If you want to go a little further and understand the dimension of the DEFI sector, this article is for you. We will do a small and basic exercise together that will allow us to create our first financial product. But this time without permits, without censorship or documentation, only with a wallet, an asset (token) and a platform (protocol) we go with algorithms, mathematics and a Smartphone.
The first thing is always simple, I need a savings bank account that offers me an easy, risk-free, profitable product, by chance or not, I just described an @anchor_protocol, our trusted financial institution in the DEFI sector, something basic but incredibly functional. In Anchor I will deposit some small savings as I have been doing all my life, but this time in the form of stable currency, something that does not suffer volatility and does not create anxiety. Since I am in the Terra ecosystem we will have to use its stablecoin, in this case the UST (a crypto dollar as 1 UST = 1 USD). What Anchor offers me in return and without paperwork is an interest rate of 19% per year, not bad at all.
In the second part of our exercise I will make it little more complicated, but returns will be bigger and much more competitive since we are going to use the same equation thanks to Terra’s annual interest rate between 100 and 120%. Simple explanation (that’s what educational programs are for https://bitbcn.org/cursos/postgrado-en-decentralized-finance-pro/ ), when you deposit UST in Anchor Protocol, you get in exchange aUST directly in your wallet.
By statistics, when average person decides to invest either in the stock market or products provided by bank, you usually do it with a capital of approx. $ 10,000. Now having the number and by allocating a little time we are just few clicks away from things to happen.
Let’s imagine that this person is me, so instead of talking to financial adviser or bank, I open my pc and in just 4 steps, I apply for my first decentralized financial product;
Step 1) I deposit my $10,000 in an exchange, the one that let me exchange my dollars (euros, pounds, etc.) for the stablecoin UST.
Step 2) I exchange my $10,000 for 10,000 UST
Step 3) Once I have the UST I send them to my wallet, in this case to the wallet of the Terra network, the Terra Station.
“IMPORTANT: I want to make it clear that this detail is extremely important, as in this wallet everything will be under my custody. As it’s the master key that connects my money with the DEFI universe in each and every one of its versions”
Step 4) I deposit my 10,000 UST from my wallet in @anchor_protocol and with this simple deposit I am automatically putting my $10,000 to work with an annual profitability of 19%, but that’s not all (and this is where the magic of code and cryptography happens), as I explained before now I also have 8,928 aUST back in my wallet for me to use.
We continue to benefit and there is little more left to do, go to https://abracadabra.money/ or so called Magic Internet Money with its MIM currency, another stable currency (1 MIM = 1 USD).
The good thing about MIM is that you can borrow it or mint it with aUST, and what a coincidence I have 8,928 aUST right now that I don’t know what to do with, therefore applying basic math if I have 8,928 aUST and I want to borrow MIM using an LTV (Loan to Value) of 80%, they will give me 7,142 MIN. Simple calculation (8,928 aUST x 0.80) = 7,142 MIM.
“IMPORTANT: MIM is issued because it is a currency backed by a guaranteed debt (CDP) and not by a supposedly guaranteed debt. In order to create and issue MIM (same as a central bank does, we are manufacturing money) it is necessary to deposit a guarantee as collateral, but with the particularity that this guarantee to the protocol that issues the money, generates performance.”
Now my 7,142 MIM can be converted in 7,142 UST thanks to a simple swap (exchange) of MIM for UST, and if I go back to the beginning of this article to part one, I will take these 7,142 UST and deposit again in Anchor, so now I will have my 10K as original amount plus 7.1K, that is total of $17,142 working for me, increasing my APY from 19.5% to 33.4%.
And if we are clever we can do the same thing again by adding 7.142 UST in Anchor, this sends me back to my wallet without claiming aUST, in this case 6.375 aUST and with them I can borrow MIM at 80% again and these MIM swap for UST and return back into Anchor, and so on an on until I bring my initial APY from 19% to 120% (it can be approx. 10 operations)
It seems that now I can catch a plane and go on vacation while my savings generate interest rates much higher than those of any banking product or services traditional and the treasury bonds of 4 countries together. But need to be aware that nothing is without a risk, so let’s be honest and also talk about the risks involved. Mainly there are 2:
1. Smart contract, as long as we use our wallet and a DEFI protocol to make a deposit, request a loan or make a swap, we put our money in a SC and this is quite vulnerable to cyberattacks, computer failures. But in order to be in this new financial architecture with such high returns, you must accept the rules of the game, otherwise you will just get a 3% annual APR, sorry.
2. Linking and Leverage, earlier I mentioned that both 1 UST and 1 MIM represent fiat since they have 1: 1 parity with the dollar even though they are not directly backed by it. It may well be the case (and it happens very frequently, do not doubt it) that this link is momentarily lost when we enter bullish or bearish markets where stablecoins also suffer (less but suffer), appearing at this point in time a loss with parity If we focus for the example in a bear market (which is the worst scenario that can happen to us when we are so exposed), the stablecoin can go below the dollar ($ 0.95 – $ 0.87). At that moment is when everything we have built can easily fall, since both Terra and Magic Internet Money will put their algorithms (liquidators) to work to avoid these temporary value losses, and can be liquidated because it is leveraged between UST and MIM.
Yes, it is true that thanks to @NexusProtocolo, a protocol built on the Terra blockchain with a special function and characteristic, now users are more protected against liquidations.
It does this by using a price feed that you can run to the liquidators thanks to an oracle. By having an initial run price feed @NexusProtocol can keep the user’s LTV ratio close to its upper limit while virtually eliminating any liquidation risk. Even so, be careful to still let technology take care of your money, do it always and above all, do it because you accept and understand the rules of the game.
https://www.loop.markets/nexus-protocol-building-the-connections-for-the-future-of-money/ https://nexus-protocol.medium.com/ nexus-protocol-litepaper-b36bf78d1849
* For this example, when I use an LTV of 80% to mint MIM with my aUST, until the price of my aUST does not fall below $ 0.80 I have no risk of liquidation.