DeFi's 'Buy, Borrow, Die' Strategy Exposes Hidden Credit Risks

A new working paper from researchers at the University of Texas at Austin and the National University of Singapore reveals the hidden credit risks associated with the 'buy, borrow, die' strategy in decentralized finance (DeFi). This strategy allows investors to borrow against their crypto assets without realizing taxable gains, but it introduces complexities that can jeopardize lending pools.

The researchers focused on the Venus lending protocol on the BNB Smart Chain, analyzing 1.36 million daily borrower observations from November 2020 to July 2022. They found that about 3% of traders experienced what the paper defined as a default, which occurs when a loan remains above the 60% loan-to-value limit for at least seven days.

The study illustrates how borrowers can use their assets as collateral to access stablecoins, preserving exposure to potential price increases while deferring tax liabilities. However, this practice creates a fragile system where a decline in collateral value can lead to liquidation risks, impacting the entire lending pool.

The researchers noted that while the strategy can be financially beneficial for individual borrowers, it also shifts the risk onto other users in the lending pool, who may be unaware of the underlying credit risks associated with these loans.