Decentralized Credit & Lending on the Blockchain

Crypto today is at a very interesting juncture. Without data, it’s difficult to know what to pay attention to and what to ignore. Data-backed research is key to bring a strategic vantage point. This understanding and transparency is critical for mass market adoption of Crypto.

Covalent, uses a data driven research methodology based on the AUDIT method, an acronym that stands for Actionable Understandable Data-driven In-depth Timely information.

We report on blockchain and cryptocurrency market trends that are unbiased, independent, best-in-class, data-backed and most importantly understandable to the layperson.Our first upcoming report is on credit & lending at blockchain

So, credit and lending on blockchain is an option for people to raise money (or loan) without going to a bank. Crowdfunding and ICOs are example of this growing process. Blockchain lending relies on the timeless peer-to-peer model, making the entire process more seamless and short cycled.

There are projects & platforms, which are evolving to cater to the credit & lending needs. Some of the platforms are Polymath, SALT, ETHLend, Ripio Credit Network, and Everex. We’re only focused on post-ICO companies, and therefore these companies are actively trading and being used on the blockchain.

Credit and lending Platforms

Why pay attention to the decentralized credit and lending space?

The average person is much more familiar with the equity and stock markets, but the debt markets are much larger. For example, in 2017, about 2.2 trillion of new corporate bonds were issued. Compare that with slightly under $780 billion in new corporate equity.

Despite its massive size, the debt markets are plagued with inefficiencies. The problems with the debt market can be distilled into one or more core points — their liquidity risks, their barriers to interoperability between markets and regions and there is a single point of failure due to their heavy concentration of players that are crucial to market operations.

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What defines the decentralized credit and lending space?

We define this sector as having four key attributes.

First — Peer-to-Peer(P2P) nature of the debt market. A peer-to-peer network of lenders and borrowers diversifies the risk and also enables cross-border loans.

Second — Digital Assets as collateral. In the decentralized version, a borrower can pledge their crypto assets as collateral to borrow a more accepted currency like the US dollar or Euros.

Sectors Definition for Decentralized Credit & Lending Space

Third — Non-traditional methods of creditworthiness. Many of the decentralized lenders have built their own in-house risk assessment technology to look at the creditworthiness of the collateral pledged for the loan. They have also developed new technology to assess the counter-party risk of the borrower combining with traditional creditworthiness scores like FICO.

Fourth — Smart Contracts. A Smart Contract is like a loan agreement that contains data about the capital, collateral, maturity terms, the parties involved, the creditworthiness and what happens in the case of default.

The Smart Contract runs autonomously on the blockchain without centralized servers and is the reason for the large efficiencies. If the platform demonstrates one or more of these key attributes, we define it as belonging to the decentralized credit and lending space.

What end-users in the market care about?

At Covalent, we have assessed the lending space according to the five C’s of finance. The 5 C’s are character, capacity, capital, collateral, and conditions. The lending space caters to two kinds of end-users, the borrowers and the lenders. To address the market needs, the five C’s have to be met in a frictionless manner to both kinds of users.

How decentralization is addressing the five C’s of finance?

Often times, end-users don’t really care about decentralization per se. They care more about how the platforms are fulfilling their needs. Therefore, we rate the decentralized platforms according to the five C’s.

For character — excellent. Capacity — excellent. Capital — average. Since that collateral that’s placed are digital assets, they are volatile in nature. Therefore, they can only secure 60% to 70% of the value of the collateral. Collateral — excellent. Conditions — poor.

How disruptive are these decentralized credit and lending platforms?

1. Business model disruption.

There are two points here. The first is that the decentralized lending space makes use of digital assets as a collateral. There’s no existing centralized player that allows you to use digital assets as a collateral. Digital assets are rapidly growing in utilisation and adoption across the world.

Second, these decentralized platforms make use of the smart contracts to enable automation and have major cost savings. Thus, a bigger addressable market and cost savings are disruptive.

2. Single point of failure.

In a traditional lending system, collaterals of all of the loans are held by one single entity which is risky, from a security point of view. Much of the credit crisis of 2008 can be attributed to the centralized nature of debt-backed securities. With decentralized platforms, collaterals are held by different entities, distributing the risks amongst these users.

3. Data transparency or data provenance.

Data provenance can be defined as a process of tracing and recording the origins of data and its movement between databases. Transparency in the lending is of utmost importance. In 2016, a centralized learning platform called Lending Club, had its CEO borrow from online lenders to inflate the company’s volume. These loans were tied to SEC-registered securities, contained misleading information. Not exactly transparent.

Another internal probe found that the company had knowing sold an investor 22 million dollars of loans that the investor did not want.

4. Censorship

Centralized companies dictate both the on-boarding as well as the off-boarding of their users on the platform. Furthermore, government regulations dictate the banning of certain kinds of industries like gambling. Crypto assets enable cross-border lending that can offer many advantages to both the borrower and the lender.

The opportunity to diversify their investment portfolio across different countries and even continents is one of the most prominent benefits for lenders.

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Borrowers, on the other hand, benefit from the global pool of lenders regardless of where they live or what they’re going to use the funds for.

The strength, weaknesses, opportunities, and threats that the sector has in the future.

The strengths of the decentralized lending and credit space are

1. it offers a high rate of return to lenders,
2. it offers a competitive rate for borrowers and
3. it has the option of having geographic diversity.

The weaknesses

1. There’s a lack of awareness with these platforms,
2. Some platforms are limited to one type of lending form like crypto to fiat only.
3. Right now it can only cater to small business size credit.

The opportunities

1. Transparency and efficiency due to the use of smart contracts,
2. Superior screening technology of borrowers,
3. Digital assets especially the tokenisation of real-world assets on the blockchain are here to stay and rapidly growing.

The threats

1. The websites dealing with cryptocurrencies are prime targets for hacking.
2. The crypto back collaterals can experience high volatility at times and this is a risk for the lender on the platform.

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What do you think about blockchain based decentralized credit and lending?

Let us know in comments.

Covalent works on data-backed research reports on a variety of different sectors like decentralized cloud computing, file storage, sports betting and gambling, currency exchanges, e-commerce, privacy and security and decentralized social media.

Feel free to watch webinar on this complete topic & grab slides and share with us if you have any questions or comments.