Decentralized lending
One of the most difficult tasks that most blockchain developers are confronted with, is to understand which real life problems can be solved using a fully decentralized system, that a conventional database was not able to solve in the past. Well, one obvious application has so much disruptive potential, that it is almost untouched by the broad community: fully decentralized peer-to-peer lending using smart contracts on the Ethereum blockchain.
In order to understand, why decentralised lending is the next logical step in the development for financial solutions on the blockchain, we need to understand what our current lending system fails to achieve.
Conventional lending is centralized and limited to the locations where banks and financial institutions operate. There is no worldwide system that gives people direct access to a global lending market. Conventional lending is institution-to-people, institution-to-institution or people-to-people, but supervised and regulated by an intermediary.
Fully decentralized lending on the blockchain gives the power to the people, encourages competition, discourages monopolistic power and allows the access to a global lending market. Anyone has the ability to participate, independent from his/her location, circumstances, believes, appearance or whatever the reason might be for getting rejected. Someone from Canada has the possibility to lend or borrow from someone in China instantaneously. Therefore, lending is no longer restricted by local markets.
This inconvenient centralized structure creates another fundamental hurdle for global lending: interest rate differences! Today, the inflation-adjusted interest rate in different countries varies based on the available liquidity. In high liquidity markets such as Europe, interest rates are between 0.5-5 percent, in Russia 12-15 percent, in India 12 percent and in Brazil 32 percent. This shows a clear inequality on how access to the lending market is distributed. Interest rates for micro loans are on average between 30-40 percent, making borrowing in underdeveloped countries almost impossible. Interest rates for decentralized lending on the blockchain are solely agreed upon participants, which means that people from underdeveloped countries have the same access to lending as people from highly liquid markets and more importantly, competitive interest rates!
Inefficiency and trust is another flaw, which can be solved using decentralised lending backed by Smart Contracts. Traditional lending requires a lot of bureaucracy, human capital, supervision and time. Even the most efficient P2P-lending FinTech companies consume up to three days until a loan request is processed. This process can be automatized using a lending platform that works with Ethereum Smart Contracts, which can provide on-demand lending and secure collaterals in the Smart Contract, that automatically distribute funds back to the lender in the case of a default. The fact that Smart Contracts are secure by design, eliminates the need for a trusted party that supervises the loan agreement.
In the current state, lending is unfair and not everyone has equal opportunities to participate in the financial market. Looking at the extreme case, we have over 2 billion people without access to finance. The most common reason is that people from poor countries have no official identification as well as registration documents and thereby no bank account. Other reasons include innocent civilians that suffer from political tensions between governments, often being excluded due to sanctions, corruption or even war. Decentralized lending on the blockchain enables financial global inclusion and can bring an end to the obstacles created by governments. It is statistically evident that countries who experienced financial inclusion, are more likely to developed positively, than those who are excluded from finance. These obstacles can be cured by the adoption of decentralized lending.
For more information about ETHLend, read the full White Paper here.
Author: @sergej.stein
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Borrowing in a deflating currency is a horrible idea. I hope you have high inflation. The most important characteristic of a currency I would want to borrow is stability.
Tell this to the people that pay 40% interests on micro loans. I personally prefer freedom of value, instead of never ending dependence from banks.
I think crypto currency has a little way to go before true peer to peer lending is realised. Normally the regulatory burden in relation to lending is to afford protection on both sides of the contract, and will be backed up by statue. A smart contract might limit the lenders risk, for there will be limits to the types of collateral that can be wrapped inside them, and the fact that collateral would be required will also act as a drag on the wider adoption of them. How would a US lender enforce a contract on a Chinese borrow for example. Also you have the problem of due diligence which is a problem that cannot be easily solved by the blockchain.
Nosajj, I like your comment. Indeed regulation is for protection. Decentralized lending can work within regulation as well. I think this is more of a question of adopting technology that is way more advanced than the current banking system. Currently there are jurisdictions where centralized p2p lending is regulated, and jurisdictions where it is not. Factually I do not see a regulatory an issue when it comes to decentralized lending. I would like to link this to the Due Diligence (KYC, I presume) question. As a person with legal background, I have followed the discussions on legal conferences etc. about KYC and the issue of how it could be adopted in blockchain. However, I noticed that many discussions are related to what is KYC and the compliance behind it. No one proposes any workable solution. Maybe that is the nature with the legal people. We tend to find risks, not solutions. Factually, in my opinion KYC is quite easy to perform on decentralized environment. There is no restraint for me adding a link to data which contains DD material or filling up a questionnaire for review. The data could be even stored with Storj which would be decentralized. This how easy KYC really is. Moreover, thresholds (such as the loan amounts, new borrower, changes) could be added to alarm when KYC is required. We legal people always over analyse things due to the fact that we need to find risk and comply with the risk. Yet we do not usually provide the solution on how to achieve it. On the contractual issue and enforcement of the loan agreement: the easiest way to approach the question is to ask, how would it be done in centralized environment? You do not pay me, I will enforce the payment, what do I need? A contract. Contract or contractual relationship between the lender and the borrower can be established via Terms and Conditions between the lender. This would become a binding contract and can be enforced (of course some jurisdictions might require handwritten signature or even a notarization). However, if we do not know the counter party that could create an issue (of course if KYC'eed, not the case). Therefore, what actually Smart Contracts can perform is the security or create trust on the decentralized lending. This means that by using a collateral such as ERC-20 token or ENS domain, the lender can fund loans that are could regain the loss of capital on default. Therefore, we would not need to escape on centralized enforcement of the loan contract, since the lender can simply sell the token or auction the domain name to regain losses. I agree that wider adoption is limited due to collateral. However, reputation system can be used to borrow as well or self-sovereign identity for unsecured lending. I think the adoption is subject to the development on crypto/token economy itself, of course since decentralized lending needs decentralized economy.
I think that the concept itself will definitely be realised, but further down the road. As we move to bio metric and cloud based ID identification, it will be easier to perform the due diligence as it will just be reaching out to an API. What I still think will be the biggest stumbling block will be enforcing the contract, as different jurisdictions have different rules in relation to contract law. For instance which jurisdiction would be responsible for the dispute process, the buyers or lenders. I think the next step for p2p lending will be to mature the technology and processes within one jurisdiction because the above issues simply will not apply. The greatest test for the people around this industry will be to find out how they can scale that cross border in way that ensures confidence for both the borrower and lender.
I agree. The enforcement is difficult. That is the reason ETHLend uses collaterals such as ERC-20 tokens or ENS domain, to regain any defaults. We are introducing unsecured lending as well based on reputation. Would be great to solve the enforcement issue if lender wants to regain the lost loan capital. I think going jurisdiction by jurisdiction is not the right way. On the bio metric, I had lot of research on it, there are still some security isses, for example if one leaves fingerprint or shows a thumb on a picture, it could be compromized, some hybrid system would definitely work. Now we are keeping the ethlend so that enforcement is not necessary due to the collateral. However, once secured loans are in place, we definitely should consider how to enforce the defaulted debt.