While DeFi has set to cover a wide range of sectors, one of the most promising and extensive use lies in DeFi credit and lending. The blockchain is the crux of anything decentralized, making it possible to have an open, secured, and transparent process of loans to a larger mass of people than ever before. Even though the system is sprouting roots, there are many blanks regarding reliability. Nested in the wide spectrum of DeFi lending products and services, we now hear about DeFi credit.
Let’s learn more about Decentralized Finance credit and how it is a level above initial DeFi lending protocols.
DeFi lending is loans processed on-chain (on a blockchain) in a decentralized finance ecosystem. It evolved heavily based on protocols rather than organizational systems seen in traditional lending. Later, DeFi lending quickly transitioned from a convenient means of anonymous lending and borrowing to an entity that fully automated and decentralized lending with collaterals with protocols such as Compound and Aave.
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When DeFi lending allowed digital assets to be mortgaged on the chain, it fed a desire for yielding the maximum out of the lending and borrowing. But the risk-to-reward ratio was skewed when unsustainable digital assets were used. In DeFi 1.0, the yields fluctuated and involved multiple risks.
It has come to a common understanding that wise use of DeFi loans comes when there is a balance between the sustainability of assets and returns. DeFi 2.0 promotes transparency and stability with exposure to the least amount of risks. Since digital assets cannot provide the desired stability, investors moved on to real-world assets, where the talk of DeFi credit comes in.
DeFi credit refers to utilizing the traditional credit checks and underwriting systems for DeFi loans. DeFi loans allow borrowers to pledge their real-world assets as collateral. For example, borrowers can put their real estate assets on the blockchain and borrow an equivalent loan as stablecoins. It fulfills two main intentions among many. It increases capital efficiency as the kind of assets you can put in a blockchain are more diversified than the limited options we get for traditional loans. Secondly, Decentralized Finance credit is a direct entry into the world of DeFi, where users can leverage their assets and access the benefits without converting crypto and fiat back and forth.
Anything that does not naturally exist in the digital world is called a real-world asset. For example, they can be real estate, properties, or gold. For the purpose of Decentralized Finance credit, they are received as mortgages for processing loans. To be used, these assets are first tokenized. This means creating a digital representation of real-world assets that become legible to transact across blockchains.
Decentralized Finance credit works by bringing real-world assets on the chain for lending. Organizations such as Credix do exactly this. When the lending process is moved on-chain, it becomes transparent to liquidity providers, and processes such as evaluating portfolio performance and risk assessments become more accurate.
When we use real-world assets for credit, we can expect yields from sources that are not configured to the volatility of the crypto market. This promises a predictable and stable source of yield with a reduced risk of credit market collapse.
For example, Tecredi is a fintech organization in Brazil that offers auto financing. Investors partially finance their vehicles on-chain. The rates are lower than the average rate for this market.
There is a lack of capital and difficulty in accessing the same. Because of this, with traditional banks, credit is pretty costly in emerging markets. The Bank of England reported that cross-border payments lag in terms of speed, access, cost, and transparency compared to domestic ones.
There is certainly a high demand for loans that do not ask for attractive credit history. Most no-credit DeFi lending platforms as for cryptocurrency as collateral. But this means that the platform is generalized on the widespread adoption of crypto. While we say that only some who need a loan have enough crypto reserves to put on a chain, organizations that offer Decentralized Finance credit with real-world assets come to the rescue. That said, we now have over 320 million crypto users worldwide. In DeFi lending in the coming days, we expect an interplay of tokenizing real-world assets and utilizing crypto to reap the most benefits.
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