What really matters for the borrower? Answer – Capability to borrow.

There are the custodian and non-custodian crypto lending platforms. The key difference between them is who controls the assets – the first ones control your crypto assets, by the second ones it’s you who is controlling your assets.

Both of them propagate the interest rates on their platform, as the key benefit for the borrowers and lenders on their platforms. But is the interest rate really all and everything, what should be followed?

Our answer is – actually not. While interest rates and risk management are the key drivers for the lenders, there is one more parameter to be followed – the capability to borrow for the borrowers.

Crypto interest rates

Here are current interest rates for DAI (they are pretty similar to the USDC)

Borrowing rates DeFi DAI
Borrowing rates DeFi DAI

Source: https://loanscan.io/borrow/historical?interval=3m

The interest rates between custodial and non-custodial platforms are more or less the same. Non-custodial platforms are saying that custodial interest rates should be higher because of more risks (hacks, loss of assets, etc). Custodial platforms are saying the non-custodial interest rate should be higher because of potential mistakes in smart contracts.

Therefore, let’s use the https://loanscan.io data as a basis.

Crypto collateral rates

Here are for example current DeFi (Decentral Finance) collateral rates:

Collateral ratios
Collateral ratios

https://loanscan.io/supplied-liquidity#collateral-ratio

These collateral ratios are more or less the same on the custodian and non-custodian platforms.

What is the capability to borrow?

Let’s imagine two scenarios for the borrower:

Scenario A

  • Loan amount: 100 units
  • Collateral: 300 units
  • Interest: 10%

Scenario B

  • Loan amount: 100 units
  • Collateral: 150 units
  • Interest: 10%

The interest rates in both scenarios are the same, but the Loan To Value (LTV) is different:

  • In Scenario A: 100 / 300 = 33%.
  • In Scenario B: 100 / 150 = 66%, which is twice as much as in Scenario A.

Capability to borrow shows, how much can borrower borrow on his given asset basis. If the borrower would have two similar offers with different LTV’s, then the borrower should choose the one with higher LTV.

What does it mean?

The capability to borrow does not matter to the lenders. Lenders are interested in:

  • Risk management (which is done fully with the collateral)
  • Liquidity after lending out their funds (capability to call in the loans or tokenize the loans)

But the capability to borrow matter’s very much to the borrowers:

  • It’s not only the interest payable, which is relevant
  • It’s relevant, how much can the borrower borrow on given asset basis

Capability to borrow with different interest rates

Let’s imagine further two scenarios for the borrower:

Scenario C (the same as Scenario A)

  • Loan amount: 100 units
  • Collateral: 300 units
  • Interest: 10%

Scenario D

  • Loan amount: 100 units
  • Collateral: 150 units
  • Interest: 15%

The Loan to Collateral Value’s (LTV’s) are different. The interest rates are different too. The loan amounts are the same. But which option is better for the borrower?

Scenario C: LTV: 33%; Interest 10%

Scenario D: LTV: 66%; Interest 15%

The borrower will pay in Scenario C for this 50% more interest for 100% higher LTV – the borrower will have higher leverage on his assets. If the borrower needs leverage, then Scenario D is preferable for the borrower – he would pay a little bit more interest for a much bigger loan

Reflection

Current DeFi and custodial platforms are using very high collateralization ratios. This is protecting the lenders.

However, the borrowers would be interested not only about the interest payable but about lower collateralization ratios, which would lead to the higher capability to borrow.

We analyzed the reasons for high collateralization ratio’s in another blog article. Here is the summary.

  • The risk management methods are rather one-dimensional, which translates into high collateralization ratios
  • The other risk management methods like credit-risk ratings or loss provisions funds or fixed-term loans are rather seldom used

SmartCredit.io approach

SmartCredit.io is funded from 2 CFA’s and ex-Bankers. The risk management is never a one-dimensional approach of over collateralizing the loans, but it’s a network of different measures, which on the end translates into usability:

  • The collateralization ratios are driven by the market dynamic (they are not something hardcoded in the smart contracts)
  • Fixed-term loans (not unlimited loan maturities) allow calculating better collateral requirements
  • Credit risk ratings for the borrowers are used and allow to separate good risks from less good risks
  • Loss provision fund is there for the eventualities when the markets are moving too fast
  • Enforceable legal contracts are created in the background – a defaulted loan will stay a defaulted loan, till all the obligations are fulfilled

This results in the least factor 2 – 2.5 smaller collateral requirements as the current standard in the industry. Which results in a higher capability to borrow.

Capability to Borrow
Capability to Borrow

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