The requirement for pre-existing capital is the biggest bottleneck in DeFi adoption today. Here’s how DeFi can benefit from undercollateralised and no-collateral loans.
Imagine this: you’re fresh out of college, you’ve landed your first job, and you’re looking to get a mortgage to buy a house. You walk in to your local bank and are asked to provide two existing houses as collateral before the bank is able to issue the loan that you initially came for.
This sounds a bit ridiculous, doesn’t it? Believe it or not, that’s DeFi today. Let’s break this down.
In the example above, why is it necessary to present proof of two houses? Well, the current loan-to-value (LTV) ratio of a stable loan (for example, via P2P lending) is, on average, 50%. If you have collateral that’s pool-friendly, you can aim for up to 80% LTV, but you risk losing your collateral (a liquidation event) if its value dips below the loan value, even for a brief moment.
The core issue is that it’s necessary for you to front collateral before you are able to take out the loan itself. This presents a major bottleneck on the borrower’s side — it’s necessary for them to have a portfolio of assets that aren’t already being used as collateral for borrowing elsewhere.
Firstly, PWN is building a partial solution to this problem through our DeFi mortgage mechanism. When using PWN, there’s no need to front collateral — instead, you only provide a downpayment and can use the purchased item itself as collateral.
If we continue with the aforementioned 50% LTV example, this leads to about 400% more capital efficiency. In other words, the capital requirements for participation in DeFi borrowing drop dramatically, and you can instantly service a much wider audience. As a result, DeFi can start thinking about onboarding a much wider audience in general.
The solution that our team is building allows you to use anything as collateral: ERC-20s (a.k.a. coins) or ERC-721/ERC-1155 (a.k.a. NFTs). A great example is a mortgage for the purpose of purchasing a property in metaverse, which you can then use to generate yield and pay back the loan.
However, that's not the endgame. Even in our mortgage scenario, you still need to have some capital available beforehand. Therefore, you still can’t service the long tail of the market: users who don’t have any existing capital (or aren’t able to transfer it to DeFi). Even people with substantial DeFi portfolios might have their assets tied up in some protocol which prevents them from collateralization and could use a helping hand in the form of a small loan backed only by their reputation.
In a nutshell, there’s likely a substantial market for undercollateralised or even no-collateral loans. With this being said, we can imply that undercollateralised and/or no-collateral loans are an awesome tool to provide value to everyone in the current DeFi market as well as a great method for onboarding newcomers.
In order to have no-collateral loans in DeFi tomorrow, the traditional methods would be to deploy KYC, credit scoring, and other popular tools. But would this even still qualify as DeFi?
We don’t think so. That’s why at PWN, we’re working on a major innovation that will unlock the value of no-collateral loans while maintaining the true spirit of the DeFi-native approach: Decentralised, permissionless and respecting everybody’s privacy.
To help us on this mission, we’ve onboarded some very exciting DeFi native partners who we will be unveiling over the next few weeks.