What is the discounted collateral value?
When borrowers are setting up the loan terms, they specify the discounted collateral value. The discount can be selected from 1% to 100%. It influences the final collateral value. The higher the discount is, the bigger the amount of collateral will be. It is calculated by the formula:
What is a purpose of using the discount?
If you ever apply for a bank loan, you come across the fact that banks also evaluate collateral with the discount. It depends on the liquidity level of an object of collateral. It is common practice for banks to issue a loan amount twice lower than the market collateral value. If the borrower does not return money, the bank will get enough money to cover the loan amount and interest payments after selling the collateral.
On Biterest the discount provides the equity in a relationship between a borrower and a lender. The borrower expects to increase his income, that's why he keeps holding bitcoins. The lender as well as investor looks forward to getting the profit from his free cash. If BTC price decreases, the collateral value decreases too. To prevent negative consequences from the BTC price corrections, Biterest provides Margin call. When it occurs, a loan period is automatically stopped, and the borrower’s debt will be repaid by the collateral.
How Margin Call is associated with the discount?
The risk of Margin Call mostly depends on the the discount. Margin Call occurs, when the current market value of collateral is lower than its initial market value by the certain amount depended on the discount. The bigger the discount is set by a borrower, the lower the risk of Margin Call will be. Also, the collateral value of Margin Call is always equal to the amount of a borrower's repayment to a lender. The current collateral value and the value of Margin Call are available on the page of a certain loan application
How to choose the discount?
Borrowers set the discount at their own discretion. The choice depends on their needs:
a) Save bitcoins for the future and get money - this way implies setting a high discount;
b) Be ready to sell bitcoin but keep hopes alive for a rapid growth of BTC - it is enough to set a low discount.
If borrowers follow the first way, they absolutely believe that the BTC rate will rise in several times. That's why they do not want to sell their bitcoins, because of a high chance to lose a great income in the future. If you are one of them, you need to specify the high discount in order to minimise a risk of selling bitcoins by Margin Call. We recommend to set it at least of 30%, and preferably of 50%. The graph below shows that fluctuations of Bitcoin price have been gradually decreasing for the last years. Retrospectively analyzing it, there is an 1% probability that a 50% reduction of Bitcoin price in one day is possible. The prolonged corrections have replaced sharp drop. If its price starts to decrease, the borrower will be able to repay the loan ahead of time in order to return his bitcoin collateral.
In the second case, the borrower is ready to sell bitcoins in order to fix his profit. Although he still has hopes for increasing his income in the future, but he cannot discount the collateral value a lot. Therefore, he specifies a small discount of around 5-15% which tends to occur a high risk of losing collateral. Analyzing the daily volatility chart of 2017, the BTC rate increased by more than 10% in a single day 16 times in the last year. Likewise, it dropped more than 10% in a single day 10 times.
How to calculate the initial collateral value and the collateral value of Margin Call?
For example, a borrower applies for a loan: the loan amount is $1500, the annual interest rate is 20%, the loan period is 90 days. The amount of borrower's obligations is 1500 + 15000,290/365 = $1573,97. He sets the 20-% discount, so the initial collateral value is 1573,97/0,8= $1967,47. For example, if the BTC price is $8000 at the moment, the amount of collateral will be 0,24593 BTC. If the bitcoin price drops sharply, the collateral value drops too. If it reaches to $ 1,573.97, Margin Call will occur. In this case the borrower's obligations to the lender will be refunded by the collateral. The current collateral value and the value of Margin Call are always available on the page of a certain loan applicationTweet