Aave: Easy Come, Easy Go?

[deisik]

My piece crossposted from Reddit



If you’ve been following the DeFI space closely, you should already know that Aave, a decentralized non-custodial money market protocol as it is called in crypto parlance, has been hitting new records by the amounts of money locked in its dApps, with over $1.53 billion of collateral provided as of this post. In more mundane terms, it is a lending platform that allows one group of people to deposit their coins to earn a passive income off another group of people who are borrowing these coins from them by offering some form of collateral

The Dark Side of Crypto Lending

The sad truth about any such system is that the scheme is sustainable only in pretty narrow margins. To better see why it is so, let’s take a look at how it might fold, or, in other words, what would make it collapse. The answer is obvious, and it is the failure of the asset used as collateral. For example, if you borrow Ether and provide some token as a pledge, it is unlikely that your token will on average outperform the premier cryptocurrency you take on loan

However, it is almost a given that the collateral will crash way harder than the asset borrowed when the market starts to slide downhill. Realistically, it is only a matter of time till we see blood in the market. It essentially means that once the borrowers start to default en masse, no matter how overcollateralized the system was at first, it won’t suffice as no collateral will be worth anything at 0. The system enters the dreaded death spiral and eventually expires

Isn’t It All Just Fear Mongering?

In fact, we had already seen something to that effect before, in 2008 to be exact, with the subprime mortgage crisis in America. But it is a difference that makes the difference. In 2008 we had a central authority in the form of the government as represented by the Federal Reserve, which had to step in to avoid the domino effect. There’s no one who is going to bail out Aave and prevent the system from imploding this time once everything starts to fall apart

There are two possible developments that could potentially stop this dark scenario from unfolding. First, the whole cryptomarket is not set to plunge into the abyss of low prices, and the assets provided by the borrowers don’t have to devalue beyond the point of no return. Then, as long as the collateral itself is not made up of useless tokens, the system may still remain sufficiently collateralized to withstand sudden price drops in major cryptocurrencies

Long story short, let’s keep our fingers crossed and hope for the best

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[deisik]

And while we are at it, can anyone explain to me what is driving the people who are borrowing coins this way? I've been trying to come up with a single reason what's in it for the borrowers, and still can't wrap my head around it. If you have to provide 200% of collateral, how does all that make sense?

Seriously, what's the point?

[Tytanowy Janusz]

And while we are at it, can anyone explain to me what is driving the people who are borrowing coins this way? I've been trying to come up with a single reason what's in it for the borrowers, and still can't wrap my head around it. If you have to provide 200% of collateral, how does all that make sense?

Seriously, what's the point?

Well that's some sort of stop-loss. You invest in small cap high risk coin (via dex because not traded on big exchanges) with 1000$ and borrow 500$ eth using your coin as collateral. Now if price drop 90% due to exit scam or something like that you will not loose more than 50% that you have in ETH (or dumped to USDT) already.

 

The Dark Side of Crypto Lending

The sad truth about any such system is that the scheme is sustainable only in pretty narrow margins. To better see why it is so, let’s take a look at how it might fold, or, in other words, what would make it collapse. The answer is obvious, and it is the failure of the asset used as collateral. For example, if you borrow Ether and provide some token as a pledge, it is unlikely that your token will on average outperform the premier cryptocurrency you take on loan

However, it is almost a given that the collateral will crash way harder than the asset borrowed when the market starts to slide downhill. Realistically, it is only a matter of time till we see blood in the market. It essentially means that once the borrowers start to default en masse, no matter how overcollateralized the system was at first, it won’t suffice as no collateral will be worth anything at 0. The system enters the dreaded death spiral and eventually expires

Interesting point. Looks like we have another brick to the domino. Another because same thing we have with stop-losses, margin trading, leveraged tokens, derivatives with leverage. One trigger another.

[deisik]

And while we are at it, can anyone explain to me what is driving the people who are borrowing coins this way? I've been trying to come up with a single reason what's in it for the borrowers, and still can't wrap my head around it. If you have to provide 200% of collateral, how does all that make sense?

Seriously, what's the point?

Well that's some sort of stop-loss. You invest in small cap high risk coin (via dex because not traded on big exchanges) with 1000$ and borrow 500$ eth using your coin as collateral. Now if price drop 90% due to exit scam or something like that you will not loose more than 50% that you have in ETH (or dumped to USDT) already

I'm not sure if it is going to work out in practice

Indeed, if the "small cap high risk coin" (as you euphemistically called it) bites the dust in the blink of an eye, it might work out. But who is going to pay for it and why would they agree to be part of this game in the first place? On the other hand, why would you want to offer a coin for collateral which is as stable as the borrowed one, and two coins for one at that? To me, it makes no financial sense
 

However, it is almost a given that the collateral will crash way harder than the asset borrowed when the market starts to slide downhill. Realistically, it is only a matter of time till we see blood in the market. It essentially means that once the borrowers start to default en masse, no matter how overcollateralized the system was at first, it won’t suffice as no collateral will be worth anything at 0. The system enters the dreaded death spiral and eventually expires

Interesting point. Looks like we have another brick to the domino. Another because same thing we have with stop-losses, margin trading, leveraged tokens, derivatives with leverage. One trigger another

This is the whole story

The system looks sustainable only as long as the market keeps rising. But trees don't grow to the sky, and the higher it goes, the lower it will crash or be made to crash (in relative terms). Do people seriously believe that Bitcoin, as the big brother of all cryptocurrencies, is going to hit 25k (100k as some predict) by the end of the year?

[Tytanowy Janusz]

On the other hand, why would you want to offer a coin for collateral which is as stable as the borrowed one, and two coins for one at that? To me, it makes no financial sense

There is one reason.

I can give here BNB as example.

BNB hodler profit:

1- IEOs - https://launchpad.binance.com/en
2- Airdrops - https://www.binance.com/en/support/articles/84d5325cf7ef4e468c1a6abd1b989dfe
3- coin voting airdorps - https://binance.zendesk.com/hc/en-us/articles/360042371812
4- delegating - soon
few others

It all sum up even to 60% annual ROI (quantitative ROI) if you dump all coins from activities back to BNB as soon as you get it -  https://bitcointalk.org/index.php?topic=5208144.msg53361035#msg53361035

The only reson why not take part in it is currency risk that you can avoid by borrowing BNB instead of buying.

Many coin are necessary for various activites.

[articlecity]

Why is it not sustainable? I mean crypto lending is simply a business where lets say the person who takes the loan pays the profit on it to the lender. So unless it is a ponzi scheme there is no reason why such projects are not sustainable.

[Anonylz]

My question is are people really borrowing from this platform? I mean  people actually using this lending platform this much to drive such need, because lately Defi project coming up in all directions and all are into lending and borrowing, between what kind of collateral is needed for borrowing btc or eth? Am a bit curious.

[bigcash2011]

Aave was a great hold for me, as usual i habe not made killing profits but still im happy with the profits, i was holding my lend tokens at binance with sell order and it was filled but it was way under the current pricebut as far as i have made some profit i am happy with it.

[bttmember]

Well as an investor or lender i am more concerned about thw returns these decentralized finance projects are paying. Even if you analyse or compare other defi projects including aave you will see return on both eth and usdt is terrible and for a small investor like me it never appeals so i will never put my money there.

[BitcoinPanther]

And while we are at it, can anyone explain to me what is driving the people who are borrowing coins this way? I've been trying to come up with a single reason what's in it for the borrowers, and still can't wrap my head around it. If you have to provide 200% of collateral, how does all that make sense?

Seriously, what's the point?

The question is, are majority of those borrowers legit?  Or just some made up statistics of the said project mover?  We all know data can be manipulated.  But for some reason, probably I might give my point of view why those people are offering a 200% collateral of crypto because, they believe on that collateral and don't want to part with it.  That in due time, they will earn the money to pay for the loan and reclaim their collateral escaping the regret of selling their asset that has tendency to skyrocket in price.

[@baoli]

If you have a good experience on how conventional banks work you will understand Defi very well. People always money to execute their projects and other pressing needs. So they will always look for loan

[deisik]

And while we are at it, can anyone explain to me what is driving the people who are borrowing coins this way? I've been trying to come up with a single reason what's in it for the borrowers, and still can't wrap my head around it. If you have to provide 200% of collateral, how does all that make sense?

Seriously, what's the point?

The question is, are majority of those borrowers legit?

Well, I would rephrase it as whether the majority of collateral is legit

Regardless, it would be extremely compelling to see detailed stats what crypto is lent out and in what amounts as well as what got offered as collateral and how much exactly. If we had these stats, we could anticipate how the system would behave if the market was to fall, say, 50%. In other words, we would be able to estimate how strong and resistant this sucker is to external shocks such as sudden and massive price crashes like the one that occurred in March

[gazilla]

I absolutely agree with you. Even though I am not entirely informed of what tokens can you leave as collateral, but sooner or latter (as did not to long ago in 2018, as we do not have mass adoption yet) the market will decline to unwanted levels.     

[wiggi]

And while we are at it, can anyone explain to me what is driving the people who are borrowing coins this way? I've been trying to come up with a single reason what's in it for the borrowers, and still can't wrap my head around it. If you have to provide 200% of collateral, how does all that make sense?

Seriously, what's the point?

It makes sense if the collateral is volatile. Then borrowers pay interest to buy leverage. They can borrow stablecoin, use it to buy more volatile stuff (Eth or token that is accepted as collateral) and then borrow even more. So 200% of collateral becomes actually 1:1.

If market goes up, borrowers get all their now much more valuable collateral back.

If the market crashes really hard, lenders have to bear the tail risk. Perhaps they supplied stablecoin and get back token that is now worthless.

For borrowers this is like a guaranteed stop. Remember, in traditional stock market, or FX market there is never a guaranteed stop, at least not for retail customers. In case of a flash crash, if you're leveraged, a broker will liquidate you at the cruelest possible price, and then may try to foreclose your home to get its money back. Not so in Defi, and this is seriously cool.

[deisik]

For borrowers this is like a guaranteed stop. Remember, in traditional stock market, or FX market there is never a guaranteed stop, at least not for retail customers. In case of a flash crash, if you're leveraged, a broker will liquidate you at the cruelest possible price, and then may try to foreclose your home to get its money back. Not so in Defi, and this is seriously cool

That makes sense, thanks to you and Tytanowy Janusz for explaining this stuff

Now that we have established what's in it for the borrowers (and that likely explains all the current hype), why are the lenders willing to lend their real coins for some potentially worthless shit, especially if the liquidity pool can never be properly collateralized (which follows from your reasoning)? To me, it seems to be an extremely risky enterprise, given that the market can crash any minute which would trigger the domino effect leaving lenders with nothing but losses

[wiggi]

[...]why are the lenders willing to lend their real coins for some potentially worthless shit, especially if the liquidity pool can never be properly collateralized (which follows from your reasoning)? To me, it seems to be an extremely risky enterprise, given that the market can crash any minute which would trigger the domino effect leaving lenders with nothing but losses

I don't think that one side (coins supplied by lenders) is per definition better quality than the other side (collateral), all can crash. On Compound the coin with highest supply is Dai (996M, which would be more than marketcap of 445M according to CMC?). Dai has already exactly this problem, it's collateralized with another coin that can crash.

If total borrowed amount is small enough compared to marketcap of the coins used as collateral and compared to the liquidity of markets in which liquidation will happen and if (big IF) the system executes this liquidation fast enough, then yes, the pool can be properly collateralized.

If someone fears a crash but wants to stay in crypto, buying stablecoin and lending them out might still be the best option. (compared to buying Tether-like stablecoin and not lending them out)

[carter34]

And while we are at it, can anyone explain to me what is driving the people who are borrowing coins this way? I've been trying to come up with a single reason what's in it for the borrowers, and still can't wrap my head around it. If you have to provide 200% of collateral, how does all that make sense?

Seriously, what's the point?

I think loan serve the purpose of help. Someone might not have money to buy such and can go into loan platform to grow the amount given. It is same as loaning cash IMO to repay back with additional interest.