If you’ve read our post on Maker, you now understand the granddaddy of all DeFi — Maker DAO.In this post, we’re going to cover an advancement of this lending and borrowing concept in DeFi, that is somewhat reminiscent of pawnshops.
So here’s a setup you might know if you’ve ever been to a pawn shop or watched Pawn Stars on TV –put up some valuable assets, and based on the market value of those assets, and you can borrow against them while paying interest on the loan.
All that’s changed in DeFi with Aave, Compound and other lending platforms. In this new paradigm, you can automate these agreements using the blockchain. In the case of Aave and Compound, that blockchain is Ethereum and it means lenders can lend their assets and earn interest, borrowers can deposit collateral and borrow against the total value of those collective assets. Meanwhile, both parties can trust the code to enforce payment of interest by borrowers, which ends up being paid out to lenders.
Collateral is needed because at the moment, there is no decentralized identity or credit score, so the only way a smart contract can know a borrower will pay their loan, is by making them put up capital. Aave is experimenting with offering undercollateralized loans, by enabling borrowers to delegate their borrowing power to users who haven’t put up collateral.
The key takeaway is in traditional finance, we go through lots of middlemen, giving away our personal information, and waiting days on end to get approved for loans.
In DeFi, there’s
- no KYC
- no sign-up
- no middlemen
And the process of taking out a loan or lending to earn interest, takes what little time is required to connect a wallet and click through some parameters on DeFi sites like Compound and Aave. With DeFi platforms like these competing for liquidity, we see them competing to add more assets and hence more choices for DeFi lenders and borrowers. It’s just a matter of time before we have undercollateralized lending and this frictionless lending goes mainstream.