In traditional finance(hereafter tradfi), when you deposit funds to your bank account, you earn a fixed interest against your savings. Depending on the type of savings, the apy varies. In most economies, the apy is a determinant of government’s economic policies & the central bank norms; which is often a reflection of the prevailing inflation rate. Banks make money by lending it to the borrowers, invest in capital markets & through fees. This diversification helps banks generate money through alternative financial services, thereby improving the probability of returning a fixed apy to the depositors.
In comparison, DeFi’s inability to effectively utilise the available assets, creates volatility in the interest rates. One of the primary reasons for this variability stems from the reason Defi lending of today relies solely on the loan books for generating yield. Naturally, efforts must be made to increase the loan distribution so that the demand can be maintained and consistent returns can be provided to all the depositors. Here lies the major adoption barrier for depositors.
Almost every decentralised lending product today is over-collateralized. It means, the borrower must provide excess collateral than the amount they seek to borrow. This form of lending addresses niche use-cases that are,
- Traders can finance new ICO investments by borrowing Ether, using their existing portfolio as collateral.
- Enabling the borrower to meet the immediate cash needs without the need to sell their assets.
Over-collateralised lending in decentralised finance ignores the primary intent of a borrower. That is, the borrower requires liquid funds in excess, or equal amounts to that of their collateral. In tradfi, the banks determine the permissible loan amount based on the borrower’s credibility. This is estimated by the borrower’s income streams, & credit score; which in itself is a reflection of the borrower’s ability to repay the loan. In an autonomous, trustless environment like defi, facilitating under-collateralized loans is an uphill task. Since, the present day defi do not offer under-collateralized loans, their ability to offer predictable yield & interest rates dwindle. This makes defi lending unattractive to an average retail borrower.
At Hashstack, we have developed an autonomous lending framework that improves upon the known inefficiencies in the present day decentralised finance through a three pronged approach.
- Clear compartmentalisation of apy, APR of deposits/loan with that of their minimum commitment period.
- Effective asset utilisation through diversification of available assets through lending, & providing trading capital.
- Under-collateralized loans.
Read the Open protocol’s whitepaper on implementing under-collateralised lending — Link
About Open protocol
An autonomous lending framework enabling under-collateralized loans for upto 1:3 collateral-to-debt ratio. Open protocol is Hashstack’s proposed solution to today’s defi problems.