DeFi with 2000% Rise in Token Price, Expands Scope for Uncollateralized Loans

DeFi lending platform, Aave, has launched the provision of creating selective credit lines via Delegating Credit (DC), thereby reducing the need for collateral for loans. Stani Kulechov, the CEO and founder of Aave Lending tweeted,

By delegating credit, Karen is able to earn higher undercollateralized lending rates while depositing to @AaveAave. Chad, on the other hand, is able to source liquidity from @AaveAave without a collateral.

The loans issued via DeFi are usually categorized under ‘overcollateralized’ as the collateral of the borrowers was exceedingly safer compared to the amount lent out.

Aave’s credit delegation seems to be the introductory step towards building uncollateralized debt. Moreover, in Q4 of 2019, it was the first to introduce ‘flash loans’ which provided uncollateralized loans. However, it was later exploited by bZx attacks to increase the capital of scammers.

Moving to Credit Score

The backbone of modern finance is built on a credit system. Expansion of sustainable credit is good for the growth of the economy, but its’ hyperinflation often leads to complete destruction as it did with the housing loan bubble in 2007-2008. The growth of DeFi on the back on crypto collateral is in itself a bold experiment. Nevertheless, uncollateralized debt is still the next logical step towards growth.

Qiao Wang, the head of product at Messari tweeted,

Identity and reputation seem to be the biggest missing piece of Defi. Much of the debt in the current financial system is uncollateralized debt: mortgage, student loan, treasury bonds, etc.

Without identity and reputation only collateralized debt is possible.

Moreover, Wang also noted that ‘this obviously introduces more systemic risks’ for lenders. Nevertheless, it is positive for the DeFi industry until things go completely south. Even Kulechov added to his threat that,

Credit Delegation allows @AaveAave to scale DeFi TVL (Total Value Locked) into financial debt markets world wide, making DeFi the liquidity backbone for finance.

Unsustainable Growth or New Age of Investment?

The total value locked in Aave DeFi has risen from a mere $320,000 in January to nearly a 500 times increase over $155 million, according to DeFiPulse. The composite outstanding debt on DeFi loans topped $1 billion today with Compound Finance accounting for 79.8% of the dominance. Moreover, the above composite outstanding represents only four DeFi lending platforms namely Compound, Maker, DyDx and Fulcrum.

Last but not the least, since the cryptocurrency associated with DeFi projects like ($LEND and $COMP) do not directly leverage from the loans, but from the transactions on the platform, the increasing business of DeFi further strengthens the bullish arguments for DeFi tokens. Lend, the DeFi token for Aave is up nearly 2000% year-to-date. Nevertheless, the failure of smart contracts and other project risks continue to shake the confidence of investors.

Do you think that the DeFi borrowing and lending market are set for further expansion or you see a crack in the system? Please share your analysis with us.