Lending has emerged as one of the most popular and practical use cases in the blockchain-powered financial products sector known as decentralized finance (DeFi). Ability to borrow high-value assets without the middle man, say?
That’s part of it, but there’s more to the story.
So what is decentralized lending, how is it different from traditional lending, and what are the prospects for this relatively nascent category of financial products?
What is Devolved Lending?
Devolved lending mechanisms are fundamentally similar to traditional lending:
- One person borrows assets, doing so in return for interest payments (and in some cases, additional rewards)
- Another person borrows assets, paying interest payments for the right to finance right away
Instead of dollars, however, decentralized lending relies on cryptocurrency as a medium of exchange. Various platforms exist where consumers can engage in transactions related to lending (more on that later).
Smart contracts are the mechanisms that facilitate devolved borrowing. These contracts are self-operating protocols that may have multiple functions (issuing interest payments, enacting variable interest rates, and implementing other loan terms, for example).
These contracts are unbiased, incapable of isolation from flawless incentives or bad faith tactics, and allow all participants in a lending transaction to see exactly where they stand at any given time. That is, they are not banks.
What is Devolved Lending Ownership?
Investment in decentralized lending platforms has completely skyrocketed in 2020, but why?
Widespread distrust of traditional financial institutions can play a large role in bullishness towards DeFi lending. CNBC explains how millennials in particular have shown warmth toward traditional banks, citing the Great Depression among the reasons for skepticism.
With banks having to keep 0% of customer deposits on hand, per the Fed, it appears that a willingness to try non-traditional financial products is rife. Consider the proposed benefits of devolved borrowing:
- Instead of having a financial institution with a good track record on your financial transaction, DeFi lending allows a smart contract to execute the transaction
- For lenders, interest rates on some DeFi lending platforms it can earn much more than the space for other central investment options
- Instead of a large, faceless bank benefiting from lending, DeFi lending offers a peer-to-peer experience
- Lower barriers to securing a loan than are present in traditional lending processes (if you have the necessary crypto collateral, you may generally be able to secure the loan you are seeking)
From an investor perspective, cryptocurrency lending can prevent having to sell existing poles in crypto, which could come with fees and opportunity cost. Based on the massive infusion of capital on DeFi lending platforms over the past few months alone, it is clear that the benefits of decentralized lending have legitimate appeal.
What is the Current State of Devolved Lending?
DeFi Pulse’s DeFi Inventory sheds light on 12 separate devolved lending platforms. The amount of digital assets tied up in decentralized lending platforms is significant, with leading platforms Compound, Maker, and Aave together accounting for well over $ 3 billion in digital assets alone. DeFi Pulse maintains a running account of all the “lock-in” assets of the DeFi lending industry.
$ 3 billion and change is noteworthy, and becomes even more impressive when considering that DeFi’s lending markets have seen a massive infusion of capital in 2020. Yet, decentralized products for lending and lending seem modest from their compare with traditional lending. Outstanding consumer debt issued through central sources more than $ 13 trillion.
The significant asset gap between DeFi lending platforms and traditional lending institutions is informative, but says little about the long-term viability of DeFi lending. Established financial institutions have a lead on decentralized alternatives (2016 spawned the earliest DeFi lending platforms) must be taken into account when making comparisons.
DeFi’s lending platforms must be evaluated on their own merits, rather than compared to central alternatives. Through this lens, decentralized lending is a product on which investors are very bullish.
Some have observed Transfer of DeFi lending from “specialist” to “mainstream” (injecting billions into capital in a few months will have that effect). The de facto marriage between the Ethereum blockchain and DeFi lending products it’s a blueprint, and at this point DeFi lending is well established as a force in the projected financial markets of the near and far future.
How Do Regulators View Devolved Lending?
If there is one potential threat to DeFi’s lending, the one concern that clouds the crypto sector more widely: regulation.
Publications such as Reuters has thrown up terms like “freewheeling” to describe the state of crypto lending. These types of terms are, in general, the kind that tend to catch the eye of regulators.
With its huge and growing popularity to the tune of billions of dollars invested, there is no doubt that talks about DeFi’s lending have already taken place at the offices of the Securities and Exchange Commission (SEC). But one question remains unanswered: how, exactly, will the SEC handle DeFi’s lending platforms?
There is some fear that these platforms will receive similar treatment to Initial Cash Offering (ICOs) treatment. In 2018, ICOs became involved in unsafe phrases such as “securities fraud” and “conspiracy” when the SEC took legal action against several crypto companies. CNBC takes on the SEC message: “new digital financial products must follow traditional securities rules”.
If this is the case with DeFi lending platforms, then there may come a time when regulators begin to enforce the “traditional securities rules” to which devolved lending products may or may not be subject.