From pawn shops to credit institutions: How far are we from encrypted credit loans?

From a historical perspective, the business model of DeFi is similar to that of pawnshops with a history of hundreds of years. Borrowers submit valuable collateral, and lenders issue loans to them based on the value of the collateral. But with the progress of the times, pawnshops are gradually replaced by credit loans. So, will DeFi evolve from an over-collateralized business model to a credit loan in the future? Recently, Roman Buzko, the founder of Lazzy Ventures, wrote an article on Bankless about this topic, and used this as an entry point to discuss how DeFi establishes a credit loan model and other issues. The chain catcher compiled it without changing the original intention. Today, the dominant form of lending in DeFi is over-collateralized lending. Borrowers who want to obtain $100 of DAI need to put in $150 of ETH as collateral. Of course, there are also products that are trying to carry out under-mortgage loans, but there are no successful examples yet. This article will look at various existing and not-yet-launched crypto lending protocols and what might happen next for on-chain credit lending. Today's leading DeFi lending protocols are the pawnshops of the past. As more assets enter the chain, the scope of collateral will eventually cover NFT and tokenized real-world assets. For now, though, the main headwinds are limited liquidity and poor price discovery. Undercollateralized DeFi loans will first be available to off-chain legal entities and have gained some momentum. For an individual to obtain an undercollateralized crypto loan, two things are necessary: a digital identity and a digital reputation. The main reason all loans in DeFi require over-collateralization is that both lenders and borrowers have anonymous identities in a truly encrypted manner, and the lender has no knowledge of the identity of the borrower and its reputation, and vice versa. In cases where the borrower does not have any credit score, the lender can only extend credit for less than the value of the collateral. Usually LTV (LTV = Loan/Collateral Value * 100%) must be below 100%. ConsenSys celebrates the successful merger of Ethereum and the NFT series "Regenesis" is open for casting: On September 15th, the Ethereum infrastructure development company ConsenSys ConsenSys celebrated the successful merger of Ethereum. The NFT series "Regenesis" has been opened for casting. As previously reported, ConsenSys announced that to celebrate the milestone of the Ethereum PoS merger (TheMerge), the world will be invited to participate in the minting event of its first sustainable NFT "Regenesis" launched on the Ethereum mainnet. Minting will be open to everyone free of charge for 72 hours from the date of merger, and the only cost is that users need to pay for Gas. [2022/9/15 6:58:52] According to the aforementioned formula, with a $100 DAI loan and $150 ETH as collateral, the LTV is equal to 67%. Currently, the average LTV in major DeFi lending protocols is between 50% and 80%, depending on the quality of the collateral assets. This model is not too different from what traditional pawnshops have done for centuries. In fact, pawnshops originated in China, and some of the most primitive financial primitive currencies can be traced back to the 5th century AD. Ancient Chinese pawn shops With the development of the financial industry and the emergence of various intermediaries, the pawnshop model has given way to credit loans. The main difference between credit and pawnshop business models is the relaxation of LTV (TVL > 100%), that is, lenders are willing to provide borrowers with loans higher than the value of collateral. Lenders will conduct due diligence on borrowers based on available information and assess their risk of default. This requires a non-transferable identity and data proving that identity is reputable. The current state of DeFi mimics crypto pawnshops, facilitating over-collateralized lending through autonomous protocols, thus repeating the dark ages playbook. Tesla recorded $170 million in Bitcoin impairment losses in the first half of the year: According to news on July 25, due to changes in the price of Bitcoin, Tesla recorded a $170 million impairment loss in the six months to June 30 this year. impairment. During the same period, Tesla made a profit of 64 million U.S. dollars by exchanging some bitcoins for legal currency. (Financial Associated Press) [2022/7/25 2:36:23] But the industry will move forward, let's take a look at the current situation and what may happen in the future. As mentioned above, pawnshops extend LTV-based loans below 100%. The two main business model parameters of pawnshops are LTV and collateral quality, and LTV depends on collateral quality. In the first generation of crypto pawn shops, the creditworthiness of the borrower is only reflected by the quality and quantity of collateral, but in real life many other factors are considered to evaluate the creditworthiness of loan applicants. However, in DeFi, due to the pseudo-anonymity of transactions, the situation is different. Good collateral has many qualities. According to the European Central Bank (ECB) framework, good collateral should be liquid and safe. Without a doubt, BTC and ETH are the most commonly used collateral types in DeFi lending protocols. In addition to volatility, they also seem to meet the above criteria and can be mitigated by instant liquidation of stable liquidity on decentralized exchanges. NFT as collateral The next frontier for DeFi pawnshops is encrypted assets that are currently difficult to value and have low liquidity, such as NFT-attributed assets. NFT is growing rapidly in 2021. With the surge of NFT owners, several teams have started to build NFT-specific mortgage protocols, such as NFTfi, Stater (beta product), PawnFi (just a Twitter handle, no product yet). The problem with NFT is the lack of a fixed price supply, low liquidity and opaque valuation. When the price falls, it is difficult for the system to liquidate the collateral immediately. Knowing when prices are actually falling is equally challenging given the secondary nature of the market. Italian luxury shoe brand Giuseppe Zanotti released 1,000 COBRAS sneakers NFT: Jinse Finance reported that Italian luxury shoe brand Giuseppe Zanotti officially entered the encryption market and reached cooperation with NFT communities DeadFellaz and neuno Marketplace, and held a three-day event on Decentraland Metaverse fashion event. In addition, Giuseppe Zanotti also issued 1,000 NFTs for its well-known sports shoe brand COBRAS. Users of this NFT can not only use digital sports shoes to dress up virtual avatars to express their personality, but also get a 20% discount when purchasing physical sports shoes. [2022/3/26 14:19:08] One of the ways to solve the lack of liquidity and price discovery is to tokenize NFTs into ERC20 and trade them on DEX. NFTX and NFT20 are doing just that. Of course, there are many types of NFT. The question is what type of mortgage is used as collateral for DeFi loans first. Based on the quality of collateral mentioned in the aforementioned ECB document, the most liquid and easily valued NFT will be prioritized as collateral in DeFi lending. So as mentioned above, tokenized NFT will be the first to become collateral, followed by NFT assets from games and metaverse. The reason is that game assets usually have specific digital utility (more advanced skins, stronger weapons, etc.), and are also more likely to have continuous price supply and deeper liquidity in their respective ecosystems. However, for NFT assets to be used as game assets, they should not be isolated by the corresponding game ecosystem. Real World Assets After traditional crypto assets and NFTs, the next generation of collateral is tokenized real world assets (RWA). Fiat currencies, real estate, gold, securities (stocks and bonds), invoices, tickets, etc. can all be used as collateral for lending and borrowing on the blockchain. Fiat currencies and real estate have been tested as collateral in DeFi lending protocols (USDC in MakerDAO and RealT token in Aave). In addition to the standard quality of eligible collateral, tokenized RWA is subject to idiosyncratic risks arising from the tokenization process. Exchange Traded Concepts plans to launch NFT company-related index ETF: March 12 news, ETF issuer Exchange Traded Concepts is planning to launch an index-tracking ETF for NFT companies. The Fount Token Economy ETF will track the performance of companies that develop, manufacture, distribute or sell products or services in token technology sub-sectors, including arts and entertainment, gaming, blockchain technology and NFT infrastructure. According to the regulatory filing, “The one-year forecasted revenue of each token economy company is reviewed, and only companies that expect more than 50% of their revenue to come from the token technology sub-sector can be included in the index.” It is reported that Exchange Traded Concepts last October Launch of the Fount Metaverse ETF (MTVR), which manages approximately $11 million in assets. (Blockworks) [2022/3/12 13:53:03] 1) Is there an issuing entity behind USDC, such as Circle Internet Financial Limited? 2) How transparent is the issuing entity? 3) Are reserve assets auditable? 4) Where are the assets actually held in real life (banks, custodians, etc.)? 5) Do these assets require any specific storage or maintenance procedures (eg, gold)? 6) If the issuing entity is a country, what are the political risks? 7) Is there a reliable legal enforcement framework to rely on in the event of borrower default? Additionally, certain RWAs may be subject to special rules such as KYC/AML and transferability requirements. These will affect the scoring of such assets for collateral purposes and may even make such assets untradable globally. Therefore, two conditions must be met for encrypted pawnshops to shift from over-collateralization to a more capital-effective lending method: digital identity and digital reputation. Point72 Ventures may invest in 5 to 10 crypto companies next year: Jinse Finance reported that Adam Carson, operating partner and head of crypto investment at Point72 Ventures, said that the company may invest in 5 to 10 crypto companies next year, and may even make some token investments. It is reported that Point72 Ventures is a branch of billionaire investor Steven Cohen's Point72 Asset Management Group. So far, Point72 Ventures has only publicly announced investments in four crypto companies, including Messari, Zero Hash, 24 Exchange, and Massive. [2021/12/4 12:49:58] Requirements for the transition from the pawn shop business model to credit loans (under-mortgage loans): the non-transferable identity of the borrower, and some information about their creditworthiness (credit score). The identity should not be transferable because otherwise the lender will never be able to determine who is behind the identity and whether the credit score really belongs to that individual. Enterprise DeFi Lending From a legal perspective, there are two types of actors in this world: natural persons (individuals) and legal entities (companies). The former has been around for a long time, but the latter is relatively recent. One of the earliest legal entities was the Dutch East India Company (VOC), founded in 1602. In this sense, the age of a legal person is 1/750 of that of a natural person. However, compared to individuals, companies are the first to take out undercollateralized DeFi loans. Projects under construction in this space include: TrueFi, Maple Finance, Goldfinch, Centrifuge. These agreements look more like traditional banks, which originate with borrowers, assess their creditworthiness, and enter into legally binding loan agreements. The main difference between these agreements and regular banks is the source of funding. Banks get funding from deposits, while these protocols get funding from anonymous (like TrueFi) or non-anonymous (like Centrifuge) crypto-native investors. The borrowers of these agreements are usually well-known names in the encryption industry, such as encryption exchanges, miners, encryption funds, etc. This can be used as a proxy for credit scoring to ensure alignment of value between borrowers and lenders. Whether enterprise DeFi lending will achieve measurable goals depends on whether these protocols can meet demand and supply. From a demand-side perspective, the question is whether these platforms will be able to originate enough corporate borrowers willing to take out cryptocurrency loans at a given interest rate. Potential crypto DeFi borrowers are likely to be companies (or DAOs) that cannot obtain loans in traditional financial markets (banks, bonds, etc. lines of credit). Additionally, crypto DeFi borrowers may use loan proceeds for crypto-related purposes. These two factors automatically place such borrowers in a high-risk category, making credit scoring a key factor. From a supply-side perspective, the focus is on whether the interest rates offered by lending protocols are sufficient to attract crypto investors. Obviously, interest rates can't be very high, because that would scare away borrowers. To compensate for this, DeFi protocols that operate corporate lending businesses can offer their native tokens to liquidity providers. It's unlikely we'll see a big jump in corporate DeFi lending, but there's certainly room for it. The growth of these protocols is limited by the speed at which new borrowers can be initiated, requiring business development teams to market and requiring traditional due diligence on borrowers. The competition between these platforms will be very similar to the competition in the traditional world, and some agreements may even employ bank executives. The implication is that when this cycle reverses, we could see the first corporate defaults on crypto loans within the next few years. This presents interesting legal challenges. Someone has to explain to a judge how a decentralized autonomous organization (DAO) issues loans from an anonymous pool of creditors. Personal Consumption Loans Unlike corporate DeFi loans, providing undercollateralized loans to individuals in a decentralized manner is more complex, primarily because the cost of underwriting a consumer loan greatly exceeds the expected return on originating the loan. Associated costs include due diligence, credit risk assessments and potential execution costs. Unlike corporate borrowers, individuals typically seek smaller loan amounts, so it may not be possible to spread such costs across the loan application in a cost-effective manner. Additionally, consumer lending is also a regulated business in many jurisdictions, so a successful implementation of a DeFi consumer lending protocol is likely to draw the attention of regulators.

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