Who is on the other side of the trade?

markjr

Hi folks, checking this out after listening to the Bankless podcast episode.
I've been involved in Bitcoin since 2013 and the ENS project, peripherally since 2017, I'm new to DeFi.

What I can't understand about this program is this:

If I deposit now and get my future yield now (as a borrowing), then somehow for it to make business sense, there has to be somebody on the other side borrowing my collateral at a higher yield than what I'm getting, right?

If we're essentially end-running a bank, the overall dynamic is still the same isn't it? You take in funds and pay interest on them, loan them out at a higher rate of interest, capture the spread - in its purest form, that's what a bank does (setting aside fractional reserve banking, etc).

So if we're cutting the bank out and being our own middle-man, there still needs to be some entity on the other side of this who is paying a higher rate of interest or we're doing something very odd (or circular).

Also, there were numerous references in the podcast to staking stablecoins and deriving base return there, are they saying you get paid in the order of 15% to stake stablecoins? And if so, same question there, who is on the other side of that 15% to make the stablecoin yield viable?

Is there something to all this I'm missing? Because otherwise it seems like somewhere, there's a circular reference, albeit a very convoluted one.

allyourcat

markjr The closest "real world" analogy to this would be what was previously known as "Certificate of Deposit (CD) Loans". In a CD loan, the borrower borrows against the CD at a very low or even zero interest rate, since the CD itself generates a yield that is picked up by the lending bank and makes up for the "discounted" borrowing rate.

Usually this would be the case where the CD is for an asset that is in high demand - one example where this used to happen a lot was in Southeast Asia in the 80s, where business owners who had surplus USD could deposit their USD into local banks for mid teens % sort of yields as USD was in shortage locally. By depositing the CD as collateral, they could borrow against that at close to zero borrowing cost.

In the case of Alchemix, you're taking a DAI (effectively USD) balance and buying a "floating-rate bond" which yields say 12% on Yearn, and locking it up in a smart contract escrow to withdrawing 50% of that face value in alUSD.

What's the point of all of this you may ask? Why not just spend 50% upfront?

Well you could, but once that 50% is spent you're left with 50% in assets. With Alchemix, you get to keep that 100% asset base, spin up a 50% liability against it for 50% cash up front, spend the cash and still have a means of regenerating that 100% again assuming yields hold up. It's about levering up balance sheet size in a controlled manner.

And if all goes wrong and you need to hit the liquidate button to release the remaining 50% of your collateral, you are at worst in the same situation as if you just spent the 50%. More likely than not, you would've made some collateral back from the Yearn deposits.

To put it in a different way, it's like buying a bond and borrowing against it for 50% of face value at the same time. Why would you want to do that? Because you want an income-producing asset (bond) but also would like to access some of that cash upfront. Makes sense with bonds, makes sense with DAI too.

Who's the counterparty for the "bond"? As PhiMarHal points out above, it's everyone that is generating demand for stablecoins, with boosted yields from Yearn coming as a function of its staked position of veCRV and other yield enhancements.

PhiMarHal

Alchemix uses Yearn vaults to farm stablecoins. This is where the ₁₅% is coming from. Now who is on the other end of that trade?

gamblers, traders, who believe they can profit from crypto volatility. In a space where prices can move 30% in a day when a car enthusiast tweets, the ability to borrow even at 25% APR, which comes down to just 0.06% a day, seems like a bargain.
speculators buying up governance tokens. It's common in DeFi to drip governance tokens through farms, much like Alchemix itself does. A protocol like Yearn harvests these governance tokens and sells them, to boost returns further.

lilacs

PhiMarHal I can borrow on dydx for a ₀.5% interest rate. Where is the 25% coming from?

markjr

I appreciate these answers.

So @PhiMarHal 's answer to me suggests that on the other side of Yearn, there is a combination of counterparties willing to borrow at more than 15% (or whatever the current yield is), combined with governance token farming, and, I assume, Yearn takes a small transaction fee? All together come out at a rate higher than the yield they're paying, it would have to, right?

And would it be fair to say that out here in the DeFi world, even over in Bitcoin-land where the miners are lending their BTC at 4% to 6% while depositors are getting even higher (Nexo, e.g) and 200% collaterization on borrows is normal that this more accurately reflects the true market price for money and risk, absent all the interventions we see in the fiat world?

allyourcat

Yep it's worth taking a look at say AAVE, where it's quite clear how you would relate this to a traditional banking model of deposit rate, lending rate, net interest margin (on floating rates) and a higher, but fixed, rate on offer too (like a fixed rate term loan).

Ultimately the rate that we see is market driven, a representation of the opportunity cost of those tokens, which is itself a function of what each token is entitled to, as well as the amount of leverage behind each deposit. On a platform like Alpha, for example, it's (at risk of simplifying too much) like Yearn but with leverage applied to your underlying notional deposit - hence the juiced up yields. Nothing comes for free, as one would expect, but everything ties up nicely numbers wise.

The one thing I'd add on when comparing vs fiat is that there naturally exists a barrier to flows, in that fiat money supply isn't seamlessly connected into the crypto world. There are onramps and offramps but these remain quite expensive, and there's also a divide in opinion: the fiat people don't want to move fiat into crypto because they're skeptical, and the crypto people don't want to move crypto back out and want to build returns within crypto. So there's a natural constraint in new money supply coming in, at the same time utilisation of whatever's already in the system is getting ramped up by new projects that are pushing capital efficiency. That's probably why in aggregate you're seeing double digit USD stablecoin yields inside crypto and DeFi vs close to zero yields in real world fiat.

At least, that's how I look at it. Hope this helps!