Why Loans Are Better When They’re Decentralized (#GotBitcoin?)
In the feverish quest to decentralize anything even remotely open to decentralization, one of the most promising areas is finance and the financial industry. This shouldn’t be too surprising, given bitcoin and the origins of blockchain technology, but at a time when even babies are being put “on the blockchain,” the emergence of decentralized finance (DeFi) provides welcome proof of crypto’s real utility and applicability. Why Loans Are Better When They’re Decentralized (#GotBitcoin?)
And while DeFi is covering a wider range of areas — from remittances to derivatives and investments — its most promising sector involves credit and lending. That’s because, thanks to the openness, security and transparency of blockchains, it’s possible to make loans and credit available to a larger pool of people than ever before, while the interoperability of blockchains opens up the possibility for creating a spectrum of new lending products and services.
But even though the sector has expanded considerably over the past year or so, decentralized finance still needs to put in plenty of work before it can compete with legacy financial systems. At the same time, users need to be careful when using early stage and untested DeFi platforms and services, just as they need to be aware that not all DeFi systems are truly decentralized.
The big decentralized lenders
DeFi might be a relatively new and ill-defined term, but its meaning is simple, referring to the use of blockchains, cryptocurrencies and/or smart contracts in providing financial services to clients. And when it comes specifically to loans and credit, there are numerous platforms, services and companies that are harnessing decentralized ledger technology for the purposes of lending services.
The most well known of these is MakerDAO, which lends its stablecoin — DAI — to users, who gain their loans by depositing ether (ETH) with the Maker system as collateral. According to the recently launched DeFi.Review website, it’s the biggest decentralized finance platform by a comfortable margin, having roughly $508 million in ether locked up in its platform. Behind it is EOS REX, which has deposits of EOS worth around $437 million, and which lends to users who want extra EOS in order to stake the cryptocurrency for extra CPU/NET bandwidth on the EOS blockchain.
Both of the platforms above are infrastructural, in that they serve primarily to support crypto economies and ecosystems — be this the EOS blockchain in the case of EOS REX or various cryptocurrency markets in the case of DAI. As such, they arguably don’t satisfy the common sense or traditional definition of lending and credit, given that they aren’t awarding loans to the general public. Meanwhile, the fact that they both account for approximately 86% of the total amount of assets locked up by DeFi platforms (according to DeFi.Review) is an indicator of how young the sector still is.
Why Lending Is Better When It’s Decentralized
Nonetheless, as young as DeFi lending may be, there are many other platforms besides MakerDAO and EOS REX that are offering credit via decentralized means. Launched in September 2018 and having around $42.4 million locked up, Compound is a decentralized money market where you can lend your own stores of crypto in order to earn interest, while the peer-to-peer lending platform Dharma was launched in April and has roughly $23.91 million locked up, either as ether or DAI. On top of this, there’s a long list of competing platforms, including Cred, BlockFi, Lendoit, SALT, NUO, ETHLend and Colendi.
Another one of these new DeFi lending platforms is Bloqboard, which lets users borrow or lend a range of crypto assets on the Ethereum blockchain, from Wrapped Ethereum to BAT, ZRX and DAI. Its dashboard is fairly simple, with visitors being able to choose to borrow or lend any supported crypto and with them being presented with the variable interest rate they’ll benefit from or have to pay. It also enables customers to use Ledger or MetaMask to interact with the Ethereum blockchain and track their transactions. And as Bloqboard’s head of growth, Nick Cannon, explained to Cointelegraph, such transparency is a big part of the reason why decentralized lending and DeFi more generally is likely to take off.
“DeFi brings magnitudes greater accountability and transparency to investors making for a healthier financial system. These products will broaden access to sound financial investments no matter what geography you reside in.”
On top of greater accountability and transparency, decentralized finance will also bring the benefit of greater security for users and their funds, something pointed out to Cointelegraph by Guillaume Palayer, a co-founder of decentralized crypto asset management platform Betoken.
“The main advantages are the control, security and permissionless nature offered for the end users by DeFi products,” he said. He went on, saying:
“Permissionless because everyone can access it without conditions and independent of your local financial system’s health. Security and control because the vast majority of DeFi products are non-custodial and offer the option to opt-out of their service with a simple transaction.”
As both Palayer and Cannon suggest, the decentralized and geographically nonspecific nature of blockchain means that DeFi lending is more open to a wider market of customers than centralized alternatives. But in addition to this, decentralized lending is more open in a financial sense, and for two primary reasons.
First of all, most blockchain-based credit platforms don’t actually require users to have a good credit score or even a credit history, with many covering the risks they take on by requiring collateral — often in the form of crypto — from borrowers (as in the case of MakerDAO, for instance).
“With a decentralized loan, you’re not dependant on having access to a credits system and you are able to customize the duration and the cost of the loan however you want,” Palayer explained. “As far as I know, no centralized loan providers offer this kind of advantage in a trustless fashion.”
The fact that you don’t require a credit score is in evidence, for instance, with Nexo, which offers instant loans in over 45 fiat currencies. Nexo co-founder Antoni Trenchev told Cointelegraph:
“As long as you have crypto assets, you can immediately borrow cash that is delivered straight to your local bank account.”
Nexo claimed to have issued $300 million in loans to over 170,000 users in the seven months leading up to March, while Trenchev also reports that the use of blockchain and crypto-based collateral means that loans can be made extremely flexible for users, both in terms of the amount borrowed and in terms of the conditions attached to lending: “There is no fixed repayment schedule, no strict maturities. As long as you have sufficient collateral to secure your borrowed funds, you have the flexibility to repay your loans at any time with cash or crypto assets.”
Secondly, in many cases, the decentralized, blockchain-based nature of DeFi lending systems allows companies to offer credit at a lower cost, something that obviously makes obtaining loans more affordable for a wider group of people. “Borrowing and potentially the costs of payments in distributed systems are lower,” Alexey Ermakov, the CEO and founder of decentralized payment apps Aximetria and PayReverse, said. He continued:
“Among other reasons, this is due to the fact that in the case of blockchain-based credit systems there are no compliance costs and/or they are significantly lower, and costs are also lowered by the ability to make electronic mortgages and provide loans on the basis of smart contracts.”
Feeding into the openness of decentralized lending platforms is the burgeoning area of blockchain interoperability and atomic swaps, which promise to give users more options when taking out loans or lending crypto.
“Another huge advantage that stems from DeFi’s permissionlessness is interoperability,” Palayer said. “You could take out a DAI loan from MakerDAO and convert it to Ether using Uniswap or Kyber Swap to gain leverage. The possibilities are endless, and we feel everyone should be excited about this.”
And from a more general and macroeconomic perspective, the increased openness and accessibility of decentralized loans should result in higher productivity for the global economic system, as outlined by Cannon:
“As the market matures, decentralized lending services will source more ‘dead capital’ from around the world.”
Put differently, blockchain-based loans will have the effect of putting “dormant” crypto to work in the wider economy, with hodlers having the opportunity to borrow or lend without ever renouncing the underlying ownership of their cryptocurrency.
“Many have been purchasing cryptocurrencies as a very long-term investment, expecting their value to grow hundreds even thousands of times,” Trenchev explained. “Naturally, such investors do not use their crypto for payments. They do not trade it. They simply keep their assets with the expectation of having exponential returns by just holding.”
Future challenges and future promise
There’s little doubt that the world of blockchain-based lending is a tantalizingly promising one, but the fact that it’s still in its infancy should give potential customers and the industry more generally pause for thought.
First of all, the vast majority of DeFi platforms are still untested and in development, and as SALT’s head of product, Rob Odell, told Cointelegraph, this means that users should be careful when choosing a service:
“Be vigilant about researching your options,. For all its advantages, most DeFi applications are still very new — they need time to work out all the kinks and be battle tested.”
Odell also noted that users should consider “how limited the offerings of some of the DeFi loan products can be. For example, right now, MakerDao only works with Ether,” and while MakerDAO is (like certain other platforms) planning to add more cryptocurrencies in the near future, its current limitations are one indicator of how much distance DeFi has to travel before it can compete on the same level as legacy systems.
As with pretty much every area in which blockchain technology is being applied, education will be one of the first key areas in ensuring that DeFi can expand, mature and realize its potential. “There are a number of challenges but I think education is the greatest,” Jeremy Lam, product lead at OmiseGo, a finance-oriented scaling network for Ethereum, said. He added:
“DeFi platforms will often require the capacity of the individual to be in control of their own private key. I don’t think most people are ready to handle such a responsibility. Also related to education, we have to consider who is using DeFi services. How do we protect people with insufficient financial knowledge from losing money on products they don’t understand?”
One thing that potential users need to be educated about is that some DeFi platforms will be more — or less — decentralized than others, something that could potentially put them and their money at risk. “A Service provider needs to fulfill certain conditions to be a true DeFi service,” Stani Kulechov, the CEO and co-founder of the Swiss-based AAVE, which runs the Ethereum lending service ETHLend, warned. He went on to say:
“First and foremost, ensure that the service provider does not hold your assets. This means that there must be a smart contract that holds the funds and secondly ensures that the transactions are conducted via smart contract and not through a third party signing. You should choose DeFi projects based on transparency and track record.”
More fundamentally, decentralized lending won’t succeed and make significant headway until the industry pinpoints — and builds itself around — gaps in the credit and loans market it’s well-positioned to solve. “As mentioned, education is a large challenge,” Lam said.
“The other huge challenge is to properly understand what problems DeFi is trying to solve and onboard the users that are experiencing that pain.”
And while there is certainly a demand for loans that don’t require a credit history, the fact that most no-credit DeFi platforms ask for crypto as collateral would mean that the success of such platforms is predicated on the general and widespread adoption of cryptocurrency.
And while we certainly haven’t yet reached the “widespread” adoption of crypto, there is some indication that adoption has increased in recent months, with around 9% of Americans now owning bitcoin (according to an April self-selected survey from Blockchain Capital), compared to only 2% in November 2017. There is, then, genuine hope that the DeFi sector will capitalize on this growth, with figures belonging to this sector confident that it will overcome its challenges and make good on its potential.
“I’m very confident about the tremendous ecosystem’s growth we could witness in the next coming years,” Palayer affirmed. Similarly, Odell said, “While it’s still very early, decentralized finance will eventually be the norm if the promises of transparency, openness and access are fulfilled by these solutions.”
BlockFi Drops Minimum And Fees On Interest Bearing Crypto Accounts
BlockFi has done away with minimum deposits for its BlockFi Interest Account (BIA).
Under its new rules, anyone can deposit bitcoin, ethereum, or the gemini dollar and allegedly get up to a 6.2 percent annual return.
BlockFi told CoinDesk on Friday that while the price of bitcoin and other cryptocurrencies has risen substantially since BIA’s launch in March, it dropped its minimum deposit requirement because of consumer demand. BlockFi previously mandated a 0.5 BTC, 25 ETC, or 2,500 GUSD minimum on deposits before the rule change.
Early withdrawal penalties have also been lifted on the BIA product and users can receive up to one free withdrawal per month.
“This update to our terms will make our products more widely accessible – which is a key theme of the crypto sector and part of our mission at BlockFi,” CEO and Founder Zac Prince said in a statement.
The company is eyeing an imminent Latin America market push which complements a launch in India earlier this year.
“By making BIA open to all, we plan to target clients in Latin America, where banking services and credit reporting are limited. BlockFi’s platform leverages blockchain rails to make wealth management products available on a much broader scale,” said Co-Founder and VP of Operations Flori Marquez in a statement.
“US-grade financial products have typically only been available to high net worth individuals in countries like Argentina and Costa Rica,” he added.
The product launch comes a month after the closing of an $18.3 million Series A round led by Valar Ventures. At the time, BlockFi said the funds would go toward launching additional products like BIA.
Can Crypto Exchanges Ever Be Truly Decentralized?
Earlier this week, British-American entrepreneur John McAfee, who is currently living “in exile” due to tax-related charges filed against him by the United States authorities, launched his own decentralized exchange (DEX).
The expressive crypto advocate’s McAfeedex.com is running on the Ethereum (ETH) blockchain, and, in McAfee’s own words, it is a “Wild Wild West exchange” that purportedly cannot be seized by regulators. “There is nothing to shut down,” he wrote on Twitter, “Our technology is the smart contracts forever residing on the blockchain.”
According to the businessman, the DEX, currently in beta, is open source and imposes no Know Your Customer (KYC) or Anti-Money Laundering (AML) requirements on its customers.
But can a crypto trading platform be fully exempt from regulations in the current, post-ICO environment, where authorities are actively prosecuting bad actors and discussing the possibility of digital assets in Congress?
In the new Crypto Myths series, Cointelegraph will attempt to debunk various assumptions circling around the crypto space.
What’s A DEX?
In the most basic sense, there are two kinds of cryptocurrency exchanges: centralized and decentralized. The former are much more popular, as they seem to account for more than 99% of the global cryptocurrency trade volume. As a testament to this fact, the largest and most well-known trading platforms — Coinbase, Kraken, Binance, Bittrex, etc. — are all centralized.
They act as middle men, connecting people willing to trade cryptocurrencies while holding their assets on company-owned wallets. As a result, once a trader deposits their coins onto a centralized exchange, he or she essentially hands over control of their private keys, trusting the platform with the safety of their assets.
This practice goes against the decentralized agenda prominent in the cryptocurrency space, namely the catchy, “Not your keys, not your Bitcoins” proverb. Last year, Vitalik Buterin, co-founder of Ethereum, went as far as to say that centralized exchanges should “burn in hell.”
DEXs, therefore, are built in such a way that allows users to retain ownership of their cryptocurrencies and private keys. Specifically, they are peer-to-peer (P2P) services that allow direct transactions between two interested parties directly on the blockchain. Moreover, given that DEXs use smart contracts to facilitate trade, they require far less supervision compared to centralized platforms.
While some people still find it easier to trust a third party with their private keys, DEXs have other major benefits over centralized exchanges, namely anonymity and security. Indeed, decentralized platforms are much more difficult to hack, since they rely on smart contracts. This contrasts with the regular breaches experienced by centralized servers, resulting in multi-million losses every year. Additionally, lax KYC requirements are also a plus for the cryptocurrency enthusiasts who value anonymity.
DEXs Are Still Lagging Behind Centralized Platforms. Why?
DEXs remain a strongly alternative option, as proven by relatively low liquidity rates. There are a number of reasons for that, experts say, like cost and speed of trading. Andrej Cvoro, CEO and founder of R&D blockchain firm Decenter, explained to Cointelegraph, “Centralized exchanges are of course historically older and hence had more time to accumulate both users and liquidity, win users’ trust and tweak the user experience.” According to Cvoro, even some supposed advantages of DEXs come with certain drawbacks, while security is also an issue:
“DEXes are trustless systems where users keep their funds within their wallets and have them exchanged through smart contracts, but this does involve on-chain interactions, which then includes waiting for transactions to be mined and paying required fees for them. DEXes also expose all orders and the accounts making them, which some users want to avoid. Finally, DEXes could also have security issues and have known to struggle with issues such as front-running”
User experience and institutional involvement are other factors that should be taken into consideration, according to John Todaro, director of research at TradeBlock, a provider of institutional trading tools for digital currencies. The analyst told Cointelegraph that centralized exchanges, by nature, would have more institutions and market makers using them, adding that:
“Given institutions typically operate within a specific regulatory sandbox, they are more comfortable trading through centralized exchanges than DEXs. Further, the majority of retail flows are concentrated on centralized exchanges. Using a DEX requires a deeper understanding of wallets and exchange order books than using a centralized exchange such as Coinbase which can be accessed via a smartphone app, and thus has limited the customer pool for DEXs.”
Decentralization As A Spectrum
Another crucial problem for DEXs lies within their name, as there is no clear definition that would fully explain what this kind of trading platform should entail. As the phenomenon became more popular last year, many well-known cryptocurrency exchanges like Binance and Huobi decided to use their brand to launch their own decentralized marketplaces while applying the same compliance principles. In fact, the majority of DEXs now follow regulatory standards like KYC and AML in much the same way as centralized platforms, Todaro said:
“Many DEXs have KYC/AML procedures in place and decide which tokens are added to their platforms. Regulators have shown in the past that DEXs are subject to existing exchange requirements, and if DEXs do not comply, DEX creators are subject to fines and other repercussions.”
Some experts are even reluctant to call those exchanges decentralized. “Today, most exchanges which call themselves decentralized exchanges are actually only non-custodial exchanges,” said Eyal Shani, a blockchain researcher at consulting firm Aykesubir. He elaborated:
“They do not own your digital assets, but the exchange operator is still much in control of everything regarding the platform. Any exchange that relies on a traditional web front to facilitate the order book, runs normal KYC/AML processes are not completely decentralized. But that’s a matter of definition.”
In Shani’s view, a true decentralized exchange would be the one that facilitates fee-free transactions between people without the need for KYC or AML, he noted:
“However, running such an operation is usually costly, and those who engage in that kind of business usually wishes to make a profit out of it. And this is where the law kicks in and dictates that if one is making profit out of the operation, he is de facto in charge of it, and requires that entity to run KYC/AML among other requirements”
Thus, to avoid potential confusion, decentralization should be seen as “a spectrum, rather than a binary, black and white classification,” Cvoro suggested, providing some specific examples:
“On one end, there are the least decentralized options, such as Binance DEX, that require KYC, have limited availability depending on the user’s country of residence and rely on centralized, server-based order matching, among other things. And on the other end there’s, for example, Uniswap that has no KYC whatsoever, has unlimited global availability and does everything on-chain without any accounts with admin privileges of any sort.”
So what about McAfee’s DEX, boldly marketed as an independent platform and backed by someone who is himself hiding from authorities in international waters? Shani said in an email to Cointelegraph, “To the best of my understanding, McAfee’s DEX does profit from running the operation, so I recommend him to ask the creator of EtherDelta what the SEC thinks of those kind of exchanges.”
Shani was referring to when U.S. authorities charged Zachary Coburn, the founder of decentralized crypto token trading platform EtherDelta, with operating an unregistered securities exchange.
Coburn neither admitted nor denied the allegations, but consented to pay the state over $300,000 in unlawful profits, along with other penalties. Although, McAfee is well-aware of the concerns of the Security and Exchange Commission (SEC) — at least according to his Twitter, where he wrote:
“SEC says as long as we follow AML and KYC procedures the http://McAfeedex.com exchange is OK. But we don’t follow either and why should we even if we could? We are just a window into the blockchain where people trade. This is for the people, not the Government. F*ck them.”
Thus, even though the McAfee DEX “does stand out as one of the more decentralized exchanges out there” due to having a decentralized listing process and self-custody on top of requiring no personal information for KYC and AML procedures, “there are still likely central points of failure on the back-end that regulators could target,” says Todaro.
Theoretically, it is possible to run a fully decentralized exchange, Shani told Cointelegraph. However, it would certainly involve much less profit for the owners, especially considering the current trading volumes that DEXs are demonstrating. Shani added:
“There is a way to run a truly decentralized DEX. But it could potentially be so expensive that it would scare away the small traders. For that to happen, in addition to having no KYC/AML, running the orderbook and saving all data on replicating systems. But even then the government could block those services, fine whoever is involved etc.. So we would need a decentralized DNS servers, decentralized ISPs and many more services which are great solutions. Yet, based on the current volume on the so called DEXes, it seems like a solution looking for a problem, rather than a true product-market fit.”
Indeed, based on the current trading history displayed on the McAfee DEX, it seems that the service has yet to experience a massive influx of traders. Todaro explained that generally, cryptocurrency traders tend to value other features besides anonymity and decentralization:
“There is a demand for fully decentralized exchanges, but I would expect the vast majority of traders and exchange users to prioritize liquidity, token availability (i.e. access to more tokens than just ERC-20s), and ease of use over a platform that ‘no one can block.’”
Therefore, it is still unclear whether the market is ready for a fully decentralized exchange, even if there is one. Given that the top-three trading platforms are calculating their each and every step (namely in the U.S. market) to avoid facing large fines from regulators, it would seem unlikely that a “true” DEX could perform that well in the current landscape — in terms of profit, at least.