Usually collateral is supposed to be equal or more than the amount borrowed, especially in a situation like this where there is no 'credit score' to use to determine likelihood of default.
Dharma Protocol doesn't require that the value of collateral be greater than the principal of the loan, but we do expect the market will demand full- or over-collateralization.
In the current implementation / use cases we're focused on, your collateral, which is held in a smart contract, would become eligible for seizure by the lender.
And what is the collateral here? My house? A car? Money?
If my collateral is another liquid asset it doesn’t make sense to borrow, and if it isn’t how exactly does the lender go about seizing it? I want this explanation to reach a satisfactory conclusion.
The collateral can be any other asset that is represented by a cryptographic token. Right now, few crypto-assets map to real world assets in some capacity, but we're willing to make a bet that this will change faster than most expect.
Already, though, there are many interesting assets in the world of crypto that are particularly well suited to being put up for collateral -- namely, the emerging class of crypto-collectibles such as CryptoKitties.
Look at the number of people that collect all kinds of crap: DVDs, video games, stamps, baseball cards, in-game virtual items, comics, art, etc. You can argue that some of it has more utility -- art is culture! you can watch a DVD! -- but the mindset of collecting goes beyond that, and certain utility, like games or trading cards, maps just as well to the crypto collectible world. Cryptokitties is an early example, but I am 95%+ confident something like it will be a HUGE hit within the next few years. So yeah, why not use the crap you already collect to secure a loan?
You have no idea how much you underestimate what CryptoKitties started. Cryptocollectibles will most likely be the first killer app. It's not about the kitties, it's about the underlying mechanic of owning a truly unique digital item.
I'm not a crypto-apologist, but this use case I can see (sorry if it's a little rambling).
Each property/car could essentially be represented by its own smart contract, initially held by the mortgage lender. When you pay an instalment of your mortgage, it executes the contract to "release" the equity to you.
When it comes to selling, to change the name on the contract, the buyer would pay based on the split between the lender and the owner, or pay to the owner who has to close the contract with the bank (in the event of moving to a new property, the bank and owner get their relevant proportions on Property 2's smart contract, and it goes again).
You could then "lend" out the equity you've earned from the bank, and use it as collateral for something else, getting it back once you've satisfied the terms of that agreement (meaning, if you don't, the person you lent it to is a creditor on the selling of the house/closing of the contract).
It's essentially automating/giving an interface to an existing contractual relationship. I think this interface might actually be clearer for some people who are financially uneducated, as it expresses their ownership percentage, debt obligations, and potential secured borrowing options in one go. Whilst a lot of it could be done without the crypto side of things if everything happens with the same bank/group of people, with buying and selling assets, you're working on trust with a bunch of different organisations and people, the ledger aspect could help with this.
"You wouldn't download a house" memes aside, like a lot of the move from analogue to digital, there was always a chance someone could have socially engineered you out of the deeds to a house, the technology just opens up the attack potential exponentially.
> This doesn't gain anything over existing legal contracts.
>> I think this interface might actually be clearer for some people who are financially uneducated, as it expresses their ownership percentage, debt obligations, and potential secured borrowing options in one go. Whilst a lot of it could be done without the crypto side of things if everything happens with the same bank/group of people, with buying and selling assets, you're working on trust with a bunch of different organisations and people, the ledger aspect could help with this.
I'm not arguing for it, merely point out the potential use case people would push for, and if it were to be pushed, I outlined why I think it could beat out existing legal contracts.
People already have a hard time dealing with contracts written in their own native tongues, why would they prefer having to read and validate source code? Even if a few standard blockchained contracts emerged for real estate deals that could be validated into human language, regular people are terrible at using and trusting software that they use irregularly. In some jurisdictions it is possible to buy and sell houses without involving lawyers or bankers, but most people use their services anyway because they are legally obligated to act in their client's interests, and they are experts at such things. Obviously you will also have to include the government-administered land title registry, an institution that have slowly evolved over centuries and works very well. There is no good reason to decentralize land titles, even if it were possible.
So even if bringing public-key encryption and software interpreters into a real estate deal were to introduce some efficiencies compared to dealing with word docs and paper copies that any country lawyer could amend and attest to without having to hire a Solidity developer and praying that it's one that can handle a weird contract addendum without introducing a bug, which is a big if, the costs and complexities would barely budge because there is a lot more that goes into a real estate transaction than validating contracts.
Crypto-apologists (I know you're not one) seem to include a lot of people who have never stressed out over a real estate deal, or worked on a helpdesk.
All fair points - but there's no reason not to involve legal counsel in smart contracts either (if we're talking in hypotheticals about a bank being ok issuing a smart contract for a mortgage, then I think we have to make the assumptive leap Solidity developers are two-a-penny), and the benefit of the solution I proposed is that your everyday interaction with your state of the contract is more visible than it is with the current system.
My proposal is less about the legal setup, and more about the ongoing interaction with the contract, which might aid with financial education, especially around equity (see how many people are caught up in interest-only mortgages), and debt leverage.
Whether you use a ledger or not depends on how it could actually work, but there aren't many other solutions that give transparency among multiple disparate parties, without a reliance on a credit agency (which, as we all know, has caused some... issues...).
Not sure whether I'm keen on that vision of the future or not, but I can definitely see the day where physical assets are represented by some digital manifestation/token.
Since there are many tokens (and increasing) that people must hold to be part of some network, tokens that are effectively shares of a business and stuff like that, these may make a good deal as collateral. People do lend out their stock, for example, today.
If the borrower is the one setting the collateral, what's to prevent me from putting up something that's rapidly depreciating like my collection of e-Beanie Babies and effectively stealing the loan?
How can this make sense? If the collateral is X, then the borrowed amount (Y) has to be less then X. Why lend anything in the first place, when that means you can only spend Y while otherwise you could have spent X which is more?
Say I own 1 bitcoin at $10k/BTC.
I want to go buy a mining rig for $5k.
I could sell 0.5BTC and buy the rig.
BUT, I believe that BTC is going to $20k, and I don't want to sell.
So I go to person X and say lend me $5k against what is currently $10k of BTC.
He has 2x collateral coverage... so he makes the loan. if BTC falls to $7500, he may have the option to sell and recover his loan.
I get my money so I can create more "money" out of thin air (or rather electricity and metal). When BTC goes to $20k I am rich. RICH.
This can easily be done on CME futures market, we don't need dharma for this. Futures can be used in multiple ways to swap inherent volatility with a fixed stream of return.
This happens quite regularly in the world of margin trading.
Imagine the following:
1. I own ETH, and want to hold my ETH position so I can enjoy price increases, but I need liquidity to live my day to day life and, well, it's hard to pay for things with ETH.
2. Instead of selling ETH and exiting my position, I put ETH up for collateral and borrow a stable-coin (like DAI) against it. That way, I maintain my price exposure to ETH, but have liquid cash to use for my day-to-day needs.
We've pretty deliberately opted out of baking jurisdiction-specific protections (be they KYC / AML, accreditation, etc.) into the protocol insofar as we really want this to be a universal standard that's jurisdiction-agnostic -- to give a somewhat crass analogy, most developers would agree that it does not make sense for content-protection against, say, child pornography, to sit at the level of TCP / IP. Jurisdictions vary widely in how they treat lending law, and so we've opted to be as flexible as possible on a technical level.
With that being said, we're actively working on making sure that, at layers above the protocol, developers have an easy time plugging in / restricting functionality on the basis of regulatory parameters. There are several interesting projects in the decentralized identity space that are tackling ways of natively attesting to KYC / AML screening on blockchains like Ethereum, and we're actively in conversations with them to make sure we maintain compatibility.
I also work in the exchange space like you used to and my thinking is pretty much fully aligned with the way you pose the issue and I'm very excited about your intention behind Dharma. I also agree with your current thoughts on approaching KYC and AML (please see my post in response to this one's parent). I'll reach out to you via your website if you don't mind since HN doesn't have PMs, would love to figure out if there's a way I can contribute.
But that's kind of the point, isn't it. With the fixed supply the "+ interest" would be harder to come by. Wouldn't it lead to elevated levels of defaults?
One way or another, the borrower has to come up with the principal + interest or they will forfeit their collateral. So they will want to use the loan in some sort of income generating capacity: financing a project, speculative trading, etc. If they are able to use the loan to earn more than the interest rate they've committed to, they'll make money overall. If not, they'll lose money.
Bottom line: we don't think the monetary policy of crypto-assets will have much of an impact on default rates in the short term.
Yes -- two parties are permitted to lend money to one another in a mutually agreed environment. It's important to note, though, that developers who build end-user applications on top of Dharma ought to be cognizant of lending regulations / securities law in the jurisdictions they are active in. However, we've opted to build Dharma in a non-jurisdictionally-biased manner -- we think that jurisdiction-specific regulatory restrictions are better implemented at the application layer rather than the protocol piping.
That is a dangerous position to put yourself in. AML and Terrorist financing laws make everyone responsible, you generally cannot claim innocence if you take no precautions and are involved in some kind of incident.
In the short-term, as you correctly alluded to, we're focused on loans that are fully-collateralized on-chain. In the future, however, we hope to integrate trusted third-party underwriters into the network in order to open the door for unsecured loans. There are many technical / game theoretic challenges to be solved on this front, though, so we've included unsecured loans as an "experimental" feature set in this initial release.
Yup -- there are several. The most mature relayer project on Dharma we're aware of is Bloqboard (bloqboard.com), though I believe they are not ready to launch on mainnet quite yet.
Thank you! Glad to hear that you enjoyed the tutorial.
There are numerous ways in which Dharma debt agreements can interface with insurance contracts:
1. We've already seen some members of our developer community working on trustless credit default swaps -- which are functionally insurance contracts that use the programmatic endpoints of Dharma debt agreements to assess claims on defaults.
2. For non-fully-collateralized insurance contracts, Dharma debt agreements can serve as the mechanism for tracking and administering the tokenized bonds that capitalize the insurance contract.
@kang -- while I don't disagree that there's no shortage of snake oil and hand-waving in the blockchain industry ("Blockchain for X! Huzzah!"), I do disagree with your point about whether there is an efficiency gain to be had from representing debt agreements on a blockchain. The primary benefits are:
1. An ability to trustlessly hold and release digital collateral on an entirely peer-to-peer basis. This entirely removes the necessity for a whole class of middlemen that seek rent for existing lending agreements.
2. An ability to trade one's ownership in a loan as a cryptographic token -- again, something that necessitates various paying agents / clearing houses / intermediaries in the traditional capital markets ecosystem.
Re: decentralization -- that's a fair point. Right now, Dharma is functionally a centralized code base controlled by a centralized set of contributors. In the future, however, we hope to transition to a decentralized governance model so that the protocol can serve as a piece of common, shared public infrastructure -- unfortunately, we don't have robust enough decentralized governance models quite yet in the crypto community.
Both the points and your third point about a centralized system being able to decentralize itself - I am saying all of them are impossible (given current knowledge - unless you have secret protocols...).
For point ,: you're correct in that we (as in the crypto community in general) have yet to come up with good on-chain governance mechanisms, so its likely that robust decentralized governance systems are at least a few years away.
The 'underwriter' in dharma protocol is essentially current day middleman. You contradicted yourself by saying "trustlessly" in point 1 and then admitting to point 3. Point 2 is unenforceable without current legal system.
Debt agreements aren't required to be underwritten in every instance -- it's an entirely optional addition. If you want to see an example of a debt agreement in which there is no underwriter or middleman and collateral is trustlessly secured -- well, it's linked as OP :)
Oh this is interesting. In India, debt agreements have to be underwritten. Moreover, this right is a hard-to-get license that is granted by the central bank - Reserve Bank of India. Not sure what the regulations are in other countries.
Underwriting is a heavily regulated process in most countries with licensing requirements.
You could claim that you do not underwrite yourself,so don't fall under regulatory purview. Interestingly your model will fall under the P2P regulations of India and China - where there are specific models where the marketplace does not underwrite, but risk is assumed by lender.
Or - you have to make sure that the underwriters are regulated entities.
P.S. I run a lending startup in India. We primarily look at the Blockchain as a means to solve the credit history problem in India.
Perhaps unfeasible to appraise given that CryptoKitties haven't coalesced around any sort of stable value, but it'd be interesting to see what the volatility of NFTs like CryptoKitties is in comparison to normal tokens.
