Overview Overview
This article will briefly introduce the main products of DeFi lending business, and on this basis, discuss the future product form.
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Report report
The Present of DeFi Lending - Overcollateralized Loans and Flash Loans
To protect lenders and prevent borrowers from absconding with their money, there are two distinct approaches:
flash loan
flash loan
The Aave lending protocol recently introduced a new feature called credit delegation. This feature allows users to provide p2p loans without formal collateral requirements.
Both parties must enter into a formal legal agreement setting out terms such as repayment schedules, interest and other necessary conditions. Through an integration with OpenLaw, a project that creates legal contracts recorded on a blockchain, these terms can be formalized on-chain.
The use of peer-to-peer intermediaries allows for circumvention of the limitations inherent in DeFi whereby protocols cannot recover borrowers’ loans outside of the blockchain. All lending platforms require more collateral than borrowed, which greatly limits the possible uses of blockchain lending. The intermediary assumes ownership of the bankruptcy risk of the borrower. The higher the risk, the higher the interest rate the intermediary receives from the borrower.
At the same time, there is also the possibility of extending credit on the condition that the loan must be repaid in full, meaning that the borrower receives, uses and repays the funds all in the same blockchain transaction. If the borrower does not return the funds and interest by the end of the transaction execution cycle, the transaction will be invalidated and the loan itself will be returned. These so-called "flash loans" are a very interesting, but still experimental, application. While there aren’t many known cases other than arbitrage, flash loans have the potential to become a big part of DeFi lending.
Currently DeFi as a whole is still too small, and the industry needs to expand considerably in order to bring DeFi into the mainstream of digital currency. Borrowers can convert stable currency into legal currency at a lower cost, which can open up downstream channels and attract more funds to enter the market.
overcollateralized loan
Second, loans can be fully secured with collateral. Collateral is locked in a smart contract and is only released when the debt is paid. There are three variants of mortgage lending platforms: mortgage debt positions, mortgage debt marketplaces, and P2P mortgage debt marketplaces. A CDO is a loan that uses a newly created token, while the debt market uses existing tokens and requires matching between lenders and borrowers. The three slightly different types of loans are briefly described below.
mortgage debt position
Some DeFi applications, such as Maker DAO, allow users to create collateralized debt positions, thereby issuing new tokens backed by collateral. To be able to create these tokens, users must lock crypto assets in smart contracts. The number of tokens that can be created depends on the target price of the generated tokens, the value of the crypto assets used as collateral and the target collateral ratio. The newly created tokens are essentially fully collateralized loans that require no counterparty, allowing users to acquire liquid assets while maintaining market exposure through collateral. These loans can be used for consumption, enabling individuals to overcome temporary liquidity constraints, or to acquire additional crypto assets for leveraged exposure.
To illustrate this concept, let's use the example of Maker DAO, a decentralized protocol for issuing USD-DAI stable packages. First, the user deposits ETH into a smart contract, the CDP (or vault). Subsequently, the contract function is called to create and withdraw a certain amount of collateral, thereby locking the collateral. The process currently requires a minimum collateralization ratio of 150%, meaning that for any $100 worth of ETH locked in the contract, users can create up to 66.66 DAI.
Any outstanding DAI asset-backed bonds are subject to a stability fee, which should theoretically be equivalent to the highest interest rate in the DAI asset-backed bond market. This rate is set by the community (i.e. MKR token holders). MKR is the governance token of the Maker DAO project. The stability fee has been fluctuating wildly between 0% and 20%.
To complete a CDP, a user must send outstanding tokens plus accumulated interest to the contract. Once the debt is repaid, the smart contract will allow the user to withdraw the collateral. If the borrower fails to repay the debt, or the value of the collateral falls below the 150% threshold, which is where the entire loan collateral is at risk, the smart contract will start liquidating the collateral at the underlying discount rate.
Interest payments and liquidation fees are used in part to burn MKR, thus reducing the total supply of MKR. In exchange, MKR holders take on the residual risk of an extremely negative ETH price shock, which could lead to insufficient collateral to maintain the USD peg. In this case, new MKR will be created and sold at a discounted price. Therefore, MKR holders also have a vital interest, and it should be in their best interest to maintain a healthy system.
The MakerDAO system is much more complex than described here. Although the system is largely decentralized, it relies on oracles for price discovery.
mortgage debt market
In addition to creating new tokens, it is also possible to borrow existing crypto assets from others. For obvious reasons, this approach requires a counterparty with opposite preferences. In other words, for one person to be able to borrow money, another person must be willing to lend it to him. To reduce counterparty risk and protect the lender, the loan must be fully collateralized and the collateral must be locked in a smart contract, as in our previous example.
P2P mortgage debt market
Matching between lenders and borrowers can be accomplished in a number of ways. Broad categories are P2P and pool matching. P2P matching is when a person providing liquidity lends a crypto asset to a specific borrower. Therefore, the lender will only start earning interest if there is a match. The advantage of this approach is that the parties can agree on a time period and operate at a fixed rate.
Consolidation loans use variable interest rates, which depend on supply and demand. All borrowers’ funds are pooled into a single, smart contract-based loan pool, and when they deposit funds into this pool, lenders start earning interest. However, the interest rate is a function of pool utilization. When liquidity is readily available, loans are cheap. When demand is high, loans become more expensive. Loan pools have the added advantage that they can be easily transitioned to maturity and size, while maintaining relatively high liquidity for individual lenders.
The Future of DeFi Lending Ecosystem-Credit Loan
When cryptocurrency loan products can involve unsecured or low collateral (the value of the collateral is less than the loan amount), the DeFi lending market will truly usher in positive development.
Credit is not only indispensable in the modern financial system, but also plays a significant positive role. It can effectively guide financial resources into important sectors of the real economy, and the policy effect is immediate.
Expansion is always more important than destruction. The latter is a zero-sum game where the cake is simply cut into different shapes, while the former is a bigger cake. DeFi will do this by making the time and process of obtaining a loan cheaper in terms of fees and interest rates. Therefore, the emergence of credit will not erode the existing loan market. On the contrary, credit is a way to make the cake bigger.
But at the same time, in terms of interest rate channel linkage, since the credit channel can only regulate money supply, it is difficult to control demand, resulting in increased interest rate fluctuations; in terms of asset price channel linkage, since the credit channel in a broad sense is closely related to asset prices, the superposition of the two transmissions is easy to form a multiple effect, creating asset price bubbles.
While credit creates some of the problems described above, if we are looking at access to debt only as a tool for now. Like any tool, its value depends on how it is used. Borrowing money to maintain a lavish lifestyle is not sustainable, on the other hand, borrowing money to buy a car to get to work, take a course or buy inventory for your business is accretive, credit itself is just a financial instrument, There is no good or bad.
The main obstacle to unsecured and under-collateralized cryptocurrency credit is that the execution must penetrate the veil of pseudonymity to obtain real identity or assets. Fraudulent borrowers who default on credit on cryptocurrencies must be able to be blacklisted for future credit and cannot be easily circumvented by creating a new wallet address, but unfortunately this seems to go against the spirit of DeFi violated.
The problem with unsecured credit is that the lender is faced with only one address and has no way of verifying that the borrower on the other end of that address will not apply for a loan, disappear, and then create a new address to repeat the process. There are two views on how to solve this problem:
1) Authentication
Identity verification requires the borrower to submit a "full Know Your Customer" (KYC) verification, linking the wallet address to a real identity that cannot be replicated. If the address is not in use, the identity could be blacklisted from any database accessible by cryptocurrency lending providers, and the requirement for any credit loan borrower to match their wallet address to an identity would prevent borrowers from creating A new address and apply for a new loan. Currently, there are many projects developing KYC solutions where user's information (such as passport, address, date of birth, driver's license, mobile number, etc.) is stored in a decentralized manner and control over access to such information is retained. A solution that can be plugged into DeFi is still a long way off, as a publicly queried blacklist of defaulted borrowers is also required to ensure that borrowers do not commit the same fraud across multiple crypto loan providers.
2) Gamification
Gamification of cryptocurrency lending products to curb fraudulent activity has not been achieved at this stage by any single project. This approach currently takes several novel forms, including rewarding good behavior, referring or associating addresses and creating reputation points.
The authentication method aims to eliminate the possibility of fraudsters hiding behind multiple wallet addresses, while the gamification approach aims to create incentives to eliminate or minimize fraud without eliminating the pseudonymity of wallet addresses. Users can borrow from multiple addresses on the same platform, but once they default, they will be punished in the encrypted world system in a traceable and permanent manner. Or good behavior may be rewarded, prompting users to actively perform contracts. And all of this without linking their address to a real-world identity is also a possibility.
Banks leveraging DeFi platforms to lend to customers will need a source of funds. In the traditional financial system, lenders borrow money by issuing bonds to investors, who have a series of loans as collateral. There is currently no way for the blockchain to do this, but there needs to be a solution that allows lenders to meet borrowers' demand for loans through chain financing. This will be the beginning of a crypto bond market where bonds are first secured by crypto assets. The first cryptoassets to be used as collateral will be income-generating assets, as the income can be used to pay interest, thus completing the most basic debt securitization structure.
Conclusion
risk warning:
risk warning:
Be vigilant against illegal financial activities under the banner of blockchain and new technologies. The standard consensus resolutely resists various illegal activities such as illegal fundraising, network pyramid schemes, ICO and various variants, and dissemination of bad information using blockchain.
