DeFi's Hidden Credit Risk: The 'Buy, Borrow, Die' Trade

The 'buy, borrow, die' tax trade is a strategy that allows investors to defer capital-gains taxes by borrowing against their appreciated assets. This method is typically used by wealthy individuals who have valuable collateral and can afford to take on debt.

However, the DeFi lending protocol Venus has made this strategy more accessible to a wider audience. By pledging crypto as collateral, users can borrow stablecoins like USDT or USDC, which can be spent or converted into dollars without selling the original asset.

While this approach saves investors money in taxes, it also creates a fragile math problem. The loan-to-value ratio must remain below 60%, or the code will open the collateral to liquidation, allowing an outside trader to repay part of the loan and claim some of the ETH at a discount.

A study on Venus found that roughly 3% of traders experienced what the paper defines as a default. This definition is different from a missed mortgage payment, as a DeFi default involves a loan remaining above the 60% loan-to-value limit for at least seven days without later borrowing or depositing.