Decenti-funded lending (DeFi), one of the fastest growing sectors in the decentralized ecosystem, could eventually enter the real economy if it becomes less secure in terms of collateral, the BIS said in a recent report, adding that also needs to be better represent real-world assets in the blockchain through tokenization.
Keep in mind that DeFi lending platforms such as Aqru and DeFi Swap allow anonymous users to lend and borrow cryptocurrencies at high interest rates that go far beyond what traditional lenders offer depositors. The problem is that DeFi lending relies heavily on borrowers who pledge crypto collateral, limiting “access to credit for borrowers who are already rich in assets,” the BIS said. If high price volatility is needed in digital coins – as is the case now – “there is over-collateral: the collateral required is usually much higher than the amount of the loan”.
Another concern is that lenders offer crypto loans without a central intermediary as a consumer bank, which makes it almost impossible for these crypto lenders to assess the creditworthiness of borrowers and whether they can repay the loans on time.
In addition, “anonymity and collateral reliance are incompatible with DeFi’s drive to democratize finance: a collateral-based loan only serves those with sufficient assets, except those with low wealth,” the BIS said. “Dependence on crypto collateral also prevents real use cases”, which is why tokenisation will be essential to overcome the self-referential nature of DeFi and require both technological improvements and updated legal frameworks.
It was only at the end of 2020 that DeFi lending began to appear. The total value locked in the DeFi lending protocols was $ 50 billion in the second quarter of 2022, up from almost zero at the end of 2020, but declining from all-time highs of about $ 240 billion in the fourth quarter of 2021, as “the recent collapse of Anchor’s Terra Blockchain and Celsius’ restrictions on withdrawals have shaken confidence and put an end to the rapid rise of crypto lending,” according to the BIS.
Meanwhile, crypto, including bitcoin (BTC-USD) and ethereum (ETH-USD) are declining from their peaks last year in the worst bear market since the collapse of retail trade in 2018, as liquidity is shrinking and financial conditions are deteriorating. Not surprisingly, the crypto winter is affecting DeFi lending, as loans are being liquidated amid falling prices and therefore the value of collateral is declining, according to the report.
degree Celsius, which promises a weekly return of as much as 30%, appeared in the headlines after pausing all withdrawals, swaps and customer transfers on the move, which put the rest of the crypto market even more tense. Soon after, Binancethe world’s largest crypto exchange in terms of trading volume, stopped bitcoin (BTC-USD) withdrawals “due to a blocked transaction causing backlog”, wrote CEO Changpen Zhao in a Twitter post on June 13. Most recently a crypto lender Babel Finance has stopped withdrawals from customers, citing “unusual liquidity tensions”.
In the future, DeFi’s lending capacity to expand its footprint in the real economy depends on whether it can ‘token real assets and rely less on collateral by developing its ability to gather information on borrowers; as such, the system is likely to gravitate towards greater centralization, “the BIS explained.
Earlier (June 16), Three Arrows Capital failed to respond to margin requests after that cryptocurrencies have deteriorated.