Undercollateralized lending and borrowing in Web3; The next big thing?
The next innovation in the blockchain space!
Undercollateralized lending and borrowing
Crypto winter; The most boring and uninteresting time during the crypto cycles. It feels like nothing is happening, as if the space is stationary. You are not hearing any loud shills, and it seems like the space is dead. However, this couldn't be less true. There are dozens of projects in the blockchain space working hard to work on the next generation of dApps, it just takes a little bit of digging to find these projects!
One of the new blockchain innovations is undercollateralized lending. Most Web3 traders are now used to the typical lending and borrowing platforms like AAVE, where you provide collateral in order to lend part of that collateral in other tokens. These protocols are usually considered safe but very inefficient as you have to put more money into the system than you can get out, thus there will always be some assets sitting unused. Undercollateralized protocols like Deltaprime are here to change this system and unlock the full potential of DeFi lending platforms of up to a 5x loan-to-value (LTV) ratio!
So how does that work?
The fundamentals of undercollateralized lending platforms like Deltaprime haven't changed. You deposit assets as collateral, and you are then able to use that collateral to invest in other tokens or protocols. The difference between the two can be seen when looking at the technical implications of this change; undercollateralized protocols like Deltaprime have created a protected smart contract environment where the traders operate in.
When creating a Deltaprime account you are creating a new smart contract wallet, which safeguards your funds and allows you to have an LTV of up to 500% before eventually getting liquidated. In simple terms; with a deposit of 100$, you are able to borrow 500$ worth of assets! This is enabled by the protected smart contract environment you use to trade and interact with, where liquidation bots keep your LTV in check. Your (borrowed) funds never leave this smart contract, hence you are able to have this massive LTV!
The challenge of timely liquidations
The risk of providing liquidity on lending platforms is that there is a chance that some event occurs that makes the borrower of your funds unable to pay back their loan. With overcollateralized loans, the chances of this happening are very slim, as you usually can't borrow more than 80% of your collateral. With undercollateralized loans, these risks are much more present. Having an insolvent loan is bad for everyone, so how to combat that risk?
Over- and undercollateralized lending platforms use bots to liquidate (part of) accounts that are at risk of becoming insolvent. With Deltaprime this happens around the 470% LTV mark. Whenever an account passes 500+% LTV the loan has become insolvent, and someone is losing money. With Deltaprime multiple bots are checking each account, but when a loan somehow has become insolvent the loss will be paid by the Deltaprime insurance/treasury.
So there is a chance of my loan not being repaid? Yes and no. Yes, there is a chance of your account becoming insolvent, and you have lost part of your funds. No, because the chance of that happening is slim. Based on their calculations the price of a borrowed token has to change ~16% in 30 seconds on an account that's on the verge of becoming insolvent for that to happen, and even when that happens your account is backed by the Deltaprime treasury!
You can even run your own liquidation node! Take a look at https://docs.deltaprime.io/developers/ to see how.
The good and the bad
So why do we need an overcollateralized lending platform? The first one is obvious; As a borrower, you are able to borrow more with less collateral. You expose yourselves to more risk, and you are also able to make more profit! As a lender, you earn more because more liquidity is used, therefore increasing the return you get on your assets! With the typical lending platform, the vast majority of funds are locked as collateral, providing little to no value to the crypto community. Undercollateralised platforms like Deltaprime can unlock billions of dollars! ($$$)
But what are the trade-offs? With this increased utility there are bound to be some disadvantages. The one a regular trader will feel most is the decrease in freedom. You are fenced by the tokens, protocols and options the undercollateralized platform offers, and you are not able to withdraw the borrowed assets. If you just want to use your funds to trade, however, this won't be an issue, and most platforms try to expand on their products anyway!
Lastly, because all of this runs on smart contracts, there is a slight increase in smart contract risk. Check if the platform you are trading on is audited, though, and you’ll be safer. With the higher insolvency risk, it's definitely a risky business to work with an undercollateralized platform, but with audited and well-designed protocols this shouldn't be an issue!
In the end…
Undercollateralized lending platforms like Deltaprime are building the next steps in an ever-improving blockchain ecosystem. I think this could be an interesting investment option, especially for people who want to trade using leveraged positions. Leveraged positions also come with extra risks, so always be careful when investing using borrowed money as you can lose your money (just like with everything in crypto). Always do your own research!
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