As defi expands, it runs the risk of accepting the same ideology it originally rejected. The primary beneficiaries of the new financing paradigm will be those who already have digital assets.

Replacing intermediaries Doesn’t Directly Improve Financial

Financial products and solutions come with a catch. There is no exemption to decentralized finance (defi).

Defi is a popular alternative to traditional finance (tradfi). It aims to eliminate the inherent problems and disadvantages of traditional finance. Although it is clear that defi has helped lower financial access barriers, it is not surprising that defi is now, at least in part, becoming the same as traditional finance, but with a “decentralized” tag.

The Blurring Line between Defi and Tradfi Loan

In the traditional system, everyone who wishes to borrow money from banks or private lenders has to provide their credit score. The loan will be approved if the credit score meets the requirements. A borrower who has a low credit score might have to accept lower rates. The lender might ask the borrower to provide collateral in some instances.

While defi exchanges central authorities with a peer-to-peer system, accessing products like defi lending requires borrowers to post substantial collateral, often higher than the total amount they want to borrow, called over-collateralization. A fraction of the world’s population has a basic knowledge of cryptocurrency and blockchain technology in order to enter the defi market or use its financial products.

Defi lending was initially designed to allow “true, decentralized lending”, where anyone with capital needs could get a loan without the involvement of middlemen. However, today’s defi loan is not like that. This has become a way for digital asset holders to earn yields by using what they already have. The global unbanked are not being empowered by today’s defi.

It seems that defi tends to be more lender-oriented than it is inclusive. Consider, for example, the rapid growth in defi lending over the past months. The leading defi lending platforms and protocols have accumulated a total value locked (TVL) of more than $60 billion.

AAVE, an open-source and non-custodial lending and borrowing protocol, has almost $20. 96 billion TVL spread across staking and liquidity pools on Avalanche, Ethereum, and Polygon. Likewise, at the time of writing, Maker DAO boasts a TVL of $17. 06 billion and rising, Compound has a TVL of $11. 33 billion, and Instadapp commands roughly $12. 17 billion TVL, highlighting the meteoric growth of defi in general.

The lines between defi and tradfi are blurring at a alarming rate. Here’s one example.

A small business owner in a developing country needs financing. They don’t have the traditional financial services they need. They stumble upon defi lending, and they create an account on one the existing platforms. They realize that the collateral requirements are higher than they need, and they have to apply for funding.

We must also consider the perspective of the defi lending platforms. Defi lending platforms require collateral to protect lenders’ investments. Is it justified to require collateralized loans? Defi does not bring unbanked people to the system, but rewards privileged crypto owners with yield for existing assets.

Non-Collateralized Defi Lending: Great in Theory, but Downsides Exist

Honestly, there aren’t any non-collateralized defi lending platforms (none that I could find), except for Gluwa, an alternative financial system for the unbanked. Gluwa has partnered in various international companies such as Multis, Creditcoin and Jenfi. Aella’s consumer credit application has more than 2 million users in Africa. To date, Gluwa and Aella have facilitated more than a million transactions, creating more than 28 million blocks in the process.

Gluwa does not require users to upload collateral. There is a catch. These non-collateralized loans have a higher interest rate than other collateralized defi loans offered by AAVE, Compound and similar platforms.

Gluwa is a defi solution. It shares many similarities with traditional lending-borrowing models, such as private non-collateralized loans, where high-risk borrowers are taken on by the lender and passed along higher interest rates.

The Way Forward

There are many things to take into consideration between high-interest, non-collateralized and over-collateralized defi loan loans. Although platforms may require collateral, they make it simple for anyone to access capital by simply clicking a button. However, this is only for those who have digital assets. This negates the notion of inclusion and equal opportunity for everyone — which is essentially the foundations defi. Non-collateralized loans have higher interest rates to offset the risk. This again defies defi’s vision for fair and just earning for all.

A truly decentralized lending process and borrowing process must balance risk and return equally for lenders and borrowers. This is not an easy task. We may see a better form of decentralized lending in the future. Or, perhaps we will end up with truly decentralized lending that closely resembles traditional financial markets. In either case, it is possible to make the market more efficient and change the way it was once run.

What do you think of defi lending today — fair, or not? Comment below to let us know your thoughts about defi lending today.

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