Natively Digital Smart Contracts Bank Pays Algorithmic Interest on ETH
A smart contract based natively digital bank has expanded on the idea of DAI to give collaterals an annualized interest rate that is algorithmically determined by the ethereum network.
In a succinct whitepaper they describe how the system is meant to work, with it led by Robert Leshner, who says he is a Chartered Financial Analyst.
The idea is simple. You can lock wrapped eth (WETH), which is basically eth trustlessly tokenized – or for now BAT, ZRX, Augur and soon DAI – in the smart contract, and then you can borrow about 67% of the amount you put in.
The interesting thing here is that this locked eth itself earns interest. That interest comes from the borrower, with a fairly big gap between the two.
Compund borrowing and lending interest rate, November 2018.
Leshner says this gap of circa 6% between borrowing and lending is algorithmically determined to ensure there are sufficient funds to pay the lenders on all of their assets.
Instead of the lender being paid for just the amount borrowed, they are paid for all of the amount they make available for borrowing.
That means the current borrowing rate is somewhat high, nearing 10% for BAT, but it is an annualized rate. Just as it means the lending rate is very low at effectively zero, especially for Augur as of now.
That can change depending on how much people put up to lend and how much they put up to borrow, with it necessarily – due to the 1.5x collateral requirement – swaying towards a far bigger lending supply than borrowing demand.
Compound current stats, November 2018.
The liquidation discount is what you are charged if price moves against you. As a simple example, say you lock 1.5 eth and you borrow 1eth. The price moves against you, lets say by just a penny. You are liquidated.
Is that all gone, or is just a penny worth of eth lost? Leshner says just a penny is lost and you keep all of what youve borrowed. Then on top theres the 5% fee. Its a 5% fee on that penny. So 1.05 pennies, are lost in this scenario according to Leshner.
Meaning this isnt quite a margin call, but more of an algorithmic management of what you own and what you owe to the network.
There have been suggestions that this crypto borrowing method has tax benefits. So as a CFA, we asked Leshner for his views, but he said little more than:
It may, for many users, look exactly like traditional borrowing and lending; a small amount of interest income, and some interest expense.
The collateral here is itself used to lend, which would make one think this is a fractional reserve of sorts, but as the collateral is 150%, its the opposite of fractional reserve, its more than full reserve, says Leshner.
They say you can withdraw at any time from a lending position, so what happens if everyone does so at or near the same time or if eths price drops 50% in minutes.
There are members of the community running nodes that automatically liquidate borrowers below a 1.5x collateral ratio, Leshner says before adding:
If there was a doomsday, 50% decline, instantly, its possible there would be an issue, but the loss is first borne by the protocol, not the users.
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