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Comment by chucksmash | Hacker News Reader

This isn't how lending in the cryptocurrency world works.

Lending protocols rely on overcollateralization of loans instead of contract law. If you want to borrow $100k, you would give over (say) $200k worth of some token that you didn't want to sell. In that example, if the value of that token dropped by 50%, the lender would sell all of your collateral to recoup their $100k, not take you to court or send you to a collection agency.

If on the other hand you eventually return the $100k, you would get your collateral back.

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> In that example, if the value of that token dropped by 50%, the lender would sell all of your collateral to recoup their $100k, not take you to court or send you to a collection agency.

What do they do if it drops by 90%? You'd still be holding their $100k, on only $20k of collateral.

I don't see how this avoids contract law; overcollateralization has never done so in any economic system in the past, and has historically been a ripe domain for financial fraud (since the incentive is to over-value the collateral).

> What do they do if it drops by 90%? You'd still be holding their $100k, on only $20k of collateral.

I'm not super knowledgeable here, but I expect such protocols would tend to only take the top few most liquid tokens like Bitcoin or Ethereum as collateral to somewhat mitigate this issue. Very low liquidity tokens held as collateral could be subject to manipulation to trigger loan liquidations as well.

This doesn’t meaningfully eliminate the problem; it only moves the risk proportions around. Someone is still losing incredible amounts of money in the form of worthless debt should a crash happen here, and it’s not clear what their recourses are.

Ah, I think I see what you mean now.

The ability to liquidate collateral is the the stand-in for both creditworthiness and the mechanism for recouping their principal. They would have no recourse to recover their funds if a crash were so drastic that they could not meaningfully liquidate collateral.

What you are describing seems more akin to option trading in tradfi than loans. The only reason someone would be willing to give 200k worth of collateral for a 100k loan is because they are betting that the 200k worth of crypto will increase in value more than the interest on the dollars they are borrowing.

The use case for almost all individual loans in tradfi is getting a loan for more than you have in collateral.

> The only reason someone would be willing to give 200k worth of collateral for a 100k loan is because they are betting that the 200k worth of crypto will increase in value more than the interest on the dollars they are borrowing.

Well, most of the people who have crypto to borrow against would fit the description of "betting crypto will go up."

Tax implications might also play into the consideration of selling vs taking an overcollateralized loan as well.

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