> You're comparing a risk-free rate (government bonds)
> with a rate on risky investments.
I don't think so. What is the "risky investment" here?
I compared lending of different currencies. In the case of Euros or Dollars, the lender is a government. In the case of crypto, the lender is a smart contract. Both are assumed to be reliable.
If your smart contact is truly reliable and anyone can lend on it at a rate of their choosing, and all loans are fully and perfectly collateralized, the natural interest rate is exactly the risk free rate. As above, for ETH I think that ends being the return on staking, minus the costs of actually running a staking node - so pretty close to zero?
The last resort of the US, UK, etc. governments is to print money if they really want to avoid defaulting on their debt. Can smart contracts print money? Surely there must be some way for the counterparty in the contract to default.
"Defaulting" in crypto means the collateral goes from the borrower to the lender. The collateral is always more valuable than the borrowed asset. Otherwise, all borrowers would "default" all the time. As there is no other downside to it than to lose your collateral.
So, the borrower starts with X BTC. They post X BTC as collateral and borrow X-y BTC (where y > 0). Once the loan is paid off, they get the collateral back. This means they end up with X BTC minus the interest paid on X-y. Why would anyone do that?
I am not sure if lending makes sense if the collateral is the same asset that is borrowed.
A more typical example I can envision:
Someone owns land in Decentraland. The land is an NFT on the Ethereum blockchain. To make profits from the land they need to put a hotel on top of it. But they don't have the means to buy/build the hotel. So they lend Decentracoins (some other asset on the Ethereum blockchain) and provide the land as collateral.
If all goes well, the borrower buys/builds a hotel with the decentracoins. Makes more decentracoins from visitors. Pays back their debt.
If it does not work out, the land goes to the lender.
> I am not sure if lending makes sense if the collateral is the same asset that is borrowed.
It doesn't. And if the collateral is a different asset, there is no certainty that the value of the collateral exceeds the value of the principal. So there's a risk involved and that explains the premium over the risk-free rate. It's got nothing to do with the fact that the loan is denominated in some cryptocurrency.
Proof needed. I can in fact think of counter examples:
Say there is a DAO that gives more voting power if you own more ETH. In that situation, it might make sense to borrow 900 in ETH with 1000 ETH collateral. Then you make your vote on the DAO with a power of 1900. And pay back 910 in ETH to the lender. The vote on the DAO might trigger an action that is worth more than the 10 ETH you paid in interest. For example if you run a company and the vote on the DAO was to buy a service from your company.
Well, you tell me. Where do the profits come from?
> In the case of crypto, the lender is a smart contract.
That doesn't make sense. The smart contract is a contract, that is, an agreement between two or more parties. An agreement is not a lender. The lender is one of the parties.
Let's pretend the lender is "smart contract" (even though it's not). You lend X to the smart contract, and after a while the smart contract pays you X+y. Where does the y come from?
I don't think so. What is the "risky investment" here?
I compared lending of different currencies. In the case of Euros or Dollars, the lender is a government. In the case of crypto, the lender is a smart contract. Both are assumed to be reliable.