Highlights from the "Why I do or don't use DeFi borrowing"

Last week I published a post detailing the basics of how to use a platform like Aave, to borrow cash against your crypto without having to sell. You can read it here. I asked if people have experience with DeFi lending, and what sort of objections they have to using it in the future.

Some excellent comments in response to this and I felt it would be worthwhile to explore them further.

Comments on security and hacks

u/John_Crypto_Rambo linked to hacks and liquidations. I think it's hard not to argue with this point. Smart contract and hacking risk is, in my mind, the principal risk with all of crypto and DeFi. If you're absolutely looking to risk minimise, and you don't have any near-term cashflow needs, then simply using a cold wallet to store crypto may be the best option.

u/Infinite_Party_1084 responded with

Defi hacks are quite common but tbh platforms like AAVE have proven to be quite secure and stood the test of time so I will look into this more, this is a great use case for crypto, fs better than just staying in a wallet doing nothing

I think this is where myself and a lot of users fall. Under the assumption that you want to borrow against your existing crypto holdings, sticking to large, established and more battle tested protocols is IMO the best mitigation factor out there. It's not perfect, but it certainly beats the risk of a CEX stealing your money, in my book.

Comments on repayments

u/nodeocracy wanted to know how loans are repaid:

What do YOU use to repay the loan? Salary? Why not just use that salary to pay for your groceries or whatever else you’re borrowing for and save paying interest? I’d understand if you needed a large loan to buy a property or a car. But you’re paying rent and buying a monitor with a loan? Why not use salary?

There are 2 questions here.

"How do you repay the loan" opens up a really interesting point about DeFi loans, unique to crypto: you can pay directly from the value of the ETH you deposit. Put another way:

• You depost $2000 of ETH and borrow $1000 of USDC
• Later, ETH goes to $3000, but you don't have $1000 to repay the loan
• It's possible, using "flash loans" to repay the $1000 loan with the value of your ETH, this leaves you with $2000 worth of ETH remaining, and the loan is cleared (aka - you are $1000 better off)

You don't need to understand how flash loans work, simply that they exist and that there are utilities out there that allow you to use them to repay and exit loans.

In answer to "why use a loan over salary", this is much simpler: it makes sense if you think that the value of ETH you sell will be worth more in the future than the interest. It's a typical investment decision. But then again, if you already have ETH, your choice is sell vs. borrow, not purchase.

Comments on Liquidations and volatility

Liquidations on DeFi loans use the supplied collateral to pay back lenders automatically, when collateral falls below a certain value. This is the risk you take when opening a loan of this kind:

Mountainman220 encapsulates the tradeoff succintly:

Sucks if you get liquidated on said loan though. Volatility can really fuck you

HoofHearted47 has personal experience here:

I lost a crap ton of eth on Black Thursday. All fine and dandy until everything goes down by 50+%

u/Ghola_Mentat felt that the extra headache of the loan was not worth it:

It’s just too much of a headache while crypto is this volatile. Can’t see trying it again until crypto matures and becomes more stable.

I do agree (in part) here. Volatility is the main risk to manage if you're considering a loan. In particular, I'd recommend you keep the borrowing percentage relatively low (max 50% of collateral). I put together a calculator if people are interested in seeing what percent ETH would need to fall before a liquidation occurs, for a given deposit level.

Overcollateralised Loans are Bad?

u/AvatarOfMomus is skeptical of overcollaterialised loans, in general. They write:

The only time you'll see loans like this outside of Crypto is on ultra high-risk loans where the borrower still wants a loan, for some reason, instead of paying in cash but doesn't want to pay an exorbitant interest rate. They're really uncommon outside of a few specific areas...
...You're basically betting that whatever asset you're putting up as collateral won't fall in value to below the value of the loan. If it does, then you probably should have just sold the asset and spent the money directly. In order for a loan like this to make sense to pay off a bill then the potential losses from loosing the collateral PLUS the interest have to be less than the taxes from just selling the asset to pay your bills.

I feel like this ignores the main reason why you would do this type of loan in the first place: given the choice between selling crypto now, or borrowing, selling exits the position. Borrowing gives you exposure to the upside.

Tax benefits aside, the response seems to ignore or downplay that part of the argument, and the reason I personally have made use of these loans.

Comments on leverage:

u/VinsentN writes:

It’s called leverage, a.k.a. What gets ppl rekt. In small doses it could help if you’re unable to part with some of your position, but that in and of itself reveals that something is not right about your situation.

u/jps_ seconds:

This seems to be selling the notion of borrowing from yourself. But in reality it is just another way of recommending folks apply leverage to their positions.
The risk with any leverage strategy is that while you capture the opportunity to gain more than you would without leverage, you also capture the opportunity to lose more.

u/1millionnotameme counters:

...most people think borrowing is leverage and leverage = bad and can get liquidated. Of course, that can happen if your collateral falls a certain price, but as long as you're sensible and you are able to top up with more collateral when needed then that's a non-issue. Too bad most people don't see it that way.

I sympathise with the argument that any sort of leverage is safer to avoid, unless you know what you're doing.

Ultimately though, loans/leverage are tools and it's up to you to make the assessment if these tools are of value to you.

I personally don't subscribe to "all X in bad" in cases like this, I try to come up with my own assessments, although it's fair to say that less borrowing == less risk.

Comments on Greed and Following the Herd

u/After_Sock_3550 writes:

people in crypto are greedy or invest way too much in some random alt and lose everything because "BTC won't do a 10x".

u/usernamehighasfuck

most people don't do this because they only pay attention after something's already up 3x, just following the crowd

These are valid comments, and maybe it should be noted that the best time to get a loan is when you see high future upside. From personal experience, I find that alts typically have more "hidden" risks than, say, ETH or BTC, so levering on those positions might be a better risk allocation for some.

Some comments on personal finance

u/Scholes_SC2

Most of the people on earth don't earn enough to be able to stack crypto

u/CCNightcore

You're saying why don't you guys have more money? It might seem more complex, but that is the lowest common denominator. Just be happy with your good fortune.

I won't argue with these: they're valid points that need no further explanation.

u/obermoque comments that:

If you are invested so much that can't pay your bills, you're definitely more invested than you can afford to lose.

While this may be fair, my experience is that it the reality for a number of people deep into crypto is that they are technically over-exposed. If that's the case, I think being able to choose between selling or borrowing is useful for those people.

Summing it up

I think u/sylsau provides some excellent closing words of wisdom for us:

The decisions that make the difference when it comes to investing are the ones you make on your own after integrating as much information and data as possible. At the end of the day, you decide for yourself. You are then in control and you know why you made this choice. Even in a strong correction, you are still in control because you return to the reasons that led you to make that initial choice.
From then on, you can wait.
It's all a matter of deciding for yourself.

Well put. DYOR, RTFM, and don't listen to random guys like myself on reddit.

This is part of a series of posts I'm writing on one of the real world uses for DeFi - fiat borrowing. Full disclosure: I'm currently working on a platform that helps simplify the whole borrowing process in DeFi, but I'll try and keep the shilling to a minimum and hope these posts are useful. If you want to find out more about what I do, DM me or hop over to https://ambos.finance