Why would someone take out a loan in DeFi? I’ll tell you why
I have been in crypto for a few years now and I get asked a lot, “why would someone take out a loan, when they could just sell their asset?” Here are five reasons why someone would choose to take out a loan with DeFi. This can be done on multiple chains (ETH, Polygon, BSC, SOL, AVAX, etc), though most of the numbers I used are from the Polygon chain, as of 3:46pm on 1/14/22. Notice the key component in #2 and #3 is when you swap:
1.) They need immediate funds
This might be obvious, but with DeFi, you can get quick, easy, and immediate funds if you have an abundance of crypto. Do you have a boatload of BTC or ETH and experience a sudden medical expense? Car got totaled? Rent was raised? Aave, Compound, and Alkemi Network would be happy to provide a crypto-backed loan, without you having to sell your precious crypto.
2.) They believe the price of an asset is going UP
In this scenario, you think the price of Bitcoin is going to go UP. Let’s say you deposit $10,000 into Aave in USDC and you take out a $5000 loan in whichever stablecoin offers the lowest rate (let’s say DAI). By immediately then swapping your DAI for WBTC via a decentralized exchange (aka a DEX), you are locking in your price of Bitcoin at the (hopefully) lower price. When the price of Bitcoin goes up, you can swap your WBTC back to DAI, repay the loan, and keep the difference. You will also get paid interest on your $10k principle deposit during this time.
3.) They believe the price of an asset is going DOWN
In this scenario, you think the price of Bitcoin is going to go DOWN. Let’s say you deposit $10,000 into Aave in USDC and you take out a $5000 loan in WBTC. By swapping your new WBTC for stablecoin (let’s say DAI) via DEX, you are locking in your price of Bitcoin at the (hopefully) higher price. When the price of Bitcoin goes down, you can swap your DAI back to WBTC, repay the loan with less WBTC, and keep the difference. You will also get paid interest on your $10k principle deposit during this time.
4.) Bonus interest/Liquidity mining
If you head over to Aave’s market page for V2, Polygon, or Avalanche, you will notice columns titled Deposit APY, Variable Borrow APY, and Stable Borrow APY.
Under Deposit APY, and Variable Borrow APY, you will see a small box with another x% APR. This is bonus interest you are getting paid to lend and borrow from the protocol. Just so we’re clear, you still get paid the interest on your principle deposit, and you are getting paid this bonus interest to take out the loan. Aave is charging 0.57% APY to take out a loan in WBTC, but it is paying a bonus interest rate of 1.93% APR (paid in WMATIC). That is a profit of 1.36% that you are getting from taking out a loan.
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Alkemi Network is offering similar profitable borrowing opportunities currently on USDC and DAI via the Alkemi Earn protocol.
5.) Yield farming or hypercompounding
In this scenario, you want to maximize the interest you earn. Let’s say you deposit $10,000 into Aave in DAI.
- Off the bat, you start earning 2.92% APY + bonus 1.74% APR for a total of 4.66% on your DAI.
-Now borrow $5000 USDC at 3.88% APY minus bonus 2.20% APR for a total of 1.68%.
-Next, swap your USDC for DAI on a DEX
-Redeposit DAI back into Aave at 4.66%
-Since you just added more collateral, you can borrow again! Borrow another $3k USDC at 1.68%
-This time, swap USDC for USDT
-Redeposit USDT into Aave for 4.01% APY + bonus 4.18% APR for a total of 8.19%
You are now earning interest on $18,000 instead of the $10k you started with. Since the utilization rates for USDC and DAI are 80% and 75%, you can borrow and redeposit multiple times, earning a combined interest rate between 15–20%. Since you are only lending and borrowing stablecoin, your risk of liquidation is low, though keep in mind you cannot use USDT as collateral on Aave.
Or, instead of redepositing your borrowed stablecoin into Aave, you can deposit it somewhere else that might be paying a higher yield, like Alkemi Network.
