Decentralized Lending and Borrowing
Note: Data in this section last updated March 13th, 2022
What are Decentralized Loans?
Decentralized lending operates on peer-to-peer lending platforms that allow anyone to give and receive loans without using a bank or other third-party intermediary.
Outstanding DeFi Loans as of Late 2021
According to Defi Pulse, as of late 2021 there were $23.25B outstanding DeFi loans, up over 500% from the previous year.
How Are Decentralized Loans Different from Traditional Loans?
In traditional finance, borrowing and lending is facilitated by banks or other financial institutions. While some Fintechs have introduced peer-to-peer lending, the mechanics are largely similar, as both methods rely on centralized parties and require detailed onboarding, credit checks, KYC and underwriting.
Once again, DeFi does things in a totally different way.
Instead of relying on a bank or third-party platform to serve as a matching agent, DeFi lenders contribute their assets to a pool and encode the rules of the loan into a smart contract. These pools use a mathematical formula to calculate interest rates.
When a borrower wants to take a loan, all they have to do is deposit some cryptocurrency for collateral (generally overcollateralizing by 133% to 150%) and they are free to take the loan. This process requires no KYC, no credit checks and no legal documentation. In fact, you don’t even have to give anyone your name!
Once they’re done with the loan, borrowers can simply pay back the principal plus interest and get their collateral back.
The fact that these loans are collateralized with such a liquid instrument has a few unique consequences:
Lenders have zero default risk – if the borrower fails to repay or if the collateral goes below a certain threshold, it’s immediately liquidated and paid to the lender
There are no repayment schedules or any obligation to repay at all. Borrowers can keep the loan as long as they want providing that the collateral remains in good standing
Indeed, decentralized loans offer several advantages over their traditional counterparts. They are:
Permissionless: Anyone with collateral can get a loan, and they can do it anonymously
Faster: Decentralized loans are settled instantly
Cheaper: As there is no need for loan documentation, underwriting, KYC, etc… decentralized loans often cost a fraction of their traditional counterparts
All this said, decentralized loans are not without risk, as they are still susceptible to the smart contract risk and rug pulls that we’ve discussed above.
Who are the Key Players in the Decentralized Lending Market?
The three largest players – MakerDao, Anchor and Aave – control over 63% of the lending market’s Total Value Locked (the value of assets deposited into smart contracts pools by lenders and borrowers).
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