In the last two years, the decentralized finance (DeFi) industry has grown by more than 1,000%, due in large part to an explosion of interest in the decentralized crypto loans sector.
This huge interest has seen a huge number of platforms spawn to help cater to the growing needs of the industry, improving the variety and range of options on offer, and making the industry more accessible than ever before.
However, this rapid growth has also highlighted several key areas in which the DeFi lending industry still lags behind its traditional counterpart, demonstrating the need for an out-of-the-box approach to modern finance.
Good, But Not Enough Enough
Although the industry is growing at a staggering rate, most crypto lending platforms are poorly equipped to scale and few, if any, are able to effectively handle the risk that comes with this growth.
In addition, the way these platforms handle collateral risk has largely remained unchanged in the last two years. Put simply, borrowers deposit their collateral in return for a fixed loan value based on an inflexible maximum loan-to-value (LTV) ratio.
Although this seems like a simple process on the surface, borrowers are then at constant risk of a margin call, and need to monitor the value of their collateral regularly. If this falls below a certain threshold, their collateral will be either partially liquidated to reduce the LTV, or completely liquidated to reimburse the lender’s funds, while the borrower loses out.
Likewise, both lenders and borrowers are forced to operate within a strict framework that defines how they can interact with one another, which types of collateral are considered valid and how much interest lenders must pay and borrowers can charge, stifling competition and innovation.
This two-dimensional, governance-driven approach leads to inefficient handling of risk, and leaves most lending platforms—whether centralized or decentralized—vulnerable to unexpected events that could see creditors unable to recoup their investments and borrowers lose their collateral. This, because of a lack of decentralized insurance options to underwrite collateral risks and insufficient risk handling mechanisms built into the system at the protocol level.
There is also a lack of transparency in the space, whereby borrowers are frequently unaware of the risks to their collateral and the time commitment needed to keep their loans in good standing, while lenders often have little to no metrics to gauge their current or potential risk exposure.
All-in-all, this governance-driven model is not equipped to scale and can be offputting to those looking to participate in decentralized lending, but keep a tab on their risk exposure.
Rethinking Crypto Lending
Lendroid is one of the projects looking to tackle the inefficient handling of risk and the lack of transparency in the decentralized lending space.
Through its open-source lending protocol, Lendroid hopes to change the way borrowers and lenders interact, while also opening unique business opportunities for those that want to contribute liquidity to the system and underwrite risk.
To achieve this, Lendroid compartmentalizes the different aspects of the DeFi space, by allowing users to participate in the different aspects of the lending ecosystem, such as loan financing, risk underwriting, borrowing or loan management.
After taking a loan through Lendroid and receiving their payout, borrowers can set a specific date to service the loan, or simply forget about their loan until the expiry date—just as they would expect when taking out a traditional loan. As such, Lendroid makes loans cyclical, preventing the need for borrowers to be on-call 24/7 or worry about maintaining their maintenance margin until the expiry date.
Separating Risk From the Equation
To achieve this, Lendroid completely offloads collateral risks to a network of underwriters during the loan term. These underwriters receive a fee for their services and contribute to a liquidity pool known as a ‘High Water Pool’ designed to take on the collateral risk of loans.
By separating cryptocurrency loans into separate no risk and low risk chunks, the platform essentially allows contributors to select their own risk exposure, tackling one of the biggest obstacles in the industry—dirty risk. This has been a long time coming and should address some of the major concerns in the industry as it stands.
But it isn’t just collateral risk and volatility that crypto lenders currently have to contend with.
The possibility of an unexpected adverse event known as a “black swan,” will always be present, similar to the $50 million hack that crippled the Ethereum DAO back in 2016. Although these events are rare, customers and investors should demand that safeguards are included at the protocol level in any services they use, since these events are catastrophic by nature.
Likewise, the incorporation of a network of underwriters in the cryptocurrency lending space potentially represents the next frontier in investor safety—protecting both investors and borrowers against even the worst-case scenarios. Something that has been largely missing in the industry.