Dark side Investing Background
Today I executed a strategy from the Banker's Playbook, which I jokingly call Dark side Investing because in the cryptocurrency world bankers are often called the “bad guys” which makes them operate with the Dark Side of the economic Force in the Universe 😉, so for fun I playfully call this bankers strategy Dark Side Investing!
So what is Dark Side Financing? Simply put I buy assets, borrow money against those assets, and then use the borrowed money to buy more assets. Then I borrow more money using this larger basket of assets as collateral, then use the loan proceeds to buy more assets. This can be repeated until the basket of assets has almost doubled, but no additional capitol is needed. This is commonly done to build a real estate portfolio, and is founded on the principle or belief that the real estate always goes up over time. A statement which in general is true over the longterm, but short term exceptions occur.
Banks use a version of this Dark Side Investing strategy.
When banks do this it's called collateralized asset acquisition. Many in the cryptocurrency world love to hate banks because they are profitable businesses operating within an ecosystem where all the rules favor them. One rule banks use to make money is fractional reserve rules. This rule requires they only keep cash representing 10% of all deposits they receive. Which means they can loan out 90%. Then when those loans come back to them as deposits they can loan out 90% again. They can keep doing this until they have loaned out basically the same money nearly 9 times and they are actually leveraged around 9x. For every $1000 dollars the bank takes in, they can make almost $9000 in loans. Plus they pay the depositors less then 0.25% while charging anywhere from 5% to 29% on loans, which averages around a 10% return or 40x 4000% return on their investment of the public’s money. And you wonder why banks have marble floors and beautiful stiffed leather chairs. It’s a very profitable business model, and that doesn’t include service charges and transaction fees.
Now while the bank may at first glance appear to be engaging in a risky over-leveraged strategy, but in actuality every new loan is secured by new assets and in each instance the loan will be less then the value of the asset. But the bank has the right to seize the entire asset. So what looks like under capitalized loans, are actually overcapitalized loans. Additionally the bank uses other peoples money as capitol and keeps acquiring control of more and more assets. But the best part is once you understand this you can use it in real estate and cryptocurrency to grow your assets with no additional capitol beyond the amount used for the first purchase.
Bankers traditionally are risk averse and specialize in shifting risk to others. So if they use a strategy you can assume that it has low risk.
Some real estate investors do this.
The real estate investor uses cash to buy a property. Then they refinance the property to take out some of the capitol used to buy it. Then buy an additional property. Then take out a loan on the second property and use it to buy a third. Then take out a loan on the third to buy a fourth. Each successive purchase increases the basket of properties the real estate investor owns. Ideally all the capitol comes from the first purchase. Ask our own @scaredycatguide if he uses this tool.
#scaredycatguide
Asset value is key
This all works as long as the underlying assets maintain their value or better if the asset appreciates or increases in value. If they drop in value a lot you get a crisis like the 2008 crash. But if the bank’s investments fail they don’t have to worry about having their assets seized, liquidated and being bankrupt. The government pays off their debts, for the good of society. This is called a bank bailout. You won’t be eligible for such a bailout.
Darkside Investing
While you can’t do exactly what the banks do, but crypto investors can do something similar. And to do it they use a specialized decentralized finance project called a credit debt facility, but I call them Crypto Banks
Did you know the first large DeFi project was a crypto-bank? Yes the first large usage of DeFi was the credit debt facility called the MakerDao.
How do you use credit debt facilities or cryptobanks.
In brief, you can buy cryptocurrency assets which you expect to go up in price, deposit them in an account called a vault, at the crypto bank, then borrow up to 75% of their current value, paid in a stable coin minted by the crypto bank and then use this stable coin to buy more of the same crypto asset, then deposit it into the same account in your crypto bank. So you borrow 75% of the 100 dollars worth of crypto, deposit it and now you have 175 dollars worth of crypto, so you borrow 75% of 175 minus the 75 you already borrowed and buy more that same crypto and deposit again. You do this again and again, each time obtaining new capitol which started out as 75%, then it’s 37.5%, then it’s 18.75%, then it’s 9.375% and each successive loan surplus is one half of the previous loan surplus. Thus allows you to double the size of the initial asset.
The benefit of this loan is it allows you to buy/own additional crypto assets without committing addition fiat or other funds to their purchase. The asset purchase is funded by debt or the loan taken against the initial supply of asset. So more assets, but no more capitol needed.
This is called collateralized debt asset acquisition. You are creating debt, which is collateralized by assets, but you use this debt to buy new assets, then collateralize this new asset for a new debt and use the new debt to buy more assets. There are diminishing mathematical returns in this model. But near doubling is possible, and this strategy is used for an appreciating asset you can keep buying more of the asset as the existing asset appreciates.
The risk of the initial loan at 75% value is if the token price drops more then 25% (100-75=25%) you now owe more for the loan, then the token deposited is worth, so your in danger of having the token seized and sold to payoff the debt/loan. The good news is if you use the loan to buy more asset and deposit it, your reduce the loan to value ratio and now the amount the token has to drop in value for a liquidation to occur is much greater. So, if this deposit reduces your loan to value percentage to 50%, now the token has to drop 50% (100-50=50%) to trigger a liquidation.
This is especially useful in a bull market.
In a bull market well chosen assets should appreciate and this asset value increase reduces your loan to value ratio without any additional asset purchases. This makes this strategy even more effective, and even less risky.
It’s the math, and math doesn’t lie
Loan to value is a fraction: loan/value. Anything which increases the value or denominator makes the fraction smaller. 1/4 is smaller than 1/2, and 1/8 is smaller than 1/4. As the loan to value fraction gets smaller your risk of it reaching 1/1 gets less and less. So as long as the price of a token rises, it’s value rises and you are safe from liquidation.
Final thoughts should you fear liquidation?
Yes, because liquidation causes the loss of some of money your funds. Although this strategy protects the you somewhat from the market volatility, it still requires you to monitor your positions carefully and it is wise to create alerts on your phone to alert you of large market drops.
If you get liquidated how much do you lose?
It depends, let’s look at two investors and one potential outcome.
Bob buys 100$ worth of Bitcoin January 1st. And holds it his wallet. February first Bitcoin falls 50% in value, Bob’s Bitcoin is now worth 50$.
John buys 100$ worth of Bitcoin. John borrows 50$ of Dai against the Bitcoin. His loan represents 50% of his asset value. He buys 50$ more Bitcoin. He now owns 150$ worth of Bitcoin. His Bitcoin loan now represents 33% of his deposited Bitcoin or asset value. His loan will now only liquidate if 100-33=66, the price of Bitcoin falls 66%. If the price of Bitcoin falls 50%. John’s Bitcoin is worth 75$ and his loan is not liquidated.
If the price of Bitcoin fell 66%, the value of his holdings would fall to 50$. It would match his loan balance. It would be liquidated. However if Bob adds one dollar worth of Bitcoin his Bitcoin would not be sold.
As you can see this strategy protects you from a very large market drop, but it still requires your attention
There are other scenarios and outcomes. This type of investing allows you to accumulate additional desirable assets without additional capitol. But it requires you to monitor your assets and make additional small capitol injections if needed to stay below 100% loan to asset value.
About @shortsegments
Shortsegments is a writer focused on cryptocurrency, the blockchain, non-fungible digital tokens or NFTs, and decentralized finance. He has been a community member for more then three years, and has earned a reputation of 75, on a scale of 0 to 80, which puts him in the top 300 of over 20,000 Hive accounts.
He is also a builder, with two current projects:
The first is the No Loss lottery, a prize linked savings account here on Hive, which awards more the 100 Leo in prizes weekly, and which recent surpassed 1000 tickets sold. @nolosslottery
His latest project is Easy DeFi, which creates a community investment pool allowing community members not yet confident enough to invest on their own, a chance to easily invest in yield-farming and staking on Cubfinance. @easydefi
Cubfinance is the Hive communities home grown Yield Farm and is audited by CertiK, a third party which certifies DeFi projects on Ethereum, Binance and polygon ecosystems.
Read more of shortsegments articles here: https://leofinance.io/@shortsegments
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Thank you
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This was a pretty cute allusion to Star Wars and the dark side. You wrote an artful metaphor introduction. I appreciate this suttle art you put in your posts. It’s creative and suggests a professional level of writing that is important because your posts are usually popular, so it’s really nice that you write really well. Then you give a really good explanation of how people can leverage invest. An amazing adaptation of a common real estate investment technique. Thanks
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Thank you very much for such a nice comment, and for the huge compliment. I appreciate it greatly.
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It comes with its own risk but the wealthy have so many options that the normal people don't have access to. Just the number of credit lines they can pull is amazing. I generally don't bother trying to do anything like this because I think its just way to risky given the volatility of crypto assets.
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You are right, the wealthy have many financial tootls available to them in the legacy system, which are available to others. Thats the beauty of decentralized finance, these tools are available to all. But yyou are also right that this is risky.
Money can always be generated out if thin air. It's all black magic. Nice article though 👍
That is the amazing thing about banking and cryptocurrency, thinking can really be rewarded. Right now someone reading this article is thinking of a different way to utilize this strategy that I didn't think about.