When it comes to the significance of the blockchain, most would think about its decentralized organization which is not controlled by anyone and it is open to all. When applied to finance you could come up with a “killer app” for DeFi (Decentralized Finance). The implementations of DeFi are providing ways to offer traditional financial services like lending using the techniques from blockchain architectures. It cuts out the intermediary and lets anyone become their own financial service provider.
This is made possible using smart contracts that run on top of the Ethereum public network. This is yet the best implementation of Blockchain 2.0 with the innovations that introduce Blockchain 3.0 features (e.g. staking, digital governance). The blockchain provides a layer of trust between two parties, so that transactions are transparent. There is also no arbiter or middle man who can obscure details from a transaction. Everything is executed by the smart contract, containing the business logic and conditions.
This has led to the Open Lending protocols, providing ways for anyone to make money from interest lent out. It is based on cryptocurrency and other digital assets, which can be collateralized debt to gain credit. There are no background checks or personal information needed, just a form of collateral to secure a loan. This would be considered risky in the traditional finance sense, but an over collateralized debt position can mitigate risk along with conditions that will allow lenders to leverage digital assets to their advantage. Thus, if a lendee defaults on their loan, the lender will become the owner of the collateralized digital asset.
While most lenders need to be registered as a financial service provider due to compliance with regulators, that is not the case with DeFi products. Open Lending provides an API for DApp developers to create an interface that allows them to interact with a smart contract. The smart contract is created by the lender, who enters into the transaction based on a condition that is specified in the business logic’s code. There is no need for credit checks, employer endorsement or references to secure a loan. It is all based on trust in the blockchain, through the smart contract.
Open Lending can help a large sector of the underserved members of the community, particularly the unbanked. It provides everyone a path to capital resources they would otherwise never have a chance to obtain. People who don’t have access to micro-loans because of lack of documentation will have the opportunity for financial inclusion perhaps for the first time in their lives. People with poor credit scores will get a chance to access financial services they otherwise would not be able to enroll in with traditional banks. Since these protocols run over the Internet, anyone from around the world can be a lender for anybody that needs financing through digital assets. The money can be converted into a stablecoin to avoid the volatility of the cryptocurrency market, but most will just convert to fiat through digital exchanges. At times, the smart contract may also be a DeX (Decentralized Exchange) and allow the person to get their loan in their currency of choice.
The ecosystems for DeFi applications using Open Lending protocols can be a problem for first time users. They are not easily available, and requires some understanding of how cryptocurrency works. Developers are working to make the UI/UX easier and more convenient for users by integrating the DApp with smartphones or mobile devices. It will be hard to regulate this since it is not a particular company offering the services and the smart contracts are merely running on top of an open source platform. It would be hard for regulators to shutdown the Ethereum network since it is not a single entity, but rather a set of nodes that encompass the world. As DeFi becomes more mature, so will the applications. Then more users can enter the ecosystem and realize there is an alternative to banks and creditors when it comes to financial services.
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