Cryptocurrency Collateralized Debt Positions Are Growing in Popularity

While Bitcoin (BTC) continues to hover around the magical 10,000 price level, altcoins continue to fight an uphill battle.  Simply put, hopes of a future bull run continue to diminish as Bitcoin maintains its dominance.  One school of thought is that a few altcoins will survive and flourish, but which ones are anyone’s guess.  That being said, it’s hard to go wrong picking against the top coins like Ethereum (ETH), Ripple (XRP), Litecoin (LTC), and EOS.  These projects have managed to find a foothold in the market and have a better chance than most of staying there.  While traders wait for their positions to increase in value, one opportunity that may be worth looking at is initiating a collateralized debt position.

What is a Cryptocurrency CDP?

In traditional terms, a CDP is essentially putting up collateral in order to receive a loan against the deposited amount.  There are several examples of this in our day to day lives.  Auto title loans from large companies like TitleMax are extremely popular with consumers.  Consumers are essentially able to use their car as collateral in exchange for a cash payment which can then be used for whatever needs the consumer has.  The consumer can continue using their car as long as debt payments are made.

The same concept applies to cryptocurrency CDPs.  Consumers are able to put up crypto tokens, such as ETH or stablecoins like DAI or USDC, in exchange for a loan at a specified borrow rate.  A consumer would make this trade if they feel like ETH will appreciate at a higher rate of return than what they’re paying against the loan.  A trader could use the loan to purchase more ETH, other altcoins, or simply take a vacation.  The choice is completely up to them.

Current Platforms Offering CDPs

Since crypto CDPs are still relatively new, there are only a few platforms that offer it.  A few of those platforms include dYdX and Compound.  As of this writing, the current borrow rates at Compound are as follows:

• ETH – Approximately 2.5%
• DAI – Approximately 13.5%
• USDC – Approximately 10%

Traders may also see a lending rate.  The lending rate will offer traders the opportunity to supply a coin like DAI or USDC in exchange for an interest payment.  Traders would essentially serve as the banker.  Giving the lending rates on DAI and USDC of 10% and 5.5%, respectively, it appears to be a worthwhile opportunity for those who are holding stablecoins in cold storage.

Be Aware of the Risks

“There is no doubt that CDPs will be seen as a really intriguing opportunity by some traders” says Ted Foxworth, President of CryptoRocket, “However, a CDP is not for the faint of heart and involves a rather significant risk depending on one’s risk appetite.”

Given the borrow rates shown above, traders will likely be inclined to borrow against their ETH position.  2.5% is fairly manageable and ETH likely has the most room for price appreciation.  But what if the price of ETH goes down?

Since the loan was generated against the ETH position at the price of the loan, CDP holders need to be aware that a significant price drop in ETH could result in the position being liquidated.  This is why it is recommended and sometimes even required, that a CDP position be initiated with a liquidation ratio over 150%.  This allows flexibility in ETH price fluctuations without resulting in constant liquidations.  And, as always, traders should only expose a small % of their overall portfolio to this type of strategy.

Conclusion

It’s great that innovation continues to occur within the crypto space.  As more opportunities arise, there are likely to be more and more participants over the coming years.  CDPs certainly aren’t for everyone and will likely appeal to traders with the largest risk appetite.  It will be fascinating to watch whether more platforms begin to offer CDPs as the market matures.

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Disclaimer: This article should not be taken as, and is not intended to provide, investment advice. Global Coin Report and/or its affiliates, employees, writers, and subcontractors are cryptocurrency investors and from time to time may or may not have holdings in some of the coins or tokens they cover. Please conduct your own thorough research before investing in any cryptocurrency and read our full disclaimer.

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