What’s the point of a loan if you need 100% collateral, and the collateral isn’t something like a house that you can put to good use while using as collateral?
If I can use bitcoin as collateral to get some Doge, hoping to make enough money with the Doge to get my bitcoin back later… couldn’t I just sell my bitcoin to buy the Doge, again hoping to make enough money to get my bitcoin back later?
People hold Bitcoin and Etherum because they want to be able to make a profit on it raising in price. If someone sells their Bitcoin to buy Doge and Bitcoin doubles in price they don’t earn any profit. If they however used the Bitcoin as collateral for a loan, the will make a profit if Bitcoin rises in price.
Vitalik’s explanation of how he made $56,803 on betting on Trump losing on Augur would be one practical case of someone using this method.
Just like Vitalik made profit with using the inefficiency in the Augur prediction market other people are likely using the leveraged capital to make money with the above described yield farming.
Is there any use case for these over-collateralized loans other than getting leveraged exposure to token prices? (Or, like Vitalk did, retaining exposure to token prices while also using the money for something else?) So, for instance, if crypto prices stabilized long term, would the demand for overcollateralized loans disappear? Does anybody take out loans collateralized by stablecoins?
Even if the prices of crypto-currency stabalize long-term, not every token is about being a crypto-currency. Many tokens are like shares in a venture that you wouldn’t expect to have stable prices just like stocks on the stock-market don’t have stable prices.
If I understand right you can also use tokens that are locked in to doing staking as collateral.
Well, here’s a scenario: Suppose you have owned Bitcoin since 2012 and now you have a million dollars of Bitcoin, but when you sell them you will have to pay ~$250,000 in capital gains tax, since you live in California. You still endorse owning the Bitcoin because you think it’s headed for the moon, but you want to use that capital for some other stuff, like buying a Tesla.
In this case you could deposit $200k of Bitcoin into Compound, withdraw $100k of USDC, cash the USDC out for dollars at Coinbase, and buy your Tesla. Now you are still exposed to the upside on all your Bitcoin but you also have your Tesla.
In practice I actually don’t know what kind of taxable event “taking out a loan at Compound” is so I am not sure this was a correct way to minimize taxes. (On the other hand, even if it’s not, I bet people are doing it; the IRS actually looks if you sell Bitcoin on Coinbase, but I don’t think it looks at what you’re doing with Compound.) But at least it definitely preserved your exposure to Bitcoin. That’s a way to “put it to good use” even when it just sits there.
This is one example. As I mentioned in the post, I’m not sure what is driving the majority of the demand.
So then, to get back the bitcoin in 12 years when it’s worth a billion dollars or whatever, you just have to make back the million USD you spent (plus interest), convert to USDC, and pay back (with interest)?
And then the risk you run is that bitcoin falls between now and that time, at which point your collateral would be liquidated to the highest bidder, and you’d be left with a Tesla but no bitcoin. (Not such a bad risk, all things considered.)
It would be even easier than that. Suppose for the sake of simplicity you put your whole million dollars of Bitcoin into Compound. You could then withdraw USD up to the point where you hit the collateralization ratio set by Compound, e.g. if the collateralization ratio is 150%, you could withdraw $666k of USD.
When Bitcoin goes up 1000x, your collateral is now worth a billion dollars, but you have still only borrowed $666k (plus interest). You have way more collateral than you need. So you could just withdraw 99.9% (minus interest) of the collateral, if you wanted. You don’t even have to repay anything to do that.
Somewhat easier, why take a loan against a 401k? Well, you have some value and some exposure to an asset, and you would like to use that value without facing the consequences of selling. In this case, the penalties to an early withdrawal are far higher than any normal interest rate, especially over a short time.
What’s the point of a loan if you need 100% collateral, and the collateral isn’t something like a house that you can put to good use while using as collateral?
If I can use bitcoin as collateral to get some Doge, hoping to make enough money with the Doge to get my bitcoin back later… couldn’t I just sell my bitcoin to buy the Doge, again hoping to make enough money to get my bitcoin back later?
People hold Bitcoin and Etherum because they want to be able to make a profit on it raising in price. If someone sells their Bitcoin to buy Doge and Bitcoin doubles in price they don’t earn any profit. If they however used the Bitcoin as collateral for a loan, the will make a profit if Bitcoin rises in price.
Vitalik’s explanation of how he made $56,803 on betting on Trump losing on Augur would be one practical case of someone using this method.
Just like Vitalik made profit with using the inefficiency in the Augur prediction market other people are likely using the leveraged capital to make money with the above described yield farming.
Ok, interesting! Thanks for the explanation.
Is there any use case for these over-collateralized loans other than getting leveraged exposure to token prices? (Or, like Vitalk did, retaining exposure to token prices while also using the money for something else?) So, for instance, if crypto prices stabilized long term, would the demand for overcollateralized loans disappear? Does anybody take out loans collateralized by stablecoins?
Even if the prices of crypto-currency stabalize long-term, not every token is about being a crypto-currency. Many tokens are like shares in a venture that you wouldn’t expect to have stable prices just like stocks on the stock-market don’t have stable prices.
If I understand right you can also use tokens that are locked in to doing staking as collateral.
Well, here’s a scenario: Suppose you have owned Bitcoin since 2012 and now you have a million dollars of Bitcoin, but when you sell them you will have to pay ~$250,000 in capital gains tax, since you live in California. You still endorse owning the Bitcoin because you think it’s headed for the moon, but you want to use that capital for some other stuff, like buying a Tesla.
In this case you could deposit $200k of Bitcoin into Compound, withdraw $100k of USDC, cash the USDC out for dollars at Coinbase, and buy your Tesla. Now you are still exposed to the upside on all your Bitcoin but you also have your Tesla.
In practice I actually don’t know what kind of taxable event “taking out a loan at Compound” is so I am not sure this was a correct way to minimize taxes. (On the other hand, even if it’s not, I bet people are doing it; the IRS actually looks if you sell Bitcoin on Coinbase, but I don’t think it looks at what you’re doing with Compound.) But at least it definitely preserved your exposure to Bitcoin. That’s a way to “put it to good use” even when it just sits there.
This is one example. As I mentioned in the post, I’m not sure what is driving the majority of the demand.
Right, ok!
So then, to get back the bitcoin in 12 years when it’s worth a billion dollars or whatever, you just have to make back the million USD you spent (plus interest), convert to USDC, and pay back (with interest)?
And then the risk you run is that bitcoin falls between now and that time, at which point your collateral would be liquidated to the highest bidder, and you’d be left with a Tesla but no bitcoin. (Not such a bad risk, all things considered.)
That’s pretty awesome.
It would be even easier than that. Suppose for the sake of simplicity you put your whole million dollars of Bitcoin into Compound. You could then withdraw USD up to the point where you hit the collateralization ratio set by Compound, e.g. if the collateralization ratio is 150%, you could withdraw $666k of USD.
When Bitcoin goes up 1000x, your collateral is now worth a billion dollars, but you have still only borrowed $666k (plus interest). You have way more collateral than you need. So you could just withdraw 99.9% (minus interest) of the collateral, if you wanted. You don’t even have to repay anything to do that.
Somewhat easier, why take a loan against a 401k? Well, you have some value and some exposure to an asset, and you would like to use that value without facing the consequences of selling. In this case, the penalties to an early withdrawal are far higher than any normal interest rate, especially over a short time.