DEFI lending platforms like Aave are decentralised finance protocols which enable anyone to either lend their crypto-assets (usually ethereum) for high % interest, or lock up their crypto-assets to borrow a fractional amount (usually up to 75%) of another crypto-asset.

For example, using Aave you could lock up $100 of Ethereum and get a loan of $75 in USDC.

There is an incentive to lend your cryptocurrency on a DEFI platform, because the platforms typically offer higher interest than a bank deposit. As a crypto-asset lender, you can get up to 9% PA on some assets, which is better than any bank deposit.

My Confusion...

However, I don't see why anyone would borrow another crypto-asset using a DEFI website/protocol, because you need to lock up more collateral than the total loan is actually worth.

My Question...

If the person already has enough crypto to trade into the other asset in the first place, then why would they bother borrowing it from a DEFI platform?


You would only do this if you don't mind locking up the collateral. For example, say you have $100 worth of ETH and you plan to hold it long term anyway. Having to lock it up has near zero cost to you.

With the $75 in USDC you borrowed, you could even buy more ETH. So now, you have a leverage long -- you have $175 worth of ETH for only $100 cost of your position. Of course, you lose big if ETH goes down.

Alternatively, you could spend the $75 worth of USDC. This lets you get most of the benefit of spending your ETH while retaining your exposure to any upward movement of ETH's price.

Again, you would only do this is you wanted to have a long position in ETH.

  • So it's purely a "leverage tactic", to put it simply? – Oscar Chambers Aug 28 '20 at 6:40
  • @OscarChambers Assuming you mean leverage in the most general sense. You can use it to get a true leveraged position by using the borrowed money to buy more ETH. But pretty much the only purpose is to borrow against a position you, presumably, intended to keep anyway. – David Schwartz Aug 28 '20 at 8:59
  • Thanks for the explanation, that makes perfect sense – Oscar Chambers Aug 28 '20 at 9:19

Many people who take a loan think they will make money on the loan. For example, if I lock up some Bitcoin and sell the coin I receive in exchange for cash, I can then buy a piece of real estate to rent out. Now the real estate income can pay back the loan and in the end I own the both the real estate and my original Bitcoin. Brilliant.

  • 1
    You wrote that you sell the Bitcoin, but end with still having it. – JTP - Apologise to Monica Feb 22 at 0:37
  • If you buy a House and use it to earn the costs of the house, you also end up with a house + the money that was needed to buy the house. You don't need a loan when you already have the money here. – Tarion yesterday

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