Over-collateralization in DeFi

The DeFi space has been one of the most talked-about topics in the cryptocurrency market. As per DeFi Pulse, the current DeFi locked-in value stands at $7.61 billion. Lending holds a major market share of the DeFi space, with a locked-in value of $3.41 billion. So, is DeFi a perfect? Is DeFi without any shortcomings? Not at all! DeFi, indeed, has a fair share of problems.

There’s a widespread misconception with DeFi lending in the market. Any guesses about what misconceptions we are talking about? We are talking about collateralization here. Yes, many crypto enthusiasts believe that collateralization is a major part of DeFi. They have also started accepting “over-collateralization” as the norm in DeFi space. Practically speaking, over-collateralization is a bane for the DeFi space. It is one of the top-most shortcomings of the decentralized finance space.

Reasons for over-collateralization

Market volatility is one factor that is leading to over-collateralization in the DeFi space. Volatility also contributes to a high amount of risk for crypto investors. So, when does over-collateralization occur? The situation where the value of the borrower’s staked asset is more than that of the loan amount is known as over-collateralization.

To grow further, the DeFi space will have to get over the issue of over-collateralization. It is hampering the DeFi space to achieve its true goal of making financial services truly accessible. All DeFi lending companies require borrowers to collateralize assets such as crypto tokens to receive loans. Take any leading DeFi lending players such as Maker, Compound, or any other. What issue will you find? You will notice that over-collateralization is a problem in all of the DeFi lending platforms.

In the absence of an asset with stable value, the DeFi borrower usually finds themselves to be facing the situation of over-collateralization. This is why there are multiple issues in the DeFi space today with over-collateralization taking the title of the “Most Striking Issue in DeFi.”

Let’s take a situation where a borrower decides to take out a loan from a DeFi lending platform. Now, the borrower will have to collateralize some of his crypto assets to obtain a loan from these platforms. Let’s assume that the price of crypto assets that the crypto lending platform took as collateral from the borrower increases. In this instance, the borrower will be facing a state of over-collateralization.

Let’s look at the opposite case now. Imagine if the price of the collateralized asset decreases, then the lender will ask for more collateral from the borrower. Why would the lenders do so? Because the lenders are experts at measuring risks. They can sense the situations where there will be an increase in the risk from market volatility.

There have been many instances in DeFi lending when no lenders agree to lend unless the borrowers hold a sufficient amount of valuable assets. Is this what the DeFi sector stands for? Well, the answer is a big No! It is because over-collateralization is against the tenets of decentralized finance.

Do you know what’s the philosophy behind DeFi? The first and foremost mission of DeFi is to make financial products truly accessible. Taking the banking services to both underbanked and unbanked sections of the global population is the core philosophy of DeFi.

Why is DeFi Lending Successful Even With over-collateralization?

You must be thinking that if over-collateralization is bad then why are the current DeFi lending players so successful? There’s a reason behind it.

Both over-collateralization and liquidation have successfully kept the interest rate protocols solvent. It is a situation where a user is unable to withdraw their funds as some other user borrowed assets but did not pay back to the lending protocol.

You see there’s a fine balance here! No DeFi lending protocols will be in a loss as long as the position of the users is liquid, regardless of being overcollateralized. At the same time, the lenders would be able to withdraw the assets that they supplied whenever they wish to. There’s no doubt that the current DeFi lending system has proved very successful. The billions of dollars that Defi Lending players secured is a testament to their success.

But there’s a long way ahead from here, and over-collateralization won’t help the DeFi lending market in covering the further distance.

The Solution

Even many experts have been voicing that a better category of DeFi loans must rise to take DeFi forward from here. During the Ethereal Virtual Summit, a panel of experts agreed that the DeFi space must solve the issue of over-collateralization. They said that solving the issue of over-collateralization will help DeFi achieve a higher adoption rate.

The Ethereal Virtual Summit of 2020 saw the attendance of many high profile panelists. It includes Rafaella Baraldo of Pods — a unchain derivatives project, Ryan Berkun — the cofounder of Fabrx, and Jana Petkanic — the cofounder of Eldorado.io.

There’s a solution to the problem of over-collateralization. What can it be? Zero collateralization or uncollateralized loans! Yes, this concept can prove to be a game-changer for the DeFi lending sector. We know what you are thinking — How would it be possible to get lenders to lent without over-collateralization? It is possible. Let us explain.

We at Zild Finance are bringing something revolutionary to DeFi. Our users would be able to borrow without any or minimum collateral. Are wondering how we would secure the funds of lenders? We have also implemented a way for it. We are bringing the concept of reputation score to the world of decentralized finance. Think of it along the lines of “Credit Score” that is common in the traditional financial industry.

Wanna know more about the project that will play a very important role in the zero collateral or uncollateralized DeFi lending? Head over to the website of Zild Finance.