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Comment by v_london | Hacker News Reader

Thanks for the great article! I wished the section on DeFi addressed the biggest elephant in the room, overcollateralization. A DeFi borrower always needs to lock in more assets as collateral than what they are borrowing, thus defeating the whole purpose for taking a loan aside from financial speculation. And there's no real way to solve it: all mechanisms I've heard of either try to replicate some form of background checks on borrowers (not decentralised, and uses the real world), or claim to use real-world assets as NFT collateral (once again, uses the real world). Thus I can't see a way for DeFi loans to ever be used for mortgages and other loans regular people actually need.

Of course DeFi is more than just loans and borrowing, but that's an aspect that's constantly promoted by evangelists so I think it's an important point to mention.

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This is a great point. Some ways I'm seeing this addressed are in the form of,

- Credit ratings from the real world being moved on chain, both by startups and by established companies (see Fitch report from Oct 21, pay-to-access only).

- Credit ratings across and on chains (https://www.credprotocol.com/) to make sure that a defi OG on eth can have access to collateral on other chains.

- Chainlink and others are working on products like CCIP (https://chain.link/cross-chain) to facilitate creating more systems like this through Oracles vs having to be reinvented.

I would imagine this state of affairs gets better over time.

Why would anyone want their credit history on a public blockchain?

Besides, credit histories often have incorrect information that needs to be corrected, and often creditors will cut you a deal or just be nice ("goodwill adjustments"). Blockchain history is immutable, so how do you handle this? Sure, you can write something to the blockchain that amends an existing entry, but the existing entry is still there to see, even if it was erroneous. I would bet that some lenders would use "has more than $SOME_NUMBER amended entries in history" as a negative signal, even though it's not necessarily fair to characterize them that way.

Hell, negative things on credit reports (in the US) disappear after 7 years. Sure, you can tell lenders to disregard negative things older than 7 years, but do you really expect them to do that?

Great point. I think having this data encrypted on a public system for anyone to verify will lead to much more openness in the ratings system. It has the potential to be a far cry than the black hole the US system is today. I don’t pretend to predict the future, but if you look at the past, any time “open standards” have replaced closed black box systems - it has generally benefitted the end consumer.

With zero knowledge proofs you can prove that you have a specific credit rating or above to anyone who needs to know, without having to reveal what your credit rating is.

Bad marks on credit reports fall off after certain amount of time. you can also dispute it in court or settle it for less than owed. None of which translate to a blockchain and which beg the question of privacy when it comes to collections outside of generic consumer transactions.

I think DeFi basically justifies the high market cap of ethereum. You have a decentralized exchange working 24h, with basically no downtime.

Compare it to normal exchanges:

- need to register

- need kyc

- hard to tranfer LARGE sums cheaply

- your bank can block your assets as well as your gouverment

- fees are sometimes very high as well. Example tried to convert one currency to an other 1% fees in europe. I think you would pay less in a DeFi setup.

- Now imagine you could buy stocks and so on on defi. That would be a killer application.

I could go on but the point is. DeFi solves a problem.

I have trouble imagining who might want to do this. It seems like a really small niche? Normal people don't need to trade or move large sums of money 24-7. An ATM and/or credit card is good enough.

I mean 24-7 comes for free. Security comes in some way for free as well. Large amount: its relative, so even for 10k USD you would pay 100 USD as fee. You get similar fees for purchasing stocks and many have more then 100k in equity. So it isn't really a small niche. Rather a huge market that may get more simple and cheap through DeFi.

The major brokerages have let you buy and sell stocks for free for a couple years now. (Not just Robinhood, though they started it.)

Ok maybe in the us. Anyway are you sure it is really free in regards that they don't give you a worse price or won't execute if things move in the wrong direction like Robinhood did...? My point is, its just inconvenient for me to rely on a third party without able to enter the "true" market on myself.

The question is, worse price than what? In the US you’re supposed to get at least the best price quoted at any stock exchange, the “nationally best bid and offer” (NBBO). Surprisingly, you can often do better, but this is still a good price. I don’t think you can easily do that with cryptocurrency where you normally only trade at one exchange?

Maybe relying on a third party is useful if they can get you better prices without needing accounts with all the exchanges? And brokerages normally give you a better price than any exchange. This is called price improvement. [1]

Robinhood got in trouble for falsely claiming that they get better prices than their competitors and not disclosing that they get payment for order flow, but their customers still got the NBBO I think? Although see [2].

People make a big deal about payment for order flow because they don’t like the idea of someone else making money off them, but that doesn’t mean you got a bad price.

[1] https://www.investopedia.com/terms/p/priceimprovement.asp

[2] https://mobile.twitter.com/matt_levine/status/13594921198162...

Actually you can do it for cryptocurrencies as well. There are a lot of aggregators that execute or split your order across different exchanges.

As you said yourself, brokers may offer somehow better prices. My point is just, it is not possible to interact directly with the exchange, even if it maybe for some people more convenient to use a broker. There is no free lunch, more third parties means in my opinion worse price or higher fees.

You'd think that, but apparently retail customers get better prices because market makers are more likely to lose money trading against a professional who knows something is coming, and the smaller spread from lower risk for them is enough to pay for the business model. They still make money on the spread but it's lower.

It's a bit weird that it works that way, but there is a logic to it. Price discrimination can work in your favor.

(And having gotten many literally free lunches from an employer, there is no harm to it if you know why they do it.)

Got it. Sounds interesting. Just one remark about it, europe seems to be banning practices related selling the order flow. As you said it sounds a bit weird. Lets say non transparent. So maybe you don't always get a good deal.

PS: Crypto isn't always better in this regard since, there are some frontrunners and so on. The difference is that it is completely transparent.

GAS fees are nuts.

This is still mostly restricted to those living in the USA. It's also only a fraction of the investment market too, to invest in higher risk things such as startups you need to already have a net worth of $2M or make $250k/year+ which is only the top 1% of people. I'd like to see a lot more democratization of finance than that.

> your bank can block your assets as well as your government

It wasn't until recently that governments (arguably) became good at using technology to physically regulate banking activity, and it's only because the financial system became centralized enough for them to gain visibility into what was going on. Before then, and - to be honest, even now - government regulation was operationalized through the threat of repercussions and consequences for non-compliance.

Aside from reducing visibility into the transactions themselves, I don't understand what, exactly, DeFi or any of the other acronyms for ledger based systems do to stop this. Does DeFi, crypto, or whatever it's being called at the moment make it easier to avoid government oversight? Sure, but if you are doing something illegal in the process and get caught, there will still be legal repercussions.

> hard to transfer LARGE sums cheaply... fees are sometimes very high as well. Example tried to convert one currency to an other 1% fees in europe. I think you would pay less in a DeFi setup.

Is this still true? I'm pretty (very) sure that Interactive Brokers and other platforms allow for extremely cost effective currency transfers.

1% is true, for a lot of banks in my country. IB may be an exception, without going into details I had trouble with their kyc.

DeFi is a buzz word. Lets take Uniswap. You get direct access to an exchange. It works 100% of the time. You pay the same fees as everybody else. Traditional exchanges: try to get the same fees as a HFT shops. Yeah forget it. Even through IB you don't get direct participation on the exchange. So in my perspective the traditional system is kind of rigged in the way how different actors are able to participate. At least at the moment DeFi is fair in this regard. Also you get full access to the assets you are holding without any third party..

Aren’t mortgages actually also examples of over collateralized loans? You borrow 80% of the homes value, and use the entire home as collateral.

A more important limitation for defi loans is that nothing other than blockchain assets can be used as collateral. You can't use the loan to buy anything real without having enough money to buy it already.

A mortgage lets you buy and live in a house even if you don't have enough money to buy the house.

That is a bit too simplified. You can add yield bearing tokens as collateral. That basically means that as long as the yeild is more than the cost of the loan the loan wil pay back it self.

Hmm, that's sort of interesting but it seems like it presumes you own the income stream to begin with, and that it's already been turned into a cryptocurrency token. What are some examples?

You can live in the home while it is collateral. You can’t use your collateralized coins.

Not totally true. You could, for example, use as collateral tokens that represent staked Ethereum (rocket pool ETH for example) so you are effectively using the ETH to generate staking yield, and also using it as collateral simultaneously.

The ability to wrap ownership in a smart contract can extend to pretty much any use case, as long as the lending protocol supports using the wrapped token as collateral.

Liquidation is quite different.

CREAM's Ironbank does undercollateralied/uncollateralized loans. They approve lending to protocols but they can easily decide to take risk on individuals if they want.

Likely there will be competition, and bad actors causing no recourse. But non-performing loans are easy to see so much faster than the traditional system, could easily limit losses with lending caps.

I didnt really understand the part about loans only usuable for financial speculation, you can cash those loan proceeds out for USD to do whatever you want. But even if you couldnt, financial speculation is called “good debt” anyway, compared to consumptive spending, so I dint understand the criticism standard here.

Can you provide an example of someone claiming defi can provide solutions for loans?

The best I can come up with logically is something like cardano's prism that effectively puts a persons encrypted identity on the blockchain which allows that person to reveal things like their grades etc. to future partners as a means of quickly establishing trust. Maybe something like that could enable defi loans? Even that is a stretch.

Searching for "DeFi loan" returns a deluge of results with https://defirate.com/loan/ at the top for me. They seem content claiming that secured loans are useful loans.

They are primarily useful when selling the collateral would involve paying income taxes. Instead you borrow against it.

It works well for coin speculation. You can take a heavily levered position of borrowing USDC, swap and buy X-coin, deposit and repeat.

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