Andreas Park PRO
Professor of Finance at UofT
Defi LEnding and Borrowing
Instructors: Andreas Park
Borrowing/Lending & Unit of Account creation
Idea:
- create fiat money on chain with borrowing
- mechanism
- a collateralized loan with ETH in escrow
- DAO-managed monetary policy (=creation or destruction of tokens)
Sidebar: what is a DAO?
- DAO=decentralized autonomous organization
- \(\to\) entity without management
- governance decided by token holders essentially by vote
- We'll devote a class to DAO governance
user perspective
4 ETH
(1 ETH = $375)
(Oct 15, 2020)
\(\approx\) $1,500
\(\vdots\)
1,500 DAI
(1 DAI = $1)
formally: this smart contract is a collateralized debt position (CDP)
user perspective
fractional collateral \(\to\) collateralization factor \(=\) 150%
\begin{array}{rcl}
&&\textsf{maximal amount of DAI in \$}\\\\
&=&\frac{\textsf{\$ equivalent of ETH in escrow}}{\textsf{collateralization factor}}\\\\
&=&\frac{1,500}{150\%}=\$1,000
\end{array}
total collateral = $1,500
maximum loan = $1000
overcollateralization = $500
actual loan (example) = $500
buffer = $500
user perspective: what happens if the price of ETH rises?
ETH \(\nearrow\) $500
value of ETH collateral = $2,000
maximum loan = $2,000/150%=$1,333
total collateral = $2,000
maximum loan = $1,333
overcollateralization = $667
actual loan (example) = $500
buffer = $500
overcollateralization = $667
new loan capacity= $333
user perspective: what happens if the price of ETH falls?
ETH \(\searrow\) $187.5
value of ETH collateral = $750
maximum loan = $750/150%=$500
total collateral = $750
maximum loan = $500
overcollateralization = $250
actual loan (example) = $500
buffer = $0
for reference: former value of collateral
user perspective: what happens if the price falls & max loan is exceeded?
Maker DAO
ETH \(\searrow\) $150
value of ETH collateral = $600
maximum loan = $600/150%=$400
total collateral = $600
maximum loan = $400
required overcollateralization = $200
actual loan (example) = $500
buffer = -$100
for reference: former value of collateral
\(\Rightarrow\) triggering of liquidation auction by "keeper"
sell 3.33 ETH=$500=500 DAI
repay $500=500 DAI loan
retain incentive
return remainding ETH to vault owner
Maintaining the Peg: monetary policy
Maker DAO
- How works:
- 1 USDC=1.01 DAI
- use USDC to mint new DAI
- supply (DAI) \(\nearrow\)
- price (DAI) \(\searrow\)
- use USDC to mint new DAI
- 1 USDC=0.99 DAI
- Swap Dai for USDC (more below)
- demand (DAI) \(\nearrow\)
- price (DAI) \(\nearrow\)
- 1 USDC=1.01 DAI
\(\Rightarrow\) all relies on behavioral assumptions
\(\Rightarrow\) But: there are also real incentives & mechanisms
Maintaining the Peg: monetary policy
Maker DAO
- stability fee
- DAI savings rate (DSR)
- debt ceiling
borrowers of DAI need to pay interest \(\to\) stability fee
- if too much minting (=too much DAI) then
- \(\to\) interest \(\nearrow\) \(\to\) cost of DAI \(\nearrow\)
- \(\to\) minting \(\searrow\) \(\to\) supply DAI \(\searrow\)
DSR paid on "locked" DAI
- DAI deposited to specific contract (demand \(\nearrow\))
- funded by stability fees
- \(\to\) SF>DSR
total amount of debt (or DAI) outstanding is limited
Sidebar: how is this decided?
\(\to\) special "governance" token MKR
Value locked Oct 27, 2021
Maker DAO
Source: daistats.com (Oct 27, 2021)
Source: daistats.com (Oct 26, 2022)
The March 12, 2020 "BlAck Thursday" Drama
Maker DAO
- some crypto prices dropped more than 50%
- cascading liquidations in leveraging platforms
- network congestion: some liquidations done at near-zero prices
- collateral shortfall in DAI
- MakerDAO sold new DAO tokens to collect collateral
- odd: DAI became riskier but high demand for DAI to trigger liquidations!
PEG stability module (PSM)
Maker DAO
The Problem:
- in extreme bull/bear runs, the peg may no longer work
- example: March 2020
- ETH dropped significantly and suddenly
- a rush occurred to (a) get out of ETH into save assets and (b) to collect DAI to get keeper fee
- upward pressure on price of DAI
The Solution:
- Peg stability module
- swap a given collateral type directly for DAI at a fixed rate (no minting/borrowing)
- like regular vault type with a zero stability fee and a liquidation ratio of 100%
- accessed through a user-facing smart contract containing the relevant swap functions (no ownership, just straight swap)
Note: In May 2021, ETH prices dropped again by >30% but no drama in DAI
The frontier: DAI loans for real-world assets
Maker DAO
categories and assessment for defi
Our focus
interoperability
inefficiency
centralized control
limited access
opacity
payments
/lending
- Lightening Network
- xDai
- Makerdao
- Compound
- Aave
How does compound finance work?
Lending
Fundamentally, what does a bank do?
- size intermediation
- term intermediation
- risk intermediation
And how is this done?
- pooling deposits
- issuing loans based on deposits
- loan rates based on collateral or credit rating
on blockchain
- short-term loans
- pseudo-anonymous
collateral
compound Finance
- Collateral ratio \(\in[0,90]\)
- =0 \(\to\) not usable
- =90 \(\to\) stablecoin
- post 100 DAI
- factor 90
- \(\to\) for each $1 borrow, deposit $100/90=$1.11
- can borrow up to $90
- post 1 ETH=$300
- factor 60
- \(\to\) for each $1 borrowed, deposit $100/60=$1.67
- can borrow up to $180
Example 1
Example 2
Example 3
- post 1 ETH=$300 and 100 DAI \(\to\) $400
- factor 60 and 90
- \(\to\) for each $1 borrowed, deposit
$100/(.75\(\cdot\)60+.25\(\cdot\) 90)=$1.48 - can borrow up to $270
borrowing and lending rates compounded per block
compound Finance
- Compound escrows tokens
- must account for % ownership
- \(\to\) tokenized user share
- \(\to\) use the c-token
- cDAI
- cETH
- minted/burned based on funds added/removed from underlying
- seamless movement of these shares (reduced transactions costs!)
- ability to use the ctokens in other protocols
Tracking ownership - How do you reclaim a deposit?
Tracking ownership - Example
compound Finance
In Compound
translated
new deposit
1,000 DAI
100 cDAI
500 DAI
add 50 new cDAI
Tracking ownership - Example
compound Finance
In Compound
translated
new deposit
1,000 DAI
150 cDAI
500 DAI
1 year later: 10% interest on compound
150 DAI
(same cDAI, ownership shares don't change, just each cDAI is worth more)
(accrues per block per deposit)
Differences to Compound
Aave
- Aave is the second-largest lending protocol to date
- has many features that are similar to Compound
- offers more assets
- offers flash loans (rate ~7bs)
Dapp composability & Flash loans
1. flash-borrow DAI
5. repay DAI
3. receive ETH
4. convert ETH to DAI
2. liquidate ETH loan with DAI
Loan liquidation opportunity
Blockchain 2: DeFi Lending
By Andreas Park
Blockchain 2: DeFi Lending
This slide deck provides an overview of DeFi protocols. It draws insights from Harvey, Ramachandran, and Santoro (2020) "DeFi and the Future of Finance"
