit of technical know-how to get started.
Have no fear though, NiftyPhill is here to help you learn the ways of the financial system of the future! I also need to preface this by saying I am not an exert nor am I a financial advisor. I'm a guy that has been playing with cryptocurrency since 2015 and has done a ton of different things with it so I'm speaking purely from experience.
When talking about decentralized finance, we have to keep in mind that we are responsible for our own assets and the security of those assets. When you don't have a bank keeping a ledger of your assets that's insured against certain things... It's all up to you to keep everything safe and secure. The other side of this is that we have freedom to use our assets freely without question.
In the financial system of the future, there's plenty of ways to put your cryptocurrency to work for you. One of those ways is borrowing and lending.
Because you don't have to interact with a central party like a bank, you're able to make use of smart contracts to earn money on your assets. You are also able to use one asset as collateral to take out a loan. Above is the Kashi lending/borrowing pools currently on SushiSwap. Keep in mind - there are different pools across different blockchains, I just opted for Polygon because the gas fees are significantly lower than other chains.
So why would you want to take out a collateralized loan with your crypto? Well, there's a lot of reasons. I think the best example would be providing ETH as collateral to take out a loan in USDC. Wanna make a purchase that requires USD without selling your ETH? Cool - you can do that with a collateralized loan at 0.25% APR. Let me know when you can find a bank that will give you that kind of interest rate.
These loans are often over collateralized meaning you can't borrow more than 70-80% of the value of your asset. There are platforms, however, that will allow you to take out leveraged positions and borrow more value than you have in your asset to begin with.
As you can see in the example above, with 1 WETH (wrapped ETH) you can borrow $1400 worth of USDC. The liquidation price of your position if 1 WETH = 1104.26 USDC. This means that if the price of ETH goes below that amount during the duration of your loan, your position is liquidated and you lose the 1 ETH but keep the 1400 USDC. You want to make sure that you're pretty far away from the liquidation price when entering these positions so there's less risk of losing your collateral asset.
As I mentioned, some platforms allow you to take leveraged positions on loans as well. Kashi on SushiSwap does this and allows up to 2x leverage on your collateral, which is definitely risky. This allows us to take that same 1 WETH and get a loan of 4403 USDC by swapping the USDC initially borrowed for more WETH then re-supplying it as collateral. That sounds really complicated, but it isn't. This makes shorting a token very easy.
Notice that when taking a leveraged position, your liquidation price for WETH has increased to 1852.28 USDC which is extremely close to the current price of ETH. If the price of ETH goes below that mark, the position is liquidated and you lose the collateral plus what was borrowed. You really only want to do this if you are 100% sure that the token price is going to increase vs. the liquidation price.
As with anything related to cryptocurrency, it's very risky to gamble with leveraged positions so most people stick to regular collateralized loans. Have some extra funds sitting around that you don't want to take out a loan with? Cool - you can lend those tokens out on one of these platforms to earn some extra crypto. For example - on SushiSwap, you are able to supply a ton of different assets.
If you supply SUSHI tokens, your APR is 43% which isn't too bad for just parking an asset for others to borrow. I would argue that it would be a better idea to put those assets in liquidity pools, but hey... I'm just a dude on the internet showing you the ways of crypto land.
I'm not going to dive into managing the health of your loan positions or anything like that as this post is getting a little long. Maybe that will be another post for another day.
Have you ever take out a crypto loan?
Post written by: @l337m45732 aka NiftyPhill.
Posted Using LeoFinance Beta
