It is More Than Just Buy Low & Sell High
Anyone that had done a little bit of trading or is interested with the investment world would have come across this mantra once in their search for that ‘Holy Grail’ investment strategy;
“Buy Low Sell High, Buy High Sell Higher!”
There is absolutely nothing wrong with this statement, but it is easier said than done. There are many factors at play here and with the randomness of human emotions we are just playing a game of Keynesian beauty contest at best (click here to read more about it), or worse; gambling.
The reason I brought this up is because it was naïve of me to think this is the only way to make it in this space. Little did I know this is just the tip of the iceberg.
One of the main premises of Cryptocurrencies and the birth of DeFi, is the removal of the Middle Man in the transaction. Thus, allowing everyone else to obtain a better yield in various exchanges and products that was previously exclusive only to the banks. It is this premise that gives birth to a different type of protocols currently available in this space and allows some people to look beyond the normal strategy when transacting in the Crypto space.
I hope through this series of postings, you will be able to understand the reason behind the commotion in this Crypto/DeFi.
Disclaimer: This is not financial advice and this posting is just to share my findings in the Crypto space. Please exercise proper capital allocation and due diligence before investing since Cryptocurrencies are highly volatile and speculative market.
LENDING & BORROWING IN CRYPTO SPACE
Lending (a.k.a bagi pinjam duit), works similar to the ‘normal’ world when it comes to your hire purchase and mortgage. But in this case, you will have a direct opportunity to play as the bank instead of just a passive depositor. Or a more common term used in this space is Be Your Own Bank (BYOB).
Why you should lend your asset to others?
By lending your assets and being a pool provider for that asset class, you are forging your way in terms of how much of the interest you would be earning by doing so. Similar like banks, different protocols will provide a different interest to the assets that you’re lending to.
Just one big difference with the bank is the APY (Annual Percentage Yield) is higher and also risker. There are quite a number of protocols providing lending & borrowing opportunity among them are Aave (Aave is P2Pool2P protocol), Compound, and Tranquil; and each protocols run on its own native blockchain network.
Do note that each of the protocols will have different rules which you will need to carefully understand by going through their whitepaper before making any lending decision. I will try to go through in detail on each of the protocols once we have covered all the strategies available in the Crypto space, especially in the DeFi land.
Borrowing in Crypto have lots of similarity to borrowing from bank. Meaning due to interest, you will have to pay more than what you borrowed and you still have to pay what you owe (*wink wink).
But, unlike your bank mortgage where you are leveraging your income as part of the KYC, and the house that you are buying is the collateral, borrowing in crypto requires you to be over-collatarized. This is because unlike, a normal bank where KYC is available to check your CCRIS report, the protocol will need extra assurance just in case you are not able to pay back the borrowed amount.
Let’s look at one example, and I’ll be answering the question why would you want to give out more as collateral to borrow less than the money you have?
Example:
Naz just got into an accident and would require RM 1,000 to repair his brand 2008 Proton Waja. And because Naz had stored all his emergency money in Ethereum (ETH) he will need to sell off the ETH in order to get that RM 1,000….which he does not want to do since he believes the asset will grow more in value over time (truth to be told, Naz is pretending that he has a diamond hand while keep on looking for confirmation bias every time the price drops more than 20%)
So what Naz will do now, instead of selling the ETH? He will go into Aave and put ETH as collateral to borrow a stablecoin (DAI, USDT, etc) and cash this out via a centralised exchange while waiting for his monthly salary (please note that there’s also liquidation risk involved)
The Calculation:
Naz need: RM 1,000 = USD 236 / 0.0773585 ETH (refer calculator here)
Since Aave Loan-to-Value (LTV) ratio for eth is 82.5% (refer to LTV document here)
Naz will need to deposit: USDR 286 / 0.0937678 ETH
Do note, that the Naz will also have to monitor the Liquidation Threshold (which is 85% for this case) during this borrowing period. This means that if ETH drops in value by more than 85% compared to the borrowed asset (vice versa), Naz will be liquidated and no longer have access to his ETH.
As long as the repayment + interest is made on time, Naz can always get his ETH back.
With this in mind; borrowing lesser than collateral and liquidation risk, why does this product is still available in the first place? (and perhaps we should be asking the banks as well why the CDO and other products created that led to the 2008 sub-prime mortgage crisis are created too?).
A better question, why would anyone want to borrow RM 80 if they already have RM 100?
I believe there could be more use case for this scenario but there are 3 main reasons that I am aware of, but let’s talk about this in the next posting ya ;)
