Are DeFi Lending Protocols Too Risky?

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Published on Aug 26, 2020

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With DeFi lending protocols reaching new all time highs in terms of users and total value locked, it’s becoming increasingly important to understand the risk/reward tradeoff to using collateralized loan products. The LEND token (Aave) just became the first DeFi Token to reach a $1b USD market cap.

I have a relatively decent amount of experience with loan products. Having used them for almost a year now, I feel comfortable with various loan protocols that offer liquidity in exchange for collateralizing some of my crypto.

We’ve posted several tutorials on the LeoFinance social channels related to DeFi and CeFi collateral loan products. One thing that I consistently include in each tutorial is a warning about the risks of using these liquidity products.

Many people in crypto are highly risk-tolerant. That’s the nature of the game when you’re deeply entrenched in an industry that is filled with high-flying assets that make 10% moves look like a mild Tuesday.

My goal in warning people about the risks is to simply keep people informed about how you can both utilize these products to improve your investing returns in crypto but also use them cautiously to make sure that you don’t blow up your money and lose your crypto.

In this clip from the Roundtable podcast, we reviewed one of the lending protocols that I’ve been using for a while now: MakerDAO CDP Vaults.

These vaults allow you to deposit various forms of crypto collateral. In this clip, I show a BAT vault that I utilize to collateralize a portion of my BAT long-term holdings in order to gain liquidity and do other forms of trading.

The key to my approach is that I use a small enough amount of collateral to where I can cover the collateralization ratio in the event of a “margin call” which would occur when the collateral ratio gets down to 150%.

Other lending protocols like Aave have different rules for collateralization ratios and margin calls. While this clip focuses on the MakerDAO rules, the general principles apply to any liquidity protocol where you collateralize your crypto.

Understanding the risk/reward tradeoff can yield big returns and help you avoid even greater losses. Stay informed and only use what you’re willing to lose. All experimental technologies carry a great deal of risk and whenever you send your crypto out of your wallet, it’s no longer under your keys. Not your keys, not your crypto applies to decentralize lending protocols as well!

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