June 28, 2023 - 8 min read
Crypto loans have become increasingly popular in recent years, with many platforms offering crypto lending services. Most of these loans, but not all, require a borrower to put down collateral (i.e., other assets) in order to borrow funds.
In contrast, crypto loans without collateral are riskier to the lender and more expensive to the borrower. However, they do provide access to capital that would otherwise be unavailable, freeing up money for investors to trade and make other investments. Many uncollateralized crypto loans are only available to businesses and institutions, while other types, like flash loans, may be available to ordinary investors.
Crypto loans can be offered by both centralized platforms and exchanges, as well as by DeFi platforms. Centralized crypto lending platforms include exchanges like Binance and Gemini, while popular decentralized crypto loan platforms include AAVE and Compound. Centralized platforms hold the private keys to all the crypto they hold, whether the balance of an exchange account or the collateral put down by a borrower. They are therefore considered to be custodial platforms.
In contrast, decentralized platforms like AAVE and Compound are structured around smart contracts and are generally governed by DAOs (decentralized autonomous organizations). They are non-custodial platforms, so they do not directly hold crypto assets; instead, they use smart contracts to match borrowers and lenders.
Decentralized crypto lending platforms are significantly more transparent than centralized platforms, as anyone can see their assets and liabilities on-chain, 24/7, through a variety of crypto and blockchain analytics platforms. This transparency can help improve risk management and prevent “bank runs” and insolvency.
For example, the crypto lending platform Celcius filed for bankruptcy in July 2022 after too many users pulled out their funds at once following a sharp fall in crypto prices. Another major crypto lender, Voyager Digital, filed for bankruptcy the same month, and as of May 2023, the company estimates that only 35% of customer deposits will be reimbursed. In contrast, during this time, AAVE and most other major DeFi lending platforms remained completely solvent.
However, DeFi lending platforms are not always superior to centralized lenders; since they are built using smart contracts, decentralized lending platforms may suffer security breaches that could lead to the loss of user funds. Some DeFi lending platforms may have an insurance fund that protects users against these types of unanticipated losses; however, users on DeFi platforms are generally more likely to permanently lose their funds to hacks when compared to users of centralized platforms.
The vast majority of cryptocurrency loans are secured by a downpayment in crypto. Much like a mortgage lender or bank can repossess a house if a borrower does not pay their mortgage, collateral allows the lender to recoup their losses in the case of loan default. When it comes to DeFi lending apps, the specific collateral requirements are programmed into the lending smart contract, meaning that the protocol cannot simply change the terms of the loan at any time.
As we just touched upon, if a borrower takes out a loan and fails to make their payments, the lender or lending protocol will generally liquidate the borrower’s assets in order to make themselves whole. However, many lending protocols will notify the borrower and give them a chance to provide more collateral to prevent liquidation.
The vast majority of lenders and protocols actually want most loans to be overcollateralized. For example, MakerDAO, an incredibly popular decentralized stablecoin issuer and stablecoin lending protocol, generally requires individuals to put down a collateral of 150% (in ETH) for each stablecoin they want to mint.
However, some collateralized loans provide higher LTVs, with some protocols offering up to 90% LTV. In general, the higher the LTV of the loan and the riskier the asset, the higher the fees and interest rates will be. Therefore, the lowest interest rate loans will generally be low-LTV BTC and ETH loans. In contrast, loans utilizing smaller altcoins as collateral, particularly those with higher LTVs, will typically have the highest interest rates and fees.
Flash loans are another type of crypto loan that does not require collateral. Flash loans are unsecured loans offered on some DeFi protocols. These DeFi protocols don’t require collateral because the loan is typically paid back in the same transaction, using a smart contract that generally pays the loan (with interest) in just a few minutes. Flash loans are often used by traders attempting to utilize arbitrage opportunities.
In essence, if a crypto is selling for one price on one exchange and a higher price on another exchange, a flash loan can be used to buy the crypto on the initial exchange and sell it on the second exchange, all in one transaction. For instance, if BTC is selling for $30,000 on one exchange and $32,000 on another exchange, a trader could take out a flash loan for $30,000, buy one Bitcoin, then resell it for $32,000 on the other exchange, making around $2,000 in profits, before interest and fees.
However, they can also be used by bad actors to steal money from DeFi platforms in what’s known as a flash loan attack. When a hacker or trader executes a flash loan attack, they buy a large amount of an asset via a flash loan and use those assets to artificially manipulate the price of the assets on a DeFi platform.
Sometimes, this just involves flooding an exchange with a large volume of a specific cryptocurrency to reduce the price and resell it to another exchange. In contrast, in other cases, it actually involves hacking into or manipulating the price oracle being utilized by the DeFi protocol. These attacks have resulted in hundreds of millions of dollars of losses over the last few years. Unfortunately, they are a continuing blockchain security issue that the industry has not yet fully addressed.
Below, we will discuss some of the best-known platforms for crypto loans without collateral. Some of these include:
According to their website, “Goldfinch is a decentralized credit protocol that allows for crypto borrowing without crypto collateral—with loans instead fully collateralized off-chain.” Instead of requiring crypto assets as collateral, Goldfinch relies on the assessment of other participants to determine an individual’s creditworthiness. However, these loans are collateralized– but by real-world, off-chain assets and income. Users of Goldfinch can take on one or more of three key roles, including borrowers, investors, and auditors. Interest rates and loan repayment schedules are all determined and enforced by audited smart contracts.
Atlendis is a DeFi borrowing and lending platform which permits users to lend crypto to approved businesses. They offer a wide array of lending products that users can invest in, including buy now pay later services for businesses, trade finance products, providing crest for companies in emerging markets, and revenue-based financing for small and medium-sized businesses, just to name a few. Loans offered by Atlendis are unsecured, managed by Ethereum smart contracts, and generally do not require collateral, which does make them riskier for lenders, but provides significantly more financial flexibility for borrowers.
Ondo Finance is a decentralized security token platform that connects investors to both DeFi and traditional investments that it tokenizes using regulated security tokens. Acting somewhat like a traditional investment bank or fund management firm, Ondo runs a variety of funds and allows users to deposit stablecoins in order to invest in their funds, which they can later exchange back to stablecoins when selling their security tokens. Ondo does not offer loans without collateral to ordinary consumers but can offer loans with no or low collateral to institutions. To promote decentralization, Ondo Finance is governed by a DAO that votes on important decisions regarding the platform.
Centrifuge is a platform that brings real-world assets onto the blockchain, matching borrowers and lenders for structured credit transactions. Their platform hosts decentralized asset pools in which investors can invest in a variety of real-world credit transactions, like residential real estate investment loans, commercial real estate loans, working capital for businesses, consumer loans, and short-term cash advances, just to name a few. Centrifuge allows investors to choose either a senior debt position by buying the DROP token or a junior debt position by purchasing the TIN token.
While some loans on Centrifuge are collateralized, some are not, allowing borrowers to get the most liquidity possible.
While crypto loans without collateral can seem risky, they do have a place in the overall economy and can provide much-needed liquidity to businesses and individuals alike. As the blockchain ecosystem evolves, it’s likely that we’ll continue to see more services offer crypto loans with little or no collateral for both ordinary people and large institutions.
This is because, as blockchain tech matures, it will be easier for platforms and protocols to determine a borrower’s crypto credit history and create a kind of “crypto credit score” to determine an individual borrower’s default risk. This can be calculated by looking at factors like repayment history, debt-to-income ratio, available capital, and other considerations. In addition, as blockchain IDs evolve, platforms may combine an individual or business’s on-chain and off-chain credit history in order to determine their creditworthiness.
In addition, much like Goldfinch already does, uncollateralized loans may also be approved through group consensus, allowing current members of a platform’s ecosystem to have the authority to vote on whether to approve a borrower for a loan. This type of consensus-based underwriting and approval process can promote decentralization while potentially reducing risk for borrowers.
In terms of flash loans, these loans will still likely remain available to borrowers in the coming months and years, though more restrictions may be placed upon them to avoid flash loan attacks.
Overall, the future of uncollateralized crypto lending is bright, and we can expect to see a variety of industry innovations in the near future. However, only time will tell exactly how this market segment will shape up– and how it will impact the broader crypto market and the economy as a whole.
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