Lender of First Resort

January 17, 2019

The MakerDAO project aims to unlock the power of the blockchain for everyone by creating an inclusive platform for economic empowerment -- allowing equal access to the global financial marketplace.

A fantastic way to bring this to life is to showcase Dai use cases from community members and partners. 

Contributed article by @ProgrammableTX

In 1984 I was thirteen years old and mortgages rates were over 13 percent. One night, I overheard my parents going over their finances in the dining room. They were super stressed so I barged in and asked them what was going on. I’m amazed, looking back in this moment now as an adult, that they chose to simply show me the numbers; parenting through radical transparency.

They went through monthly expenses vs. their income and, as you can surmise, the two columns did not cancel each other out. The biggest expense was the mortgage payment.  The amount instantly felt wrong to me so I grabbed my dad’s calculator to figure out the total payout after 30 years. By the time they paid off their $350K mortgage, they were going to pay the bank over a million dollars. It seemed completely ludicrous to me.

Now I’m 47 and I have my own mortgage. It’s not an unreasonable one, but I still dislike mortgages. My biggest gripe is that it keeps me shackled to a paycheck. That’s because the mortgage tax deduction is worth zero unless I have a salary against which to deduct it. I fantasize pretty constantly about how I can pay off my mortgage without spending the cash I need to make those columns balance out a little better than my folks did.

The Numbers

In 2017, I took out a mortgage for $540,000 at 4%.

My monthly payment is $2578.04, of which $1793.48 is interest.

Let’s break my mortgage into chunks of $50,000.

For every chunk of $50,000, I will pay $2,000 a year in interest alone. I will retire those chunks one at at time, but the total lifetime interest cost for the final 50K chunk will be $60,000 (this does not include principle).

Granted, inflation will slowly reduce the net real “cost” of the $60K over 30 years, but for someone like me who is allergic to debt, and who still basically thinks like a 13-year-old, it’s not a good story. Objectively I can see how the numbers are actually fair, but I’ll always reduce it to the simplest narrative. For the last $50K that I borrowed, I will pay back $110K.

Enter MakerDAO. While stable tokens are getting a lot of coverage, and while Dai is a true innovation, the CDP mechanism is the most transformative tool for wealth management that I've ever encountered.

There are a lot of caveats, and difficult hurdles to clear in order to maximize one’s appreciation of how CDPs work. The biggest hurdles are 1) belief in the underlying assets and 2) Acquiring the over-capitalization for your loan. But if you can satisfy those two conditions, then MakerDAO will provide a pathway for your family, your institutions, and your businesses to route around the traditional banking system, save untold sums in interest, and even preserve wealth between generations while still being able to put that wealth to work.

My CDP Experiment

In 2018 I paid off one $50,000 chunk of my mortgage using a CDP. Due to the runup of 2018, I had a significant sum of ETH I could use as collateral. This was, in a sense, my free pass over hurdle #2. Without winning the ETH lottery I would never have understood what Rune and the team have created.

I piled most of my Ether into one CDP. It was about $150K in Ether, just enough to over collateralize a $50K loan by 300%. Then I had to convert the Dai to dollars, which was painstaking and not super easy. I started the process in January of 2018 when the prices of all crypto assets started to slide. There wasn’t much liquidity for Dai back then, and I had to go from DAI -> ETH -> Dollars, using OasisDex and Coinbase. I split the 50K into 10 chunks of 5K each, trying never to hold onto the ETH for more than 20 minutes. I had to be both in a rush and patient at the same time. I used limit orders at every step so that in my final accounting my profit and loss would be as close to $0 as possible. I didn’t account for gas fees, so I probably ended up losing a few dollars.

As an aside, it is worth mentioning that in my entire history with crypto, it was during this process that I made my one egregious error. The kind that everyone I talk to seems to have made at some point in their career. I accidentally sent a single payment to an unrecoverable address. It’s a good thing I was making payments in steps! Even including this costly mistake, however, I will still save money in the long run. Gotta just chalk it up to experience. This bear market presented a host of other issues for me regarding my declining collateral value, not only in the process of this mortgage payoff experiment, but because I decided to go deeper in debt and use a CDP as leverage to buy more crypto. This is probably what most people are using CDPs for right now, and doing it myself gave me even more fascinating insights into some more subtle game theory of CDPs. I’ll put those thoughts into another post.

By March of 2018, the process was complete, and I sent a check to my bank, in the process trading bank debt at 4%, for CDP debt at 0.5%. This means that I’m paying $250.00 per year on $50K of Dai debt, and if I were to take 30 years to pay it back, that would amount to $7500.00 (plus principle). Perhaps in a universe where people saw thousand percent gains, this does not seem like a sexy trade. But for the way I see wealth, this was a life-changing transaction. It makes my heart race thinking about the implications. It’s a great story.

The narrative of MakerDAO for me is that with the right assets, and the right amount of starting capital, you can literally borrow from yourself. Plus, you get to keep the assets you put up as collateral. As the lender to yourself, you can pay off your loan as fast or slow as you like. You can sell your CDP at a discount, or you could even pass it along as an asset to your kids by handing them the keys to your CDP. I can definitely imagine some cases where I would advise this because unlocking the underlying assets could represent a substantial gain. Regardless, the ability to use your wealth for leverage in a way that does not put that wealth in the hands of others has never been possible in the financial universe until CDPs. That is the narrative that makes me really excited about Maker.

So let’s think of a different scenario. It’s the future, and my kid has inherited a million dollars worth of crypto assets which qualify as collateral for Multi Collateral Dai.  He puts the portfolio into a CDP and borrows $500K in Dai to buy a small first home or condo for cash. He’s now in charge of his mortgage, and free to pay it back entirely on his own time. Depending on prevailing rates in the future, he could easily end up saving an amount that is equal to the full value of the home. Plus as the value of the collateral increases, then he can use it to unlock even more capital.

There’s another significant advantage, which is that in the world of traditional mortgages, if there is some kind of force majeure event and my kid was to default on a traditional loan, the bank has one option: repossess the entire house. Banks can’t repossess fractions of a home. With a CDP, however, if the collateralization level falls below the required threshold, the system will only reclaim what is owed in Dai, plus a 13% penalty.

So let’s say that after 15 years, my kid has paid back half of the Dai, and removed most of the collateral from the CDP. His debt is now $250K in Dai, and the collateral is only worth $378K, or 151%. The value of the collateral falls, and suddenly the loan is underwater. Instead of losing the house, the Maker system takes $250K plus 13% ($32.5K). Once the bite function is called, his debt is wiped out, and he has $92.8K in crypto capital left over with which to start again.

I undertook this experiment to see if it worked, and I can tell you that it does. Now that  Coinbase and countless other exchanges have enabled Dai trading, much of the friction that I encountered have been removed from the system.

The universe of stablecoins is exploding, and new crypto loan services seem to pop up every week. None of them work in concert as a system like MakerDAO, however, and in every case I’ve seen thus far, the interest rates are not even competitive with regular banks, much less MakerDAO. Traditional lending is split into so many categories, all of which come with different costs. Auto loans, home loans, construction loans, & education loans are all segmented into different industries, with separate hoops to jump through.

With MakerDAO the narrative is simple. If you have built up some collateral, you can borrow from yourself at the kind of interest rate only you would charge yourself, and stay long on your crypto assets for the future upside.

About the author: @ProgrammableTX

I began my investing career in 1990 with money I made selling suits in college. All of my investments express parts of a larger thesis about where we are heading as a civilization. This thesis changes constantly and I am wrong as often as I am right. Bitcoin fully captured my imagination in 2015. We now live in a world where money is a laboratory, new narratives have emerged, and every transaction is a story.

Twitter: @ProgrammableTX

Medium:  medium.com/@ProgrammableTX


January 17, 2019