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Decentralized finance (“DeFi”) lending, one of the fastest-growing sectors in the decentralized ecosystem, could eventually make inroads into the real economy if it becomes less reliant on collateral, the BIS said in a recent report, adding that it also needs to better represent real-world assets on the blockchain via tokenization.
Note that DeFi lending platforms like Aqru and DeFi Swap allow anonymous users to lend and borrow cryptocurrencies at high interest rates that far exceed what traditional lenders offer to depositors. The problem is that DeFi lending relies heavily on borrowers pledging crypto collateral, limiting “access to credit to borrowers who are already asset-rich,” the BIS said. If high price volatility takes hold in digital coins — as is the case now — “there is overcollateralization: the collateral required tends to be much higher than the loan size.”
Another concern is the lenders offer crypto loans without a central intermediary like a consumer bank, making it near impossible for these crypto lenders to assess borrowers’ creditworthiness and whether they can pay off loans in a timely manner.
Moreover, “anonymity and dependence on collateral are incompatible with DeFi’s aspiration to democratize finance: collateral-based lending only serves those with sufficient assets, excluding those with little wealth,” the BIS pointed out. “The dependence on crypto collateral also prevents real-world use cases,” which is why tokenization “will be essential to overcome DeFi’s self-referential nature and requires both technological improvements and updated legal frameworks.”
It wasn’t until the end of 2020 when DeFi lending started to emerge. The total value locked in DeFi lending protocols stood at $50B in Q2 2022, up from almost zero at end-2020, but down from an all-time high of around $240B in Q4 2021, as “the recent collapse of Anchor on the Terra blockchain and Celsius’ restrictions on withdrawals…
