I’ve been in the need to purchase a car lately and for many people, this decision requires taking out a loan. Traditionally, this has meant approaching a financial institution or bank to apply for a loan. However, with the advent of decentralized finance (DeFi), there is now an alternative way to get a loan for purchasing a car. I’ve put together a short vlog and walkthrough with regards to how I went about the process and written up a piece explaining why and how I did this.
It all started with a tweet (as many revolutions do):
As you probably know by now, I’m a big fan of DeFi, primarily because it allows us to transact value without unnecessary rent-seeking intermediaries. I see DeFi as an opportunity to leap-frog archaic traditional financial institutions and offer people the opportunity to leverage cutting-edge cryptographic technology to access more financial freedom.
It is this same conviction that led me towards conducting a Fellowship at the Ethereum Foundation where I conducted a comprehensive research project to explore the opportunities for DeFi in Latin America. The outcome was a 50-page report that outlined the challenges and opportunities for DeFi in the region:
I also accompanied the report with a podcast series by the same title of Last Mile DeFi where I spoke with thought-leaders and builders across the Latin American ecosystem exploring the opportunity for crypto in the region:
With all of that in mind, I wanted to really put this to the test and therefore explore and share how DeFi could provide us with the opportunity for an updated financial system here in Latin America. As such, I decided to conduct a little experiment whereby I would compare the process of acquiring a car with a loan from a traditional financial institution versus the process of going through DeFi. After about a couple of week of speaking with a number of banks and consulting the process, I managed to get my car!
My intention with this blog and accompanying video is to do a step-by-step walkthrough for purchasing a real world asset with DeFI, share where and how DeFi is preferable to traditional finance here in Guatemala and also share some insights with regards to other avenues that I believe we can continue to improve to continue to make DeFi an even more optimal solution for people around the world. So, dear reader, let’s dive straight into this!
TradFi Loan
In order to compare fairly, I went to my local bank, where I have most of my fiat stored, to inquire about getting a loan through them to buy a car. I was patted down as I walked in and waited for twenty minutes until one of the clerks could speak with me. I then asked the clerk about the possibility of getting a loan through them.
The clerk then proceeded to spend another fifteen minutes tapping away on his computer and “hum”-ing and “ah”-ing while I had to diligently sit and wait for him to give me an answer. Finally, he proudly said they would be able to issue me a loan within a matter of three days and it would be deposited directly to the account that I had with them.
He obviously was happy to share the news with me, but happened to omit a really important factor in the equation which was the interest rate they would charge me with the loan. Upon asking him the question, he seemed somewhat surprised that I would bring that up and didn’t quite have a clear answer for me so he then proceeded to spend another ten minutes looking at numbers on a spreadsheet and informed that the best rate they could offer me was 24% APR!
For many in the north, 24% may seem like an usurious rate, but anywhere between 20-30% in Guatemala is relatively standard rate. Many people down here use financing to purchase vehicles, homes, cellphones, pay medical bills, and more - without fully understanding the long-term obligations implicit with credit.
Regarding the collateral for the loan, the banker informed me that my balance in the bank would functionally serve as the collateral for the loan. Comparing the deposits I had in the bank with the amount of funds the bank could give me, I was offered a collateral ratio of ~130%. I didn’t necessarily have to lock up the capital, but I did have to maintain an approximate balance in my bank account.
With that information, I had all I needed to explore what DeFi could offer me…
DeFi Loan
Since the early days of DeFi lending, people have been leveraging decentralized financial infrastructure to put their assets to work. At its peak, DeFi had ~$175B in total value locked, which allowed people around the world to earn yield, take out loans, and swap assets seamlessly. Despite that, many critique DeFi (and much of the wider crypto space) as not having any value outside of the so-called “bubble” we’ve created.
Given the absolute debauchery that has transpired over the course of the last couple of years, I often times find it hard to entirely disagree with some of crypto’s most poignant critics. Despite that, however, I am also a staunch believer that we have in our hands an incredible opportunity to entirely re-define the way financial markets work around the world with DeFi and therefore spend my time researching and educating folks with regards to DeFi’s potential in the real world.
With that in mind, it was obvious that what I wanted to do in this instance was to buy a vehicle utilizing a DeFi loan to access the capital to make the payment. The following section breaks down the step-by-step process to access the loan.
First, I had to choose how and where I would take out a loan. At the time of writing, I hold both stablecoins, and a number of other tokens, including Ether. It was evident therefore that I would seek to use these assets as the collateral against which I would take out the loan.
There are a number of lending protocols available to take out these loans, including MakerDAO, Aave, Compound, Liquity, Alchemix, among others. As I was parsing through the options available, I wanted to ensure that I was optimizing for a few different features with the protocol that I ultimately used: battle-tested and reliable, sufficiently decentralized, lowest possible interest rate, and easy to use.
With all of these parameters in mind, I ultimately decided to use Liquity as the protocol that I would use to take out the loan to purchase the vehicle. If you aren’t already aware of Liquity, it is a protocol that is entirely governance-free and only accepts ETH as collateral, for which it issues its native stablecoin LUSD. Thanks to the power of smart contracts, LUSD is always redeemable for its equivalent value in Ether, making it a trustless USD-pegged asset.
And guess what the interest rate on Liquity is? 0%. That’s right, Liquity does not charge an interest rate for borrowing against your ETH, but rather has a base rate fee that is automatically set by the protocol, which varies from 0.5%-5% (but never above). Further, it has a refundable liquidation reserve of 200 LUSD and requires a minimum collateral ratio of 110%.
Liquity doesn’t have its own front-ends, but there are a myriad of options available for you to use. I chose DeFi Saver, as it has been a DeFi aggregator I’ve used in the past and I like the fact that it has a host of embedded features that make the platform easy to use. You can also integrate automation into your strategy on DeFi Saver with stop losses, profit taking, among a number of other approaches.
By all of that said, Liquity met all of the above requirements:
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Battle-tested: they’ve been around for a couple of years and they currently have $750m in TVL on their protocol.
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Decentralized: can’t get more decentralized than immutable and non-upgradeable smart contracts only accepts ETH as collateral.
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Interest rate: A 0% interest rate (plus the 0.5% base rate) is significantly lower than the 24% rate quoted to me by the banks.
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Ease of use: DeFi Saver, a Liquity front-end makes taking out a loan an absolute breeze.
Having made my choice, I then proceeded to head to DeFi Saver and take out the loan. Here’s the process of how I went about the process of acquiring the car with the loan:
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Opened up a Trove where I deposited ETH and borrowed LUSD with a collateral ratio of 250% | 0.5% base fee
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Swapped the LUSD for USDC on Uniswap to off-ramp | 0.3% swapping fee
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Off-ramped the USDC for dollars | 2% off-ramp fee
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Paid the owner of the car in dollars and voilá!
From the moment I had the ETH to the moment I had the processed the off-ramp, the process took me the same amount of time that it did walking from the entrance of the bank all the way to the clerk’s desk. As far as the net interest rate goes, including the base rate, the swapping fee, and the off-ramp fee it comes out to 2.8%!
That is nearly an order of magnitude cheaper than what the bank was offering me as far as interest rates go, and all of this done through permisionless peer-to-peer financing networks. Given the intention of this experiment was to showcase where DeFi could provide an alternative to TradFi in Latin America, I also wanted to speak to some of the challenges with regards to this process.
The Other Side
Let’s start with the obvious fact that in order to take out the loan, the loan itself has to be overcollateralized by at least 110%. While many are exploring the ways in which we can bring this collateral ratio down, this is a relatively nascent ecosystem in DeFi as far as retail is involved. Therefore, this strategy is particularly valuable if you’re long Ether and instead of selling the ETH, you’d rather take out a loan against its value.
Depending on the size of your loan, gas fees may also be an impediment with regards to the extent to which you can access the protocol (thanks, memecoins). At the time of writing, Liquity is not currently available on any other network aside from Ethereum mainnet and therefore this could be a barrier with regards to anyone accessing the protocol.
In my case, I am going to be receiving future cash flows in crypto, so the on-ramp piece wouldn’t necessarily be a concern. However, if you intend on taking fiat money and repaying the loan back into DeFi then you’d have to tack on an additional 2-4% for the on-ramp and swaps.
When I initially posted my tweet asking folks for recommendations upon which approach I should use, many suggested using some form of a Liquid Staking Token (LST) as collateral which would functionally create a self-repaying loan, with regards to the interest rate on other lending protocols. The issue here is that you begin layering on multiple levels of centralization, and therefore I felt that for this initial experiment, I wanted to focus on going with as fully as possible trustless mechanism to take out the loan.
I chose Liquity as I already had year’s worth of exposure to a number of DeFi protocols out there and could rapidly compare and contrast each of the different options available across lending protocols. For your average person, this wouldn’t be feasible, so we’ve got to offer easy to understand, reliable information and education that allows people to make the best possible decision with regards to which protocol to use.
Side by Side Comparison
With all of that said, I would like to provide you with a comparison on an example with specific numbers and analysis with regards to where I believe DeFi is fundamentally a better offering than TradFi by comparing the following factors: time, collateral ratio, ease of access, fees, interest rate, and sovereignty. The comparison assumes the car costs $20,000 and a loan that will be repaid over the course of four years with monthly payments (48 total). The DeFi section assumes the loan is repaid with fiat back onchain.
TradFi
Time to issue: Three days
Collateral ratio: 130% (somewhat flexible)
Ease of access: Deposited directly to my bank account
Interest rate: 24%
Sovereignty: High trust in the banks not rugging me or inflating away our local currency (as has been the case elsewhere in LatAm)
Additional fees: None
Total $ of 48 payments: $31,297.76
DeFi
Time to issue: Two minutes + one day to off-ramp
Collateral ratio: 110%-250%
Ease of access: Multiple steps that require somewhat complex DeFi knowledge
Interest rate: 0% + 0.5% base rate
Sovereignty: Fully trustless, private key risk**
Additional fees: 2*(Swap fee = 0.3% + on/offramp = 2% + gas fees = ~.5%)
Total $ after 4 years: $21,220
There are certainly areas of improvements that would drive the cost of the loan even further down: if you were to do a peer-to-peer on/off-ramp you could reduce that cost drastically as well as reduce the time of transaction and if the protocol were deployed on a Layer 2, your gas fees would be negligible. This model doesn’t take into account the appreciation of Ether which could take place over the course of the for year period either, which coupled with DeFi Saver’s automations, could even amount to an even cheaper option for folks. Obviously, overcoming the barrier of overcollateralized lending is another area of exploration, but not one I will dive into in this specific post.
Conclusion
As you can see from the above comparison, purely from a financial perspective, the DeFi loan is a substantially preferable option with regards to taking out the loan. As of now, DeFi and much of crypto is under a wave of critiques from those who do not fully understand the system. Many critics point to the lack of utility for crypto, which as this exercise proves is simply not the case.
Crypto has the power to massively disrupt financial systems in emerging economies where our financial systems are lagging behind big time. DeFi is already having a massive impact on the global financial markets, and I look forward to seeing where we can continue to develop this technology to create better rails for people to access more economic freedom.
If you’re interested in learning more about how you can use Liquity, you can connect with them on their: website, blog, Twitter, and Discord. If you have any questions or comments about the process with regards to other strategies/protocols to use to bring more utility to DeFi in the real world, do feel free to reach out on Twitter or join our Telegram community and let’s talk there. Cheers!
Disclaimer: Please note that the information provided here is for educational and informational purposes only and should not be considered financial advice.