Understanding Decentralized Finance: Terms

Bank

This a business that makes money providing credit.

Credit

This means credit cards and loans like those used to buy cars and homes.

Interest

This is the fee or money you pay the bank for borrowing money in the form of credit cards or loans.

Stability fee

This is the same as interest.

Default

You are in default if you don’t pay your credit card bill or loan payments for two or more months. Aldo if the value of your asset falls below a predetermined value.

Default fee:

The extra money you pay the bank on top of your loan balance if you default.

Liquidate: if you default on your loan used to buy your car or home the bank takes your car or house and sells it to pay off your loan.

Liquidation fee

This is the same as a default fee.

Debt:

The money you owe the bank for credit card balances or loans.

Credit Facility

This is another name for a bank on a blockchain like the MakerDao or DJED.

Collateralized Debt product

This is another name for a loan granted you in exchange for the title or ownership papers of your collateral.

Collateral

This is an asset like a car, home or cryptocurrency, whose ownership papers are held by a bank or credit facility when you borrow money and use the asset as security for the loan.

Agree with liquidation.

If you offer an asset as security for a loan, you agree the bank or credit facility can sell your asset if you default on your loan or the value of your collateral falls below a certain dollar value.

Ownership papers:

For a car it’s the title and for cryptocurrency it’s your keys.

Concepts

Fractional Banking

This is a banking strategy which allows banks to loan out more money then they have in deposits, multiplying their profits, because they are only required to have 10% of their outstanding loan balances backed by capitol.

Example of Fractional Banking practice.

Adam deposits $1000 in his savings account at the bank, at 1% per year or $10.
The bank is only required to keep 10% of deposits on hand. It can loan out the rest.
The Bank loans $900 of Adams money to Bob, at 10% per year or 90$ pay for 10$ cost. Bob deposits the $900 dollars in his account at the same bank.
The Bank is only required to keep 10% or $90 in Bob’s account, $900-$90=$810.
The Bank loans $810 dollars of Bobs money to Charlie at 10%, that’s $81 per year.
Charlie deposits his $810 in his account.
The Bank is only required to keep 10% so $81, $810-$81=$729
The Bank loans Daniel $729.00 at 10% or $72.9 profit per year.
Daniel deposits his $729 in his account at the bank.
The bank keeps 10% or $72.9 in his account, $729-$72.9=$656.1
The Bank loans $656.1 to Eric at 10% and makes $65.61.
Eric deposits $656.1 in his account
The cycle continues.
The Bank got Adam to deposit his money for 1% interest.
The bank turned around and loaned 90% to Bob for $90, 9 times as much as they paid Adam and a $80 dollar profit. But it didn’t stop there; The bank made $81 dollars from Charlie, $72.90 from Daniel, $65.61 from Eric and this cycle repeats it self until there’s no more money to lend from Adams account. This is a simplification of Fractional banking. But it illustrates how the bank can make multiple loans and have multiple streams of income from Adams deposit, for which they pay him very little 1%, while charging 10% to loan out his money.

Loans

These are a Debt, which can secured, as in backed by collateral or pledged assets or unsecured, as in backed by your promise to pay.

Loans

These are a Product created by a bank or a credit debt facilities.

Collateralized Loan Product or Collateralized Debt Products

Loans are secured or Collateralized.
In the Decentralized Finance World, Loans are called “Collateralized Loan Products“ and also called
“Collateralized Debt Products”.

CDPs

Collateralized Debt Products are also called by their abbreviation “CDPs”.

Loan to Value Ratio

Traditionally, a bank doesn’t loan you 100% of the value of an asset. It loans you a percentage. If the bank loans you 50% of the assets value, the loan to value ratio is 50%.

Collateralization Ratio

Credit Debt Facilities don’t use a loan to value ratio, they use something called a Collateralization Ratio. It is the inverse or opposite of a loan to value ratio. In a loan to value ratio you create a fraction with the loan value on top (numerator) and asset value on the bottom. (denominator). In a Collateralization ratio the value of the asset is on top, and the loan is on the bottom. If the asset is worth two dollars and the loan one dollar the collateralization ratio is 2:1 or 200%.

Liquidation

If you don’t pay your loan, the bank sells your asset, the car or your home you pledged as security or collateral and sells it to get back the money it loaned you. This process is called repossession in America in the case of a car or foreclosure in America the case of your home. In the world of decentralized finance the bank or “credit debt facility” will also liquidate your assets if your collateralization ratio drops below a pre-agreed upon number.

Vault:

The name for your account at a “credit debt facility” or Bank on the blockchain.

Competitive suction.

If you default on your collateralized debt product, the credit debt facility will sell your asset. To lessen the downward selling pressure on the value of the asset, the asset is not sold on an exchange. Instead it’s sold in an auction where people make bids and the highest bid wins.

Over-capitalization of CDP:

The value of your asset in the vault collateralizing your loan or CDP is above the collateralization ratio number which triggers liquidation of your assets. This is a bad.

Under-capitalization of CDP,

This is the opposite of over capitalization, as the value of your asset means your collateralization ratio is “at or below” the number which triggers liquidation of your assets. This is good.

Decentralized finance profit motive for CDP or collateralized debt products.

Investors take out loans on cryptocurrency they are holding long term, so they can earn money from the appreciation of the cryptocurrency asset and use the loan funds to invest in another asset that generates an additional return on capitol. This means multiple streams of income from the original capitol investment and an increased return on investment.

Tokenization:

The representation of a physical asset Ads digital token.

Fractional ownership:

After a physical asset is tokenized investors can buy very small portions of an investment and these small ownership portions are called fractions.

This is an introduction to terms you need to understand in decentralized finance.

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