What is a CDP?
CDP is an acronym for Collateralised Debt Position, a smart contract that allows you to store your ETH as collateral in order to take out a loan. Maker's CDP allows you to take out a decentralised loan denominated in DAI stable coin.
As an Ether holder, what is the benefit to me?
Let us take the scenario that as a true believer in Ethereum, you have invested all your available fiat into Ether already. Suddenly, there is a market situation such that you would like to ""buy the dip" or simply increase your stack of ETH but you cannot since you have no fiat at your disposal. Nevertheless, thanks to a CDP you can lock your already owned ETH as a collateral, take out a loan in DAI (~USD), and buy more ETH with it. This is called leverage and the principle behind it is the same as margin trading.
What risks are involved?
The catch is that you have to repay your money otherwise your CDP gets liquidated and/or you lose your collateral. Please, never let your CDP liquidate! It is way more expensive than repaying.
If for example, you lock 150 ETH in a CDP, Ether price is currently 850 USD. The max collateral/loan ratio of the Maker CDP is currently set to 150%. Therefore, you can take out 85,000 DAI (100ETH*price) as a loan. Remember the loan is always in DAI. However, since you borrowed the maximum amount allowed (two-thirds of collateral), your liquidation price is exactly 850. If the price drops to 849.9, your CDP will be liquidated because its collateral is insufficient. Always make sure the liquidation price is sufficiently low!
There is another risk that can also arise. Taking the previous situation as an example, however, this time you only take out 30,000 DAI instead of 85,000. Since your collateral/loan ratio is now higher, you are protected from liquidation as long as the price of ETH is above the liquidation price of around 300 USD (sounds sufficient).
Again bear in mind that the loan is denominated in DAI. If the ETH price goes to 500 USD, nothing changes and you still owe 30,000 DAI. However, this may cause issues when investing the borrowed funds. For example, suppose you invested the whole loan in ETH at the initial price of 850 but now one is worth 500 and you have no other fiat available. The CDP does not go into liquidation this time. However, you cannot repay the debt and free your collateral.
How can one avoid these scenarios?
If you plan to invest the borrowed DAI from the CDP, never collateralise your entire ether holding. Always save an appropriate amount of money to be able to pay off the CDP at liquidation prices.
Want more information?
You should check the Maker CDP dashboard (https://dai.makerdao.com) and watch their introductory video and terminology guide. Make sure you understand what you are doing before creating a CDP. If you have further questions please feel free to contact us at JKRB and we can provide a consultation.
DISCLAIMER: This is not an investment advice or strategy; only an introductory material. If interested in using CDP, you should read more detailed materials involving more detailed descriptions of the liquidation process, fees, etc. Also, always do the calculations yourself and check your results. Do not trust the provided formulas if you have not checked they apply to your situation. Make sure you understand what you are doing. Be cautious and stay safe.