The first ever DeFi mortgage may have just gone through.
An engineering lead at a top DeFi protocol, who asked to remain anonymous to keep his personal finances private, on Jan. 22 paid off his mortgage loan with Commonwealth Bank of Australia, and now is paying down his refinanced home loan through DeFi protocol Notional Finance, which provides fixed-rate lending and came out of stealth mode last month.
This development marks a major step in a sector often derided for lacking use cases beyond speculation. The rise of fixed-rate lending protocols in decentralized finance may attract users seeking stability in longer-term investments and loans, such as mortgages.
“I feel like I’m in full control of my situation,” he said. “People should be all over this stuff.”
Boxed Out of TradFi
The path towards what seems to be DeFi’s first mortgage started last month, when the borrower was seeking to refinance his home loan through a vehicle called an offset loan, which would direct a savings account’s interest towards paying down a mortgage.
But it was tough to do so in traditional finance.
“Banks are being very cautious about lending during this time of economic uncertainty,” he told The Defiant. Despite the fact that he and his wife have been called a “golden brick” by a mortgage broker, and have sizable incomes and assets, this engineer has been rejected for a basic credit card for four years.
This is partially because of how “banks don’t like self-employed people,” he said, explaining why he had to jump through so many hoops to access credit.
With this struggle in mind, and upon reading about Notional’s fixed-rate loans in The Defiant’s Jan. 13 newsletter, he “jumped out of bed” to do a test loan.
Fixed Rates in DeFi
“What I liked about Notional was like, okay great, fixed! Someone solved this fixed rate product that I need,” he said, diving into the details of his mission to become his own lender.
There is currently $5.2B in outstanding loans in DeFi, according to data from DeBank, with over 80% issued on MakerDAO and Compound Finance at variable rates. Besides Notional, a growing number of DeFi protocols are tackling the fixed-rate market, including Yield Protocol, Mainframe and Aave.
Notional provides fixed-rate loans for up to six months. Users can deposit WBTC, ETH, WETH, or DAI, and then take out a loan with these crypto assets as collateral. In contrast to how a house is the collateral in a conventional mortgage, in Notional and other blockchain-based lending protocols, the collateral is crypto.
MakerDAO was the first protocol to enable anyone to borrow against their crypto assets, maintaining the upside potential of those assets, but rates are variable, adding risk to longer-term loans.
A Complex Approach
It was a multi-step process. First he had to pay off the home loan from the bank, for which he needed Australian dollars (AUD). After confirming this was possible, the engineer went to Notional to borrow USDC at a fixed rate.
But, noticing there was slippage due to the nascent platform’s low volume, the borrower provided USDC liquidity to the protocol, equal to the amount he wanted to borrow, in order to capture his own fees, and ostensibly act as his own lender, when he borrowed on the platform.
After adding liquidity, the engineer added ~$1M collateral to Notional (as WBTC and ETH), against which he borrowed ~$500K of USDC. Borrow rates for USDC are at ~6% on the platform currently. He then converted the USDC to AUD with a crypto off-ramp to pay off his loan to Commonwealth Bank.
The engineer will now soon have the title to his $3M house.
Advantage of Crypto Collateral
Most MakerDAO borrowers use collateralized loans as a way to buy more crypto, betting that their trades outweigh the variable interest and fees they’d have to pay on those loans.
But with the instability of lending rates on stablecoins, the engineer needed a fixed-rate option to feel comfortable with the risk of a DeFi-facilitated mortgage.
Borrowing with crypto assets as collateral instead of a home comes with additional advantages. The obvious one: The borrower gets to keep his exposure to crypto in a bull market.
ETH and WBTC are also much more liquid than a house. If a home’s price rises, a person can’t sell part of the house to pay down the mortgage. But this can happen with Notional and similar systems. If the collateral appreciates, users are able to maintain their collateralization ratio but also liquidate part of those assets to pay off a portion of the loan, reducing the total interest paid.
He is also able to offset some of the borrowing costs thanks to the fees he’s earning from his liquidity provider position.
“That all sounds a bit crazy,” he said, but the “complicated structure serves two main reasons.” The first is he gets “to keep my exposure to crypto without liquidating it, in a bull market,” he said. If he’s lucky, this borrower is hoping to potentially close out the loan on Notional thanks to crypto gains.
The engineer’s second reason to put up crypto collateral, rather than cashing out to buy a house, is to avoid triggering a taxable event. If he had sold his crypto he would have had to pay taxes on his capital gains.
Of course, to be able to do this, the homebuyer would have to have the crypto to put up as collateral.
TradFi Makes Ethereum Look Fast
People often lament Ethereum’s gas fees and transaction times. Compared to payment processors like Visa, Ethereum has a ways to go to reach a similar scale. Compared with the paperwork involved in applying for loans though, DeFi may already be miles ahead.
There was no need to fill out any forms or applications to perform his refinance. It was based on pseudonymous on-chain data. He even tried to use centralized crypto lending platform BlockFi, but couldn’t get past the KYC process because his passport photo had him sporting hair before he went for a new “bald look.”
“It felt like it would’ve taken months of applications, finding tax returns and bank statements for the bank to refinance me, but I was able to do it all in one day, under my own agency,” the borrower said. “I couldn’t think of anywhere in TradFi where I could sit down on my computer, quickly shop around the lending markets, and be like, that’s a good rate, I’ll just do that. And it’s done.”
He quickly built the structure in Notional, the way he wanted it, too the borrowed stablecoins from through a fiat off-ramp to pay off the bank, and about a week later from when he first discovered the platform, his home loan was closed.
To be sure, while rates on Notional loans are fixed, they’re only fixed for six months. The borrower will need to roll over the loan every six months. As the interest rate is dictated by the liquidity in the ecosystem, borrowing costs could spike.
However the engineer feels it’s worth the risk, in that, if the rates are too high on Notional, he can go to other lending providers, potentially temporarily get a variable rate loan, and then return to Notional if rates drop.
“It is a bit of a gamble right now,” he admits, though it’s a risk he believes he can handle.
In the next few days, he’ll go to the bank with his wife and retrieve his home’s title from them. The process has been a revelation.
“Here’s all these people with these mortgages thinking they’re living in their own homes, but not really, it’s the bank’s home,” he said .
“I think it’s incredible. We should be able to be our own lenders.”