Most of the current DeFi lending platforms operate in an over-collateralized manner, which means that if you want to borrow a thousand dollars, you have to mortgage ETH worth 1,800 yuan first. The use of over-collateralization is a last resort. On a decentralized platform, if the collateral is insufficient, it is easy to have bad debts. Over-collateralization is a natural choice.
Over-collateralization also brings two problems. First of all, the low asset utilization rate means that the assets are being used in shrinkage. Although the mortgage rate can be reduced in a way similar to the pyramid revolving loan, it also means a higher risk of liquidation. In addition, due to the need for digital assets as collateral to serve users in the encryption field, it is still difficult to get out of the circle. After all, for users outside the circle, they must first buy digital assets with legal currency and then mortgage to obtain stablecoins.
In addition to over-mortgage loans, unsecured loans are a broader world. In the traditional financial market, we can see that the credit loan market is several times that of mortgage loans. In the DeFi field, this track is an open line, but due to various reasons, it is not easy to solve.
Readers should understand that the field of DeFi unsecured lending is still in its infancy. After all, DeFi itself has not been around for long. This article briefly sorts out how relevant project parties in this track try to solve related problems in unsecured lending.
1. In addition to over-collateralization, what other methods are there?
As far as I can see, DeFi unsecured lending can be achieved in three ways.
Flash loan
Platforms such as dydx and Aave provide such services. Borrowers need to complete borrowing, transaction and repayment operations at the same time in a transaction. It is suitable for arbitrage trading of high-frequency quantitative traders. Although it is possible to borrow without collateralizing digital assets, it uses technical means to ensure that the transaction will fail if the payment is not repaid, thus avoiding the existence of the old problem.
However, flash loans are also the cause of frequent accidents. In addition to the platform's own security issues, there have also been cases of arbitrage taking advantage of the design flaws of DeFi products.
Credit model
If you have used Huabei, you should be able to understand what a credit loan is. According to big data analysis, Alipay evaluates users' credit scores (sesame credit scores), measures the users' ability to perform contracts, and gives corresponding credit lines. In addition, credit rating agencies such as Fico and TransUnion will also provide consumers with similar credit ratings. DeFi unsecured lending may also adopt a similar approach.
The most natural idea is to introduce off-chain credit ratings into the platform. Through KYC certification and the addition of data from traditional credit rating agencies, the oracle is used to introduce credit data to the blockchain, so as to evaluate the user's repayment ability based on the user's credit data, thereby giving the corresponding loan limit.
This is the direction that Teller Finance, Bloom and other teams are doing. Among them, Bloom has also carried out some other explorations, such as the combination of decentralized digital identity (DID) and credit loans to realize DeFi's unsecured guarantee. The Aesis network is also in a similar way. Through algorithmic scoring, users are authorized a certain amount of credit loan, and the corresponding loan service can be used on its platform.
Aave's unsecured lending agreement chose the way of entrusting credit lines . Depositors in the Aave agreement will have a corresponding credit line, and they can entrust their credit line to the borrower, so that the borrower can obtain the loan without collateral. In this way, the user who entrusts the credit line becomes the ultimate guarantor of the borrower, and the loan terms are negotiated through the OpenLaw agreement between the two to ensure the execution of the repayment.
DAO mode
The third mode can be called the DAO mode, and the current one is the TrueFi approach . The borrower submits the loan terms and applies for the loan; and the group of lenders decides whether the borrower's loan plan is feasible through voting. If the contract expires, the lender will bear the risk, so voting interests are at stake. At present, TrueFi borrowers need to pass the TrustToken team (TrueFi's team) review and enter the whitelist before they can initiate a loan application proposal. Currently, it is only open to institutional investors.
Unsecured loans do not need to be over-collateralized. Instead, they rely on credit ratings, off-chain credit data, or community reviews to determine loan approval and limit. The question is: how to ensure repayment?
The solution to the problem of default is generally divided into two parts: qualification review and loan recovery. Qualification review is used to ensure that the borrower is relatively reliable, and this process is relatively centralized; while the recovery of loans is mainly offline litigation and claims. Let's take a look at the solutions of platforms such as Aave, TrueFi, Teller Finance, and Aegis, the main products in the current DeFi field.
2. Aave: OpenLaw + CDS
In August this year, Aave issued the first credit loan to the decentralized exchange DeversiFi. This loan came from Karen's credit authorization, allowing DeversiFi to borrow money for market making without collateral. Karen and DeversiFi sign a contract through the OpenLaw agreement. The OpenLaw agreement can associate the contract setting content with the smart contract and also has the corresponding contract status.
Specifically, karen first signed a credit entrustment contract with DeversiFi for borrowing through the OpenLaw agreement; then the OpenLaw agreement created the corresponding credit entrusted vault (CDV), and Karen, as the credit entruster, agreed to open credit lines to DeversiFi through operations, and coexisted Enter USDC. The authorized DeversiFi, as a borrower, can withdraw any funds within the limit from the CDV (Credit Entrusted Bank).
Aave CEO Stani Kulechov said, “Credit entrustment is more for institutional-level users, such as some price-sensitive trading institutions, who need fast and easy loans. These institutions include over-the-counter trading departments, market makers, Traditional financial institutions seeking to borrow stablecoins for cryptocurrency transactions, as well as smart contracts set up to implement specific strategies."
Under this model, the lender/credit entruster needs to trust that the borrower can repay the loan, and if there is a problem with the repayment, it needs to resort to law. However, there are other supplementary measures in the follow-up to further enhance the protection of lenders.
Credit Default Swap (Credit Default Swap) is a common tool in the credit industry to protect the rights and interests of contract buyers. Even if a third-party borrower defaults, it can still obtain benefits. The seller of the swap agreement will charge a premium and bear the risk of default by the third-party borrower.
On August 23, Opium announced the creation of a credit default swap (CDS) product for the Aave agreement. Through opium.exchange, users who lend credit on Aave can buy CDS as insurance. The premium paid is equivalent to credit Entrusted to buy an insurance.
Another point worth mentioning is that the assets acquired by the borrower can be restricted to specific operations through smart contract restrictions. For example, yEarn created a credit delegation pool for Aave in August. Liquidity providers can create a delegation pool and deposit DAI, while borrowers can obtain credit and withdraw funds from it. The use of the funds withdrawn will be restricted. It can be used in operations such as mining to reduce the risk of credit default.
On the whole, Aave's credit products should be said to be still in the proof-of-concept stage, running through the initial process. According to Aave's official introduction, governance will be introduced in the future to allow more borrowers to participate. But this innovative approach of Aave has provided a demonstration for many other DeFi projects, and I also look forward to seeing more innovations in DeFi in the field of credit lending.
3. Teller: Off-chain credit data + local collection
In Teller Finance's solution, some elements of open finance are combined. Personal transaction data in the bank can be authorized and extracted through the bank api accessed by TellerFinance, and then based on these transaction data, run the algorithm of the Teller Finance platform to verify credit. According to the corresponding risk parameters, the Teller platform will calculate different credit limits, and the collateral requirements for users will also vary. These risk parameters are used to monitor the user's cash flow, account balance, legal authority and other conditions, and to verify the user's possibility of repayment.
When borrowing through the Teller platform, users need to sign an encrypted and signed document agreement. In the user agreement, they need to agree to authorize the local debt collection company to contact them, which is consistent with the traditional financial settlement collection method.
The figure shows the operation page of Teller Finance. After selecting the unsecured loan method, you need to link to the bank to obtain personal transaction data at the bank for verification and obtain the corresponding credit rating.
4. Aegis: Credit score + CDS + offline collection
Similar to Teller Finance, Aegis also provides users with unsecured loans based on users' credit information (off-chain data). Users need to complete KYC and submit credit scores to Aegis. The Aegis network will evaluate their credit limits and give users Aegis points. The score corresponds to different credit lines. The higher the score the user gets, the larger the credit line that can be obtained. After the account gets the initial score, the Aegis score will be updated based on the user's borrowing and transaction activities, in this way to build your own credit system.
Regarding the issue of breach of contract, Aegis official information shows that they consider three ways to provide:
- Using CDS credit default swap agreements, CDS sellers cover the corresponding risks.
- Establish cooperative relations with licensed financial institutions, and file claims against loan users through legal proceedings in the event of breach of contract. In fact, it is still a collection method.
- The Aegis project has set up a risk hedge fund to make corresponding repayments when problems arise.
According to the official roadmap, credit lending products will not be launched until the first quarter of 2021. Relatively speaking, Aegis may have a lower threshold for non-institutional users, but it still uses a centralized method to select lenders’ qualifications by the platform’s data algorithm, which is a method that many projects tend to adopt when they start. .
5. TrueFi: DAO credit evaluation
TrueFi is developed by TrueToken, a company that is the stable currency TUSD, and includes services for mortgage loans and credit loans. Credit loans have higher handling fees. The loan application will be handed over to the holders of the TrueFi platform token TRU to vote on whether to lend. In other words, unlike Aave, Teller Finane, Aegis, etc., TrueFi adopts a DAO method to decide whether to lend or not through a crowd's decision. It adopts a collective intelligence algorithminstead of a pure data algorithm. In addition to the voting results after the pledge of TRU holders, the risk parameters of the platform's fund pool will also affect the final loan.
To borrow through the TrueFi platform, the borrower needs to go through the KYC process and submit materials. In the early stage, it was approved by the TrueFi platform and added to the whitelist. Later, the restrictions will be gradually relaxed, and the TRU token holders will conduct pre-approval research on their own. There are not many applications for TrueFi loans, mainly from Alameda Research, a quantitative investment company. According to the team, Multicoin Capital will also join as a borrower.
The TrueFi plan, like Compound, achieves complete on-chain governance, with TRU holders making the decision to approve loans. In terms of the qualifications of borrowers, it plans to integrate Openlaw and other agreements.
What should I do if I meet Lao Lai? According to the information, TrueFi's plan is that TrustToken will hire a lawyer to initiate a lawsuit against the borrower to collect debts. At present, when there are only a few loans and they are distributed to a few institutions after review, there will be no litigation cases.
6. Bloom: Use DID for credit lending
In addition to the above-mentioned projects, finally I want to mention one additional project: Bloom. Bloom represents another possible idea for unsecured lending , applying decentralized identities to the DeFi field, and using credit ratings to determine whether to lend.
Bloom is a blockchain solution for secure identity and credit scoring. Through its digital identity service, Bloom aims to allow consumers to control personal data to a certain extent and protect their identity. According to the project party, Bloom has been committed to building a financial service ecosystem in the past few years, allowing people to participate in the traditional credit system.
DID, or decentralized identity, is known as one of the holy grails in the world of blockchain encryption, and many project parties participate in the pursuit. DID protocol platforms such as Bloom use externally provided data to build a credit system to assess the credit rating of those associated with a particular account as a reference for credit lending services.
In contrast, platforms such as Bloom provide a set of universal solutions, which means that applications like Aegis, Aave, Teller Finance, etc., in the future may be like calling APIs, directly calling agreements such as BloomID, and knowing user transactions Ratings, past defaults, etc.
Bloom has reached a partnership with TradeUnion to provide credit monitoring services for US users. DID applications such as BloomID allow users to have more control over their data compared to KYC and banking solutions. For example, if you need to prove your income, Bloom can temporarily access this data and create an income voucher instead of providing a bank statement containing a lot of additional personal data. If you wish, when you apply for a loan, you can share your income verification data with multiple lenders. Users can apply for loans through the app based on their credit scores.
However, I haven't seen any information about the collaboration between Bloom and the DeFi platform. Bloom is mentioned here more to explore a future possibility, giving users one more choice when participating in credit loans.
Seven, summary
Despite the attractive prospects and huge market share in the field of unsecured lending, it can be seen from the review of several representative products in the current industry that there are still not many options for dealing with the problem of "old people".
Through the KYC process and the borrower's submission of information (bank transaction records, third-party credit rating data or possible future DID digital identity), through platform screening, algorithmic scoring or handing over to the community for review, determine whether to lend or approve the credit limit Size, and use a method similar to OpenLaw or a cooperation agreement to establish the partnership so that it can be recovered in the event of a breach. It is also possible to further enhance the security of lending through CDS or smart contracts to limit transaction behavior.
However, we have to face up to this situation: the pawnshop model of over-mortgage will still be the best choice in the DeFi field in the long run. After all, it is so difficult to achieve recourse in a decentralized world. In the end, we still have to resort to legal proceedings or local debt collection companies. It will be difficult to extend credit loans to benefit more people.
I think the more likely path is in some regions with relatively loose jurisdictions, where institutions are the main participants in borrowing to reduce the risk of default and provide DeFi lenders with more stable cash flow protection. This is also the route taken by projects such as TrueFi, starting from the organization and gradually expanding the scope of participation.
Despite the difficulties, unsecured lending is still worth exploring. What we need is a more reliable solution and the diligent attempts of several pioneers. A recent post I read came from DeFi Prime's inventory of projects in the field of unsecured lending at the beginning of the year. Many of these projects, similar to Zer0Collateral, have disappeared. It is inevitable that people will be particularly lamented about the difficulty of this road.
But once there is a breakthrough, waiting for DeFi, waiting for the encrypted world, will be the stars of DeFi Xintiandi.
Reference
https://blocktrend.substack.com/p/truefi-defi-
https://realsatoshi.net/21199/
https://newsletter.banklesshq.com/p/unsecured-loans-are-coming-to-defi
https://messari.io/article/aave-announces-credit-delegation-enabling-uncollateralized-lending
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