Crypto vs Traditional Lending Platform: Is Crypto the new frontier in Lending Services?
When we mention the word “lending” to most people, you will get a varied response of both the good and bad of this this service. Despite all this, lending has been an essential way for the growth of many countries or business and for a long time this has only been available through traditional banking system. Lately Crypto backed Lending has seen massive growth over the year and stands to rival the traditional system in providing easier lending service to the people. So how does this Crypto Lending Work? And is it better than the traditional systems?
How does Crypto Lending Work?
Lending has become a staple of our life so much so that it is really hard to find a family that has not utilized some sort of lending services. Whether it is mortgage, student loans or credit cards, lending gives us the freedom to inherently delay payments for the future while receiving the benefits today. This service obviously can be used in a good way in which to buy income producing assets that will pay itself for the loan or in a spendthrift way by using the credit card to purchase unnecessary luxuries. At the end of day, lending services provide an alternative to the financial constraints faced by people or institutions so it depends on how people utilize that alternative.
Lending has been present since Ancient Mesopotamia around 3000 BC but it began to be popular around the 1800s with the emergence of Banks. Of course in the 1800s people were wary of financial institutions so they began giving out loans under the term of Personal Savings Funds but lending found its breakthrough with the emergence of credit cards. Credit Cards were founded in the 1920s to be used in specific stores but it took them a further 30 years for universal credit cards to be used as what they are today.
Why Credit Card was so popular? Right now an average American holds 4 credit cards for themselves and with the total Credit Card debt at over $840 Billion, it stands to show why credit card is the most popular lending platform and a cash cow for most banks. Credit Cards offer an easy way for people to gain access to lending as applying for a card is much easier than a loan and people are not realizing that they are actually lending money. This is what has formed our traditional lending system where banks have been in control of our loans and the access towards it but lately with the emergence of the crypto space, Crypto Backed Lending has been on the rise.
Crypto Backed Lending or as what we call DeFI lending has grown over 1000% on a year on year basis with the Total Value Locked in DeFI reaching $110 Billion as investors pour into this new space. This number is expected to triple by next year due to factors such as the pandemic where people are looking for easier access to loans and the yield provided by DeFI that surpass the rates given by traditional banks.
How does DeFI lending work? DeFI just like its name suggests is a financial ecosystem that is built around the decentralized technology of blockchain. Of course one of the forms of DeFI is a lending platform which utilizes all of the unique features of smart contracts In the blockchain systems to be a replacements for intermediaries like Banks in the traditional system. It basically builds a peer to peer platform to connect borrowers and lenders through the use of smart contracts.
Of course there are benefits towards being a borrower or lender in the space as borrowers could obtain quick loans with their crypto asset as collateral and lenders can lock their crypto to earn yields. Lenders would contribute their crypto assets or fiat money to a Liquidity Pool that will then be distributed to the borrowers as loans and from those loans, a portion of the interest paid by the borrower is given back to the lenders. This can only be done through blockchain networks that have a smart contract feature like Ethereum or Binance and all of the procedures are done automatically through these algorithms.
The question you may ask is what if the borrowers didn’t pay back the loans? This is where the collateral plays a role because the borrowers are required to put up a crypto asset that is more valuable than the amount of loans they are taking so if the loans are not paid, the collateral will automatically get liquidated. This ensures that the lenders can be repaid with the sufficient amount and there are other forms of DeFI Lending like Flash Loans where the loans have to be paid in the same block of the network.
Of course there are risks associated with DeFi Lending with impermanent loss being the most frequent one to affect both lenders and borrowers. Impermanent Loss occurs because assets locked in lending platform will always be affected by the volatile nature of the crypto space and due to the assets being locked, the losses are not permanent or dealt with until the assets are sold in the market. These impermanent losses sometimes could even exceed the yield earned by lenders and hence why it could sometimes be a huge problem. This is still not mentioning the amount of rug pulls and attacks that would not occur in a traditional lending system.
Obviously DeFI Lending is still growing and despite the risk, the users of these platforms continue to increase from time to time. Some of the more well-known Lending Platforms in the space include Maker DAO, AAVE, Anchor or UNISWAP. One of those platforms experiencing sensational growth is AAVE which has seen its TVL increased by more than 1000% reaching its peak at $!9.28 Billion in October 2021. Some people use this platform to get quick loans but most of them use it as a source of income from yields and avoiding the capital gains tax.
DeFI Lending has seen a rise in interest from investors and institutions as people moved on from the traditional banking system. Obviously it is still not the most secure but Its growth has seen the potential of being the leader in lending services. So is it better than the traditional system?
Is Crypto better?
The debate will forever continue on why Cryptocurrency will replace the traditional system and whether DeFI is really the way to go. With the recent dip in the crypto space and the case with Anchor Protocol in the Terra Ecosystem, we really don’t know where the future will head toward lending services. On one side, we have traditional lending services which are safe but are heavily centralized and DeFI Lending which provide great yields but hampered with unclear regulations so far.
DeFI does provide greater access for people to obtain lending service when they are in need and also due to the enormous TVL in the liquidity they can also provide it much faster than the traditional lending services. Of course with greater access means it’s good for the economy but it also opens the door for criminal activities to obtain easy funding while simultaneously being unnoticed.
There is also the aspect of both privacy and transparency that only can be provided using the blockchain system. Blockchain provides transparent data for the network to see while also concealing your identity with random numbers and alphabets in your wallet address so you can remain private. Of course this ties in pretty well to Banks which, although it does its due diligence in avoiding criminal activities but somehow has control over our data and purchases themselves.
The most interesting aspect definitely is that in the crypto space, you are allowed to take part in the lending service as a lender which otherwise would have been just banks. This prospect also comes with higher yields that provide a win — win solution for both the borrowers and lenders so the platform could grow. Again these high yields also come with higher risk in which cases like Rug Pulls or Scams have resulted in a lot of crypto assets being stolen. After all, codes cannot be altered but placing your money in a developer’s hand without any regulations in place, is not quite a safe option as it should be.
There are Pros and Cons towards both lending services but as utility coins will not likely be adopted as a legal tender anytime soon same goes for traditional lending service. The banks and credit cards will still be there but DeFI Lending could be the preferred option for people as long as its growth trajectory continues. will all depend on the value of the cryptocurrency itself and how future regulations could enable this space to be much safer for people to invest in but certainly it could lead the lending services in the years to come.
We in Nagaya Technologies Pte. Ltd are excited with the development that is going in the crypto space and hope that it continues to provide value to a lot of people. Peer to Peer Loan is in the roadmap of Nagaya’s future development in which the world’s first hybrid crypto asset could be utilized inside the platform. So if you want to know more exciting updates and information on Nagaya, you can visit us at nagaya.io.
Or talk to us at t.me/nagayaofficial