Most of the current DeFi lending platforms operate in an over-collateralized manner, which means that if you want to borrow 1,000 yuan, you must first mortgage 1,800 yuan worth of ETH. The use of over-collateralization is a last resort. On a decentralized platform, if the collateral is insufficient, it is easy to have bad debts. Over-collateralization is a natural choice.
Overcollateralization also creates two problems. First of all, the low asset utilization rate means that the assets are being used in shrinking amounts. Although the mortgage rate can be reduced in a way similar to the pyramid revolving loan, it also means a higher risk of liquidation. In addition, due to the need for digital assets as collateral, it has served users in the encryption field, but it is still difficult to get out of the circle. After all, for users outside the circle, they must first buy digital assets with fiat currency, and then mortgage them to obtain stable coins.
In addition to over-collateralized loans, unsecured loans are a wider world. In the traditional financial market, we can see that the credit loan market is several times that of mortgage loans. In the field of DeFi, this track is a bright line, but due to various reasons, it is not easy to solve.
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flash loan
flash loan
Platforms such as dydx and Aave provide such services. Borrowers need to complete borrowing, transaction and repayment operations in one transaction. Arbitrage trading suitable for high-frequency quantitative traders. Although borrowing can be done without collateralizing digital assets, technical means ensure that the transaction will fail if the loan is not repaid, thus avoiding the existence of Lao Lai.
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credit model
If you have used Huabei, you should be able to understand what a credit loan is. Alipay evaluates the credit score (Sesame Credit Score) for users based on big data analysis, measures the user's performance ability, and then gives the corresponding credit line. In addition, credit rating agencies such as Fico and TransUnion will also provide consumers with similar credit ratings. DeFi unsecured lending may also take a similar approach.
The most natural idea is to introduce off-chain credit ratings into the platform. Through KYC certification and the addition of data from traditional credit rating agencies, the oracle machine is used to introduce credit data into the blockchain, so as to evaluate the user's repayment ability based on the user's credit data, thereby giving the corresponding loan amount.
This is the direction that teams such as Teller Finance and Bloom are doing. Among them, Bloom has also carried out some other explorations, such as the combination of decentralized digital identity (DID) and credit loans to realize the unsecured guarantee of DeFi. The Aesis network is also in a similar way. Through algorithmic scoring, users are authorized with a certain amount of credit and loan, and can use corresponding lending services on its platform.
Aave's unsecured lending agreement chooses the way of entrusting credit lines.secondary title
DAO pattern
The third model, which can be called DAO model, is currently the typical practice of TrueFi.The borrower submits the loan terms and applies for a loan; while a group of lenders decides whether the borrower's loan plan is feasible through voting. If the contract expires, the risk will be borne by the lender, so voting is at stake. At present, TrueFi borrowers need to pass the review of the TrustToken team (TrueFi's team) and enter the whitelist before they can initiate a loan application proposal. Currently, it is only open to institutional investors.
Unsecured loans do not require over-collateralization, but rely on credit ratings, off-chain credit data, or community reviews to determine loan approval and amount, but the problem is:How to ensure repayment?
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2. Aave: OpenLaw + CDS
In August of this year, Aave issued the first credit loan to the decentralized exchange DeversiFi. This loan comes from Karen's credit authorization, allowing DeversiFi to borrow without collateral for market making. Karen and DeversiFi signed a contract through the OpenLaw protocol. The OpenLaw protocol can associate the content of the contract with the smart contract, and also has the corresponding contract status.
Specifically, karen first signed a credit entrustment contract for borrowing with DeversiFi through the OpenLaw agreement; then the OpenLaw agreement created a corresponding credit entrustment vault (CDV), and Karen, as a credit entrustor, agreed to open a credit line to DeversiFi through operations, coexisting Into USDC. Authorized DeversiFi, as a borrower, can withdraw any funds within the limit from the CDV (Credit Entrusted Vault).
According to Stani Kulechov, CEO of Aave, “Credit entrustment is more aimed at institutional-level users, such as some price-sensitive trading institutions, who need quick and easy loans. These institutions include OTC trading departments, market makers, Traditional financial institutions looking to borrow stablecoins for cryptocurrency transactions, smart contracts set up to execute specific strategies, etc.”
In this model, the lender/credit consignor needs to trust that the borrower can repay the loan, and if there is a problem with the repayment, it needs to resort to the law. However, there have been some other supplementary measures in the follow-up to further enhance the protection of lenders.
Credit Default Swap (Credit Default Swap) is a common tool in the credit industry, which is used to protect the rights and interests of contract buyers, even in the event of default by third-party borrowers, they can still obtain income. The seller of the swap agreement charges a premium and bears the risk of default by the third-party borrower.
On August 23, Opium announced that it has created a credit default swap (CDS) product for the Aave protocol. Through opium.exchange, users who lend credit on Aave can buy CDS as insurance, and the premium paid is equivalent to credit Entrusted to buy an insurance.
Another point worth mentioning is that the assets obtained by the borrower can be limited to specific operations through smart contracts. For example, yEarn created a credit entrustment pool for Aave in August. Liquidity providers can create an entrustment pool and deposit DAI, while borrowers can obtain credit and withdraw funds from it. The use of the withdrawn funds will be limited, only It can be used in operations such as mining to reduce the risk of credit default.
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3. Teller: Off-chain credit data + local collection
In Teller Finance's solution, some elements of open finance are combined. Personal transaction data in the bank can be extracted through the bank api authorized by TellerFinance, and then based on these transaction data, the algorithm of the Teller Finance platform is run to verify credit.According to the corresponding risk parameters, the Teller platform will calculate different credit limits, and the collateral requirements for users will also be different. These risk parameters are used to monitor the user's cash flow, account balance and legal authority, and to verify the possibility of the user's repayment.
When users borrow money through the Teller platform, they need to sign an encrypted and signed document agreement. In the user agreement, they need to agree to authorize local debt collection companies to contact them. This is consistent with the traditional financial solution to debt collection.
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4. Aegis: credit score + CDS + offline collection
Similar to Teller Finance, Aegis also provides users with unsecured loans based on their credit information (out-of-chain data). Users need to complete KYC and submit a credit score to Aegis, and the Aegis network will evaluate their credit limit and assign Aegis points to the user. Scores correspond to different credit limits, and the higher the score the user gets, the greater the credit limit that can be obtained.After the account gets an initial score, it builds its own credit system by updating the Aegis score based on the user's lending and transaction activities.
Regarding the issue of breach of contract, Aegis official information shows that they consider providing three ways:
With a CDS credit default swap agreement, the seller of the CDS bears the corresponding risk.
Establish a cooperative relationship with a licensed financial institution, and file a claim against the loan user through legal proceedings in the event of a breach of contract. In fact, it is still the way of collection.
The Aegis project has set up a risk hedge fund to make corresponding repayments when problems arise.
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5. TrueFi: DAO credit evaluation
TrueFi was developed by TrueToken, a stablecoin TUSD company, and includes services for mortgage loans and credit loans, and the handling fee for credit loans will be higher.The loan application will be handed over to the holders of the TrueFi platform token TRU to vote on whether to lend.In other words, unlike Aave, Teller Finane, Aegis, etc.,TrueFi adopts the method of DAO to decide whether to lend or not through everyone's resolution.What is adopted is a collective intelligence algorithm rather than a pure data algorithm. In addition to the voting results of TRU holders after staking, the risk parameters of the platform's fund pool will also affect the final loan or not.
To borrow money through the TrueFi platform, borrowers need to go through the KYC process and submit information. In the early stage, it passed the review of the TrueFi platform and was added to the white list. Later, the restrictions will be gradually relaxed, and TRU token holders will conduct their own research before approval. There are not many borrowing applications for TrueFi, mainly from Alameda Research, a quantitative investment company. According to the team, Multicoin Capital will also join as a borrower.
Like Compound, TrueFi plans to achieve complete on-chain governance, with TRU holders making approval and borrowing decisions. In terms of borrower qualification, it plans to integrate agreements such as Openlaw.
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6. Bloom: Using DID for credit lending
In addition to the above projects, I would like to mention one more project: Bloom. Bloom represents another alternative to unsecured lendingA possible idea is to apply decentralized identity to the DeFi field, and use credit ratings to decide whether to lend or not.
Bloom is a blockchain solution for secure identity and credit scoring. Through its digital identity service, Bloom aims to give consumers a degree of control over their personal data and protect their identities.According to the project party, Bloom has spent the past few years working on building a financial services ecosystem that allows people to participate in the traditional credit system.
DID, or decentralized identity, is known as one of the holy grails of the blockchain encryption world, and many projects are chasing it. DID protocol platforms such as Bloom use externally provided data to create a credit system to assess the credit rating of those associated with a specific account as a reference for credit decision-making for credit lending services.
In contrast, platforms such as Bloom provide a set of general-purpose solutions, which means that applications such as Aegis, Aave, and Teller Finance may directly call protocols such as BloomID in the same way as calling APIs in the future to know users' transactions ratings, past defaults, etc.
Bloom has entered into a partnership with TradeUnion to provide credit monitoring services for US users. DID applications such as BloomID allow users to have more control over their own data than KYC and bank statement solutions. For example, if you need to prove your income, Bloom can temporarily access this data and create proof of income, rather than providing a bank statement with a lot of additional personal data. If you want, you can share your income verification data with multiple lenders when you apply for a loan. Users can apply for loans through the app based on their credit scores.
7. Summary
7. Summary
Although the unsecured lending field has attractive prospects and a huge market share, it can be seen from the review of several representative products in the current industry in this article that there are still not many options for dealing with the "laolai" problem.
Through the KYC process and the information submitted by the borrower (bank transaction records, third-party credit rating data or possible DID digital identity in the future), through platform screening, algorithm scoring or handing over to the community for review, it is determined whether the loan is granted or not, and the credit limit is approved size, and use a method similar to OpenLaw or a cooperation agreement to establish a cooperative relationship so that it can be recovered in the event of a breach of contract. The security of lending can also be further enhanced through CDS or smart contracts to limit transaction behavior.
However, we have to face up to this status quo: the over-collateralized loan of the pawnshop model will still be the best choice in the DeFi field in the long run. After all, it is so difficult to realize the right of recourse in the decentralized world. In the end, we still have to resort to legal proceedings or local debt collection companies. It will be very difficult to expand the credit loan method to benefit more people.
I think the more likely path is that in some regions with relatively loose jurisdiction, institutions will be the main participants in borrowing to reduce the risk of default, and also provide DeFi lenders with more stable cash flow income protection. This is also the route taken by projects like TrueFi, starting with institutions and gradually broadening participation.
Despite the difficulties, unsecured lending is still worth exploring. What we need is a more reliable solution and the hard work of some pioneers. A recent post I read came from DeFi Prime’s inventory of projects in the unsecured lending field at the beginning of the year. Many of these projects, such as Zer0Collateral, have disappeared, and it is inevitable to lament the difficulty of this road.
Disclaimer: This article is the author's independent opinion, does not represent the position of the Blockchain Institute (public account), and does not constitute any investment opinion or suggestion.
References
https://blocktrend.substack.com/p/truefi-defi-
https://realsatoshi.net/21199/
https://newsletter.banklesshq.com/p/unsecured-loans-are-coming-to-defi
https://messari.io/article/aave-announces-credit-delegation-enabling-uncollateralized-lending
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Disclaimer: This article is the author's independent opinion, does not represent the position of the Blockchain Institute (public account), and does not constitute any investment opinion or suggestion.
