Decentralized finance (DeFi) is the delivery of traditional financial applications and services such as lending, borrowing, insurance, and exchanges on blockchain. Many of the most popular DeFi apps can be found at DeFi Pulse.

Recently, DeFi lending applications have seen a healthy rise in adoption, as early crypto asset holders use such platforms to earn passive interest or take out fiat and crypto-denominated loans. nuo is one such crypto lending application; the nuo platforms offers interest to those who lend out crypto assets such as ETH, USDC, DAI and more. The lending interest on nuo and similar platforms are paid by borrowers who primarily use the lent crypto asset for trading purposes.

Interest return comparison between Defi platforms (15 July 2019)

Interest return

While conducting a deep-dive on various DeFi lending platforms, our team discovered a few interesting characteristics of nuo. One observation is that nuo provides much higher returns than other platforms (for instance, nuo offers almost 20% interest for DAI and USDC, which is more than twice the rate of all other platforms). Since nuo shares the same features as most of its competitors, such as requiring no minimum lock-up period, this huge discrepancy between nuo’s interest rates and other platforms is a curious phenomenon.

Interest return displayed on nuo website (15 July 2019)

Furthermore, there were other data points that raised concerns. nuo quotes only 13.8% to borrow DAI, but lending DAI earns 19.3% interest. Which raises the question: who is paying for the spread?

Example entry on nuo when you lend out USDC

In addition, users in nuo’s Telegram and indeed our own team’s experimentation showed that there were unusually high deviations between nuo platform’s potential gains calculations and actual interest gains. As one can see from the image above, a lender has lent out about 4,000 USDC. nuo quoted calculated potential gains for 30 days as $60.06, but the lenders’ real gains were only $17.36, less than one third of nuo’s proposed figure.

This is evidence that nuo platform’s interest rates, at least the figures shown on the platform, are calculated in an inaccurate, and unintuitive manner. Buyers beware.

Collateral

For any crypto lender using DeFi applications, comparing the interest yield across platforms is just one aspect to consider. The use of any of these DeFi platform contains its own inherent risks and tradeoffs.

When lending on nuo or any comparative platform, the most salient risk is the following: as a lender, what is the risk of losing my principal?

On the nuo platform, borrowers are required to place a collateral value higher than the principal value of the loan. This way, if the value of the collateral asset falls near the value of the lent principal, the collateral is liquidated to preserve the lender’s principal. Thus the counter-party risk of lending is closely associated to how much collateral is required, and the particular asset the collateral is in. ETH would be much lower risk as a collateral, as its price is far less volatile than low-cap crypto assets with lower liquid trading volume.

When considering counter-party risk on nuo, you can consider the makeup of nuo’s collateral, which are stored here.

Collateral composition for nuo (15 July 2019)

From the chart above, we can see that more than 85% of loans on the nuo platform are backed by LINK tokens as collateral. LINK has a market cap of $1 billion as of 15 July 2019, but as recently as last month, the token was only trading at 1/5 of today’s value. There have been high volatility associated with LINK, which makes any loan collateralized by LINK far riskier than other options.

Indeed, other Defi platforms seem to not have this risk; LINK is not accepted as collateral on most competitors. Thus, nuo’s collateral quality is significantly worse than its competitors. However, this information is not readily available to users, who may not be aware of the higher underlying risk of nuo’s lending scheme.

Historical returns

In nuo, interest returns are distributed once a day only after loans and trades are closed instead of being accrued in realtime like some other platforms. Since nuo is built on Ethereum, the profit and loss to the lenders for each loan and trade can be retrieved publicly.

Returns for DAI lenders

From the chart above, bars show the daily DAI distributed to lenders as interest. Red bars (on 4 June) are losses instead of gains, which occurs when the liquidated collateral falls below the principal loan value. The annual return is calculated by summing the net profit for the past 30 days and making it a percent of the total DAI on that day and multiplying by 12 to show annual yield.

The loss on 4 June was contributed by a few loans; one of them can be found here. For this loan, the collateral was LINK with a principal of 2,765 DAI. After liquidation of LINK, only 2,551 DAI was recovered, booking a loss of close to 200 DAI to the lender.

Below is the same chart but for USDC lenders.

Returns for USDC lenders

Below is the same chart but for LINK lenders.

Returns for LINK lenders

From the chart above, note that most of the annual returns are negative. In fact, LINK lenders lost their principal due to the abrupt increase of LINK price, which caused the borrower’s collateral value to fall below that of the principal value.

Creating a lending platform whereby many (likely first-time DeFi) users are booking negative returns is irresponsible of the platform operators, who should educate and alert users on such adverse events.

Conclusion

DeFi applications are an excellent way for long-term crypto holders to earn passive income. That being said, many of these platforms differ in details which significantly affect their risk of use. Our team believes that nuo is one particularly risky option. Indeed, lending on nuo exposes you to a) high differentials between nuo’s proposed interest earnings and actual earnings b) unintuitive interest calculation and c) high risk of losing money as a lender/borrower due to the price volatility of volatile tokens such as LINK, which is currently nuo platform’s primary collateral. It is likely that many users are unaware of these risks — nuo should explicitly indicate these risks and provide accurate returns calculation so that lenders can be better informed and DeFi can progress the cryptocurrency ecosystem accordingly.

Technical details

nuo’s smart contracts address and source code can be found at their github. Events from the smart contracts can be retrieved and analysed. However, to enable easier interpretation of the events, we have used Graph and created a subgraph for nuo. This enables easier, faster queries and allows sharing such that someone else can also perform the same queries without reading the smart contract source code to parse relevant events for their own analysis.