Maker hit the headlines recently when its native token (MKR) climbed above NEO into 16th place on Coinmarketcap.
This rise is in no small part due to the growing popularity of Maker’s decentralised crypto loan system, which may one day bring about the end of expensive bank loans or even dreaded payday loan companies.
(This article is taken from 21CRYPTOS Magazine – read the full 100 page monthly magazine HERE)
What is a crypto loan?
Broadly speaking, there are two types of cryptocurrency-based loan offerings on the market currently. Companies like BlockFi lend users fiat currencies in return for crypto collateral deposits. Alternatively, crypto-lending companies like Maker and Ethlend allow users to put up their existing crypto as collateral in order to borrow more crypto.
For example, in return for sending Ethereum to Maker’s smart contract as collateral, users receive a loan amount of Maker’s Dai stable coin which is pegged to the value of 1 US Dollar. They can claim their original collateral back at any time by paying back the Dai loan.
Why would I want a crypto loan?
Firstly, loans give crypto holders liquidity on their investment without actually having to sell their crypto.
In the case of Maker, after depositing Ethereum as collateral, a user could take the Dai they were loaned and buy a car or pay for a holiday and still get their crypto back when they paid off the loan.
In the U.S for example, a user could access the liquid value of their Ethereum without having to pay capital gains tax, because the Ethereum hadn’t actually been sold.
Thirdly, the price of obtaining such a loan is substantially less than with banks. Maker, for example, charges a 0.5% stability fee rather than interest. SALT offers rates as low as 5.99% APR. In comparison, credit card interest rates can reach 30% while some payday loan companies charge 1,500% APR.
Because Maker’s loans are decentralised, there are no credit checks, no risk of being turned down and no waiting period – as long as you have the Ethereum to put up as collateral, you can have a Dai loan.
Lastly, loans such as these are sometimes used as leverage positions on a trade. For example, if you thought Ethereum was undervalued at its current price, you could spend your Dai on more Ethereum and then sell it when the price goes up. Once you’ve paid back your original loan amount to the Maker smart contract, the remaining profit would be yours.
How do Maker Collateral Loans work?
A user opens a “collateralized debt position” (CDP), by sending Ethereum to Maker’s smart contract – after which they are allowed to mint an amount of Dai in return.
A user can choose how much Dai to borrow, within a reasonable range, based on the collateral they put down.
The way that Maker regulates the Dai creation and its price is extremely complex – but decentralisation is the key. In basic terms, instead of being backed by physical dollars, Dai is backed by Ethereum. The Ethereum is held in a smart contract on the blockchain so that anyone can check that Dai is backed by an equivalent value, at any time. Dai’s value has been steadily pegged to the U.S.Dollar, remaining in a range of $0.98 and $1.02 for the majority of its existence.
What are the risks?
If the price of ETH drops below a certain level, the “liquidation price,” the user must pay back the Dai owed to the smart contract or add more Ethereum as collateral, otherwise their original collateral in the CDP would be liquidated – much in the same way a bank would repossess a house if a mortgage loan could not be paid back.
The less Dai a user borrows, the lower their liquidation price would be – and so the further the price of Ethereum would need to drop in order for their collateral to be at risk.
If paid back, the Dai is burned by the smart contract so that the supply doesn’t inflate.
There is also always the risk that a bug or an attack on the Maker smart contracts could cause users to lose funds – but this risk can be weighed up against those posed by loans obtained through centralised entities who could collapse or easily steal collateral.
An interesting experiment
One thing is for sure, collateralised cryptocurrency loans are catching on. The Maker smart contracts currently hold over 2 million Ethereum in CDPs with over $80million in Dai loans still outstanding. If the experiment continues to see such positive results, loans like those offered by Maker may be the first real use case for cryptocurrency that captures the imagination of the mainstream.
This article is taken from 21CRYPTOS Magazine – read the full 100 page monthly magazine HERE.