Thank you for writing this. I have around 6 figures of student loan debt and every time I read your blog and get more of your insights, I feel a bit better about myself and smarter each time
TY for this. Putting my $90k piece of paper to use:
Start with the assumption that markets are somewhat efficient at pricing perceived risk. Most of the world is still at Paul Krugman levels of NGMI perception - "*All* crypto is a scam".
The Bowtied thesis is that *some* crypto is not a scam. There should be Alpha in this area as long as public perception doesn't match market reality.
I'm trying to better understand the dislocations, especially after the posts by BtB recently. I'm late to the game I think, but also not really understanding how this works and how to seek and find these dislocations that can be capitalized on. Hoping to get any pointers.. thank you
Don't the banks lever up 10x on the money they take from customers? So that $1000 deposit is lent out 10 times over at 4%? Isn't that why bank runs cause massive problems?
In contrast, DeFi is overcollateralized (except flash loans). Doesn't that tip the balance more towards TradFi?
If it's lent out 10x at 4%, they should be making 40% on the loan interest, not 4%. Also, they get 9x the principal as profit, assuming no defaults. If these are 30 year loans, they get an extra (1000 x 10 - 1000)/30 = 300/year, which is another 30%. That's $700 return per year on $1000, or 70%. Based on the 25% math from the statement sheet (which takes defaults into account as part of operating expenses), they're earning 17.5%, not 1%, profit from their loan.
With DeFi, loans are all overcollateralized, so you can only lend a fraction (call it 70% if you're a degen) of your BTC or DAI, instead of 10x. So lending platforms are only earning 0.07x what central banks make on the same principal. This gets offset some by the ability to invest the principal.
This will likely change once credit scores are figured out for crypto (presumably using something like Chainalysis).
Yep have seen that will eventually come to defi. Haven't heard about chainalysis but chainlink could do zero knowledge proof to check your credit score and give data to aave for example to make the loan.
Think there a few protocols working on this but cant remember names off top of my head.
How does DeFi make the jump into standard retail loans? Much of the banking revenue comes from mortgages, car loans, lines of credit, personal loans, etc. Many of these are uncollateralized or collateralized with objects in the physical world.
It seems that on the retail side, this is where DeFi will eventually need to compete with banks the most as it's a large portion of banking revenue.
If you have $40,000 in ETH and want to stake it great, but what about the guy who just wants to (stupidly) take out a $40K loan to buy {insert consumer product}. Will DeFi touch that?
- title search/insurance vs cryptographically secure ledger
- show statement asset/income and coordinate mortgage/sale = reams of paperwork and 5 people on email threads. vs ZK-proof revenue stream > X, unencumbered assets > Y
there's mundane approaches like credit score oracles
what if anons are securitized? e.g. ​lambda school ISA taking slice of future income. but rules (anon's performance -> payouts) enforced on-chain with ZK-proofs
DeFi offers a higher yield, as it is riskier & is trying to win customers. But can it loan out at a higher percentage than 4%? If not, then the higher yield paid to customers will cut it's margin.
e.g. DeFi gives 3% interest and earns 4% on loans. Now it is in a similar position to TradFi
The other question is whether DeFi can make as much on loans as TradFi, as a new offering. Does it loan out at 4% or at 3.5% in order to be more competitive.
It seems the sweet spot for DeFi is to give marginally better rates than TradFi competitors without cutting too much into their own margin. Then the question is whether it can find a large enough body of customers using this approach
No it means that is the inefficiency. As long as TradFi is around it means that market value shifts to DeFi over time. Tough to guess what rates will be 10 years from now but it doesn't matter what the percentage is
if so, collateralized defi loans would be a bit over 1.5% ish?
it is hard to say. crypto poised to be excellent collateral so could see low loan rate. however, crypto has utility and velocity that is hard to wrap head around, e.g. paying 200% APY flash loan
The structural inefficiency is something Anchor Protocol (on the Terra blockchain) is already exploiting to provide 18-20% APY. They take in Luna/Eth as collateral for loans, and allow anyone to deposit UST into their Earn. It's brilliant. Exactly as you mentioned, they keep the APY high by cutting out the middleman costs.
And the 31x is net income vs market cap! We are early
Thank you for writing this. I have around 6 figures of student loan debt and every time I read your blog and get more of your insights, I feel a bit better about myself and smarter each time
TY for this. Putting my $90k piece of paper to use:
Start with the assumption that markets are somewhat efficient at pricing perceived risk. Most of the world is still at Paul Krugman levels of NGMI perception - "*All* crypto is a scam".
The Bowtied thesis is that *some* crypto is not a scam. There should be Alpha in this area as long as public perception doesn't match market reality.
Excellent content as always!
I'm trying to better understand the dislocations, especially after the posts by BtB recently. I'm late to the game I think, but also not really understanding how this works and how to seek and find these dislocations that can be capitalized on. Hoping to get any pointers.. thank you
Can you address this Hex scam, more and more friends are falling for it hard. Hate to see it but their gains are massive right now
Don't the banks lever up 10x on the money they take from customers? So that $1000 deposit is lent out 10 times over at 4%? Isn't that why bank runs cause massive problems?
In contrast, DeFi is overcollateralized (except flash loans). Doesn't that tip the balance more towards TradFi?
Was hoping someone in the comments would have spotted otherwise wngmi
Can confirm this is correct
(Generally) central banks plug the leverage gap
Solid article with an important key message but huge slip on the fundamentals
Hmm so how should #'s be different in your opinion? on net income for example
If it's lent out 10x at 4%, they should be making 40% on the loan interest, not 4%. Also, they get 9x the principal as profit, assuming no defaults. If these are 30 year loans, they get an extra (1000 x 10 - 1000)/30 = 300/year, which is another 30%. That's $700 return per year on $1000, or 70%. Based on the 25% math from the statement sheet (which takes defaults into account as part of operating expenses), they're earning 17.5%, not 1%, profit from their loan.
With DeFi, loans are all overcollateralized, so you can only lend a fraction (call it 70% if you're a degen) of your BTC or DAI, instead of 10x. So lending platforms are only earning 0.07x what central banks make on the same principal. This gets offset some by the ability to invest the principal.
This will likely change once credit scores are figured out for crypto (presumably using something like Chainalysis).
Thanks for clarifying!
Yep have seen that will eventually come to defi. Haven't heard about chainalysis but chainlink could do zero knowledge proof to check your credit score and give data to aave for example to make the loan.
Think there a few protocols working on this but cant remember names off top of my head.
Great content as usual.
How does DeFi make the jump into standard retail loans? Much of the banking revenue comes from mortgages, car loans, lines of credit, personal loans, etc. Many of these are uncollateralized or collateralized with objects in the physical world.
It seems that on the retail side, this is where DeFi will eventually need to compete with banks the most as it's a large portion of banking revenue.
If you have $40,000 in ETH and want to stake it great, but what about the guy who just wants to (stupidly) take out a $40K loan to buy {insert consumer product}. Will DeFi touch that?
Yes eventually DeFi will use homes etc. This was covered in other posts
Mortagage = just a contract. Therefore it can be a smart contract
real estate market is ridiculous. can't wait
- agent fees, why?
- title search/insurance vs cryptographically secure ledger
- show statement asset/income and coordinate mortgage/sale = reams of paperwork and 5 people on email threads. vs ZK-proof revenue stream > X, unencumbered assets > Y
there's mundane approaches like credit score oracles
what if anons are securitized? e.g. ​lambda school ISA taking slice of future income. but rules (anon's performance -> payouts) enforced on-chain with ZK-proofs
How did you come up with the 3x more efficient? 1.25Tx3
TradFi gives 0.5% & loans 4%
DeFi offers a higher yield, as it is riskier & is trying to win customers. But can it loan out at a higher percentage than 4%? If not, then the higher yield paid to customers will cut it's margin.
e.g. DeFi gives 3% interest and earns 4% on loans. Now it is in a similar position to TradFi
The other question is whether DeFi can make as much on loans as TradFi, as a new offering. Does it loan out at 4% or at 3.5% in order to be more competitive.
It seems the sweet spot for DeFi is to give marginally better rates than TradFi competitors without cutting too much into their own margin. Then the question is whether it can find a large enough body of customers using this approach
so 3x tradfi yield means a stabilized 1.5% ish yield in defi over time?
No it means that is the inefficiency. As long as TradFi is around it means that market value shifts to DeFi over time. Tough to guess what rates will be 10 years from now but it doesn't matter what the percentage is
if so, collateralized defi loans would be a bit over 1.5% ish?
it is hard to say. crypto poised to be excellent collateral so could see low loan rate. however, crypto has utility and velocity that is hard to wrap head around, e.g. paying 200% APY flash loan
The structural inefficiency is something Anchor Protocol (on the Terra blockchain) is already exploiting to provide 18-20% APY. They take in Luna/Eth as collateral for loans, and allow anyone to deposit UST into their Earn. It's brilliant. Exactly as you mentioned, they keep the APY high by cutting out the middleman costs.
Highly recommend looking into it.