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Comment by rawtxapp | Hacker News Reader

MakerDAO (aka oasis, dai system) is one of the coolest software project I've ever used, highly recommend anyone checking it out.

It's essentially a system of smart contracts and surrounding system which create a stablecoin pegged to the dollar (1DAI=1$) backed by crypto collateral.

One of the benefits of that is, you can access your crypto and use it without selling your position, which means you're not paying any capital gains taxes. There's a 4% stability fee with borrowing against your collateral (notice it's not an interest, it's a fee, which means many people who can't deal or don't want to pay/receive interest can actually use it). 4% is a drop in the bucket when you consider gains on your assets and a lack of capital gains tax.

p.s. I'm a long term BTC believer who always thought most of these projects were scam until I've actually started researching and trying to understand it.

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> always thought most of these projects were scam until I've actually started researching and trying to understand it.

Unfortunately these seems to be the case for most people. What have you this notion that it's all a scam? What it news pundits? Twitter/Reddit threads?

I've been in crypto since 2014 and was here for 2017 when all ICOs that did absolutely nothing were being pumped and dumped, so I wrote off ether for a few years until defi kept creeping up in my news couple times.

I think there's still lots of scams out there, but the big projects like Maker, uniswap, compound, etc, have made me change my mind.

I'm trying to wrap my head around it and I have a genuine question: I see on these DeFi platforms coins that have APY's well in excess of 10%. Who's borrowing at these rates, and why?

I know many people that are, because if you're savvy you can earn much more than that with the amount you're being loaned.

But why wouldn't they instead borrow USD? Interest rates are the lowest they've ever been.

In other words, if you're really savvy, you can earn even more than "much more than that" by borrowing USD at low interest rates (or Euro at negative interest rates), and then buying crypto and doing whatever you would have done after directly borrowing crypto at the much higher interest rates.

Who is choosing to forsake borrowing fiat currency at lower interest rates and then converting to crypto to do profitable things in favor of borrowing crypto directly at (much) higher interest rates, and why?

Traditional finance has higher friction. I.e., higher cost to take credit, to operate, in many cases slower, and in general, has much higher entry barrier.

With defi you can get a loan for millions of dollars just immediately, maybe for a couple of seconds or milliseconds. Without filling any form asking why you need it. Without even creating any account anywhere except your own machine. It's new "in internet nobody knows you are a dog".

That makes sense.

Then the next logical question is: what if I never get my money back? What if I lend it to a "dog" who then buys highly leveraged calls on GME, only to be unable to pay me back. Do I, the lender, just write it off as a loss?

As you suggest, if you can get a loan for millions of dollars just immediately without filling any form asking why you need it or without even creating any account anywhere, then what's stopping me from just taking a bunch of loans in excess of the collateral and just never paying them back? After all, as a borrower, I don't have to worry about any sort of credit rating or rate limiting.

As a lender, how do I know that the borrower on the other end isn't running such a scam?

Then you receive the collateral, which would cover the loan amount.

But the collateral almost never covers the full loan amount...otherwise the borrower wouldn't need to borrow money in first place; they already have it in the form of the collateral.

For borrowers that ostensibly need liquidity, it would be impossible for them to put down collateral equivalent to the loan amount, else they wouldn't need liquidity. If you do have access to collateral, why take a loan in the first place? It's just extra steps (and interest) to end up with the same amount of money that you already have. Is the collateral some lower amount? If so, a bad actor could always put down a lower collateral amount than the original loan amount and then never pay back, resulting in the lender losing {original loan amount - collateral} worth of money.

How is this fraud prevented? Is the interest rate baked into the collateral? If I'm borrowing on this platform, do I need to put down more money than what I seek to borrow in collateral? Who would ever want to do that? How many lenders actually receive, on the net, 10-20% APY successfully?

At least with high yield junk bonds, there are some safeguards built into the system in the form of credit ratings, KYC, and institutional friction (which functions as a rate limiter). How does any of this work in the DeFi world?

It's an overcollaterized position, so you have to put at least 150% of the money you're trying to borrow.

Now you might ask, if I already all that money, why the hell am I borrowing it? Because your asset is going to appreciate in value (like a ton of appreciation) whereas your debt is only going to go up 4%. So you want to hold on to your asset, yet you need cash to spend. Also you want to avoid capital gains taxes which happen when you sell the asset.

That explains it. Thanks! I think it makes sense.

It's overcollateralized, but that's okay because you actually want to continue holding the asset to realize appreciation.

To your point about avoiding capital gains tax, at some point you would have to repay the full loan, at which point you'd have to pay capital gains tax anyway. I guess, at best, you could always guarantee that you pay the lower long-term capital gains tax rate rather than the higher short-term capital gains tax rate. What's the repayment schedule?

There's no schedule, the stability fee compounds every block (every 15 seconds), you can borrow money whenever you want, pay it back whenever you want. If your colleteral's value has increased so much that it's above the minimum collaterazation ratio, you can just withdraw a portion of it.

Technically, with a very simplistic math, if your asset appreciates let's say 20%, your cost for borrowing is 4% and you don't spend more than the 20-4=16% in any given year, you technically have a credit line that's worth 16% of your collateral every year, you can live off of, never have to pay your debt. You just need to make sure to never fall below 150% collateral then you'd get liquidated. Of course, there's potential bugs in the smart contract, etc, so don't put more than you can afford to lose, yadi yada.

edit: I highly recommend trying it or watching a Youtube video which shows you the UI and the process, it'll all makes sense and click.

Do you have any recommendations for a good youtube video to watch?

Besides already mentioned collateralized loans, there is another type of loan, which I think is impossible with traditional finance. It's Flash Loans.

In this case, you don't need to provide any collateral, but the smart contract is designed so that you cannot avoid repayment. It's just an atomic operation, like with database, where all of the actions happen, including repayment, or nothing at all. You can do that with defi.

It's used for market arbitrage, or maybe to restructure other loans, etc.

> But why wouldn't they instead borrow USD?

In addition to the sister comment, where else can I find these type of returns in traditional finance? There's tons of places you can find 50%+ interest, even up to 300%.

If you find opportunities for arbitrage that return you well above 10%, then it's a drop in the bucket.

Makes sense in the short run. In the long run, these arbitrage opportunities would naturally fade away as the market settles on yield/interest equilibrium.

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