As everything operates in a decentralized way, lenders need a guarantee when lending their assets to borrowers.
It enables you to borrow assets (e.g. DAI, USDC) against the collateral (e.g. ETH) that you lock up in the loan until you pay back the assets you borrowed (e.g. DAI, USDC).
Collateralized loans allow users to access capital without the need of selling their assets. This works the same both in traditional and decentralized finance. Collateralized loans are the most common type of loans offered in decentralized finance, as they allow borrowers and lenders to transact without needing a trusted middleman.
As we previously mentioned, a collateralized loan can be liquidated to keep the protocol healthy.
You can get liquidity by borrowing the assets (e.g. DAI, USDC) without giving up ownership of your collateral as long as you make sure that the Loan holds enough collateral to cover the value of the debt.
To define a liquidation threshold it is important to understand the Loan-To-Value (LTV) concept. LTV is simply the ratio of the value of your outstanding debt divided by the value of your collateral.
In Fuji, this limit is set at 75% of your collateral's value, which means you will be liquidated if you reach this limit.
There is no right or wrong answer to this question. Most Defi users use loans to make new investments using strategies like leveraging, hedging, longing and shorting assets, or spot purchases in other assets.
You can spend your borrowed assets as you wish but there are some common use cases in DeFi:
1. Get a leveraged position: for example, if you are holding $10,000 ETH and feel bullish, you can deposit your ETH as collateral and borrow $5,000 USDC, then trade for another $5,000 ETH. You will get $15,000 exposure in ETH, which is equivalent to a 1.5x leverage, compared with your initial capital of $10,000.
2. Get involved in lucrative farming pools with assets you borrow.
First, determine how much collateral (e.g. ETH) you want to lock up in a Collateralized Loan. Then, you can borrow the asset (e.g. DAI, USDC) against the collateral you locked up, and spend them as you like. Payback your loan (e.g. DAI, USDC) when you no longer need the liquidity, together with interest accrued. Paying back your loan allows you to withdraw the collateral you locked up.
However, the use cases are not limited to crypto. Fuji DAO strives to see use cases which borrowing is used for home improvements, buy a car, put a down payment on a house, pay for college, etc. In many jurisdictions selling your crypto assets represents a taxable event. Taking a loan with a low APR gives you access to capital without incurring a taxable event.
As a borrowing aggregator, Fuji sources its liquidity from external protocols. At the moment, it integrates with the three major lending protocols: Compound, Aave and dYdX which represent 70% of the total borrowing market. Cream, Maker and other base protocols should be added soon after the alpha launch.
For the alpha release, Fuji DAO deployed three pairs. You can supply ETH as collateral and borrow DAI, USDC, or USDT. We plan to propose more borrowings and collateral assets very soon.
Fuji DAO differs from the base protocols that it aggregates in the way it manages individual positions. Aave and Compound both consider risks at an account level, such that the price of any token can affect the solvency of the whole user position. While this approach has advantages in maximizing borrowing capacity, Fuji DAO proposes isolated debt positions for each collateral/borrow pair. Thus, allowing for better risk management and more effective interest rate optimizations.
Your collateralized loan continuously accrues interest that depends on the asset you borrow. This interest rate is directly derived from the base protocol Fuji DAO uses to source liquidity. For example, if Fuji is linked to Aave for loans in DAI, the interest rates accrued on this asset is the same as the one on Aave.
As long as you monitor your loan and make sure that your health factor stays above 1, your loan will not be liquidated. If your health factor is close to 1, you can add more collateral, or pay back some of the debt. If your health factor falls below 1 then your loan will be liquidated. This means that your collateral is being sold by the system in order to cover the value of the assets (e.g. DAI, USDC) that you generated. Any leftover collateral is returned to your loan so you can withdraw it.
When you borrow from Fuji, you receive tokens that represent your debt and collateral inside the protocol. These tokens are merely units of accountability for Fuji DAO to map its positions and operate the required actions.
When Fuji borrows from the base providers, some of them reward us with tokens, Aave, Compound on Ethereum, and Geist on Fantom are doing this. We had different choices on what to do with these assets, but we chose to sell them for the collateral asset of a specific vault, increasing its overall health.
The optimizer fee is the incentives for FujiDAO to operate its refinancing operations. It's called optimizer fee because it adds 0.2% on top of the lowest borrowing rate.