We looked at how the legacy of closed financial institutions is evolving towards an open economy by employing blockchain technology and open protocols that interact with smart contracts, utility tokens, and cryptocurrencies in our essay on the principles of DeFi. We'd say DeFi is the money of the future, but it's already here, and it's not going anywhere.
Okay, but how does it work in practise? We'll explore the numerous real-world uses of DeFi technologies in this series of blog postings so you can learn how to interact with them – and even start your own DeFi project!
Defining DeFi Peer-to-Peer Loans
The concept of peer-to-peer lending and borrowing is one of DeFi's most significant innovations. There are currently hundreds of DeFi projects available that allow users to directly borrow and lend crypto assets to one another without the use of an intermediary such as a typical fiat bank.
For hundreds of years, anyone seeking a loan had to win favour with a credit organisation by submitting a loan request and relying on the institution's opaque decision-making process to determine whether or not the loan would be approved. Finally, after days or weeks of waiting, you may be approved for a loan, subject to certain strict conditions.
This is required from the lender's standpoint to ensure that the person receiving credit is trustworthy and capable of repaying it with interest. This approach, however, is ultimately reliant on a thorough grasp of a person's or company's credit history.
DeFi loan applications, on the other hand, eliminate the bureaucracy in lending and borrowing transactions through peer-to-peer lending. The trading app can collect crypto assets from people who want to lend them out to those who need money. All of this would take place through a smart contract, which would not be regulated in the same way that a typical loan is. By employing crypto assets as collateral, the risk is reduced.
Individual investors that are willing to lend their own money for a set or variable interest rate governed by a smart contract provide funding to borrowers. Both parties can connect through a decentralised peer-to-peer lending platform like Oasis for DAI or Aave, where investors can examine potential creditors to determine whether the risk of lending to them is warranted.
RealT Market, which specialises in the tokenization of real estate, has teamed up with Aave to allow users can utilise their tokenized real estate as collateral for decentralised loans.
Flash Loans are an intriguing invention that has appeared on some platforms. As the name implies, these can be obtained fast and at a cheap interest rate without the requirement for any collateral. They rely on the swift timing of the payback within the same transaction as a tradeoff. The smart contract will automatically authorise a flash loan request if it is paid back within the same transaction period. If this does not occur, the loan will default, and the assets will be returned to the original owner. Users that want to exploit the liquidity to conduct a profitable arbitrage trade (such as taking advantage of price disparities between energy and commodities markets) between different decentralised exchanges usually leverage flash loans.
DeFI loans have several advantages over traditional loans.
Giving and receiving DeFi loans is a full game-changer that no one interested in finance can ignore due to a high level of control, security, privacy, and accessibility. The following is a list of all the advantages that users of such applications can enjoy:
Privacy - a loan can be taken out or paid out without revealing who is on the other end of the transaction.
Due to the permissionless nature of DeFi applications, getting the loan or payout is also faster.
Control — Because no single person or institution has complete control over the money being transferred, the possibility of fraud is greatly reduced.
Accessibility — While blockchain-based credit services like Nexo do not require a credit score or history, they can nevertheless provide quick loans in both crypto and fiat currencies.
Transparency — Anyone may monitor the blockchain and trace their transactions by logging into their crypto wallet, such as MetaMask.
Crypto assets are the ideal collateral since they can be rapidly liquidated as needed to repay a loan, posing essentially little risk to the lender.
Options: There are a plethora of assets to pick from, and the list is constantly expanding. Indeed, DeFi lending services allow users to borrow or lend a variety of crypto assets.
Easy to use — The majority of them feature a simple dashboard where you can check the variable interest rate of any listed crypto asset, lend, borrow, and make payments.
DeFI loans have disadvantages over traditional loans.
The major disadvantage of DeFi lending and borrowing for the is an undisclosed risk, as Ethereum founder Vitalik Buterin pointed out on June 20, 2020.
This is due to the fact that it functions differently from a fixed-term loan. Instead, technology like Compound constantly changes the interest rate. When comparing DeFi loans to typical fixed-income investing, there is enough variance to point out even with the accepted promise of implied continuity.
“The risks of DeFi lending at any level are rather high, and the returns are uncertain,” according to David Siemer, CEO of Wave Financial Group. “[Risks are] increased by the leverage permitted by smart contract implementations, and returns are made even more uncertain by their reliance on the volatile price of token rewards.”
Keeping this in mind, it's critical not to be misled by the hype and to conduct your own study before lending or borrowing on the blockchain system. For example, in the case of Aave and RealT, the risk is considerable because a defect in the smart contract or a hack might result in someone losing their home.
In 2021, you'll launch your own DeFi loan and borrowing platform.
The money legos world of Ethereum could be the key if you're prepared to experiment and stand out in the loan and borrowing industry. If you don't currently have the resources to design and launch your own DeFi project, you can hire a DeFi blockchain development firm to assist you in determining how to tokenize your services or industries.
What does the future hold for DeFi credit trading?
Regardless of the hazards, it's almost certain that the old school trading world will be dragged more and more into DeFi in the next years, and banks will borrow some of the DeFi space's mechanisms in terms of more transparent lending, borrowing, and notably collateralized loans. We predict that traditional “brick and mortar” banks will begin to wake up and attempt to grapple with this amazing shift in the dynamics involved in lending and borrowing as the ecosystem of “money legos” continues to stack on top of the Ethereum blockchain, compounding the value of the individual technologies. Meanwhile, our team will be working on the next generation of DeFi trading apps.