Decentralized finance has grown faster than any other sector in the crypto industry over the past year. Media coverage is also growing but Ethereum co-founder Vitalik Buterin thinks some of the terminology is cringe worthy.
Loans With No Paperwork
A recent article in tech outlet Mashable has gained a lot of attention over the past day or so. Not because it explains how easily decentralized finance works, but because it implies that ‘loans’ can be taken out with zero paperwork or verification.
The article titled ‘I took out a loan with cryptocurrency and didn’t sign a thing’ explains how DeFi works and how simple it is to setup and invest in, or borrow from. It opens up with;
“Last week, I took out a loan without meeting anyone, signing anything, or even interacting with a human being,”
This implies that DeFi is a source of free money with no recourse for those needing to borrow a quick few bucks.
The term ‘lending’ and ‘loan’ has been used in conjunction DeFi but it isn’t strictly accurate and this appears to have caught the attention of the Ethereum co-founder himself.
“every time I see an article … saying defi gives you the ability to “take out loans with no paperwork” I still cringe…”
I know I'm in the minority on this issue, but every time I see an article like https://t.co/2i7ywE7GqJ saying defi gives you the ability to "take out loans with no paperwork" I still cringe… pic.twitter.com/irIW8j3eAe
— vitalik.eth (@VitalikButerin) January 30, 2020
Buterin continues to elaborate that the reason regular loans have paperwork is to verify that the borrower can be counted on to pay the money back. This raises the question with DeFi as to where the guarantee of repayment comes from if anyone can simply borrow without ‘paperwork’. He continued;
“Here the money never leaves your hands, it just turns into a leverage position.”
The correct terminology, as Vitalik points out, would be what is known as a collateralized debt position, or CDP.
Ethereum as Collateral
Borrowing with DeFi requires cryptocurrency, usually Ethereum, to be deposited into a smart contract to act as collateral for the ‘loan’, which can then be take out in fiat if desired.
Platforms such as Compound use these smart contracts to automatically match borrowers and lenders, adjusting interest rates dynamically based on supply and demand.
Those wanting to invest can also deposit Ethereum into a smart contract to convert it into a stablecoin such as DAI which can then be locked in to enjoy a bank beating interest rate. The current DAI Savings Rate is 7.75%, payable in DAI, which is dollar pegged, but collateralized by crypto assets.
So the terminology seems to have sparked the discussion in this case and the word ‘loan’ appears to have caused the umbrage with some. DeFi is a nascent industry and these idiosyncrasies will be ironed out over time as it evolves and becomes a multi-billion dollar finance market with a foundation based on Ethereum.
Have you used DeFi to borrow or lend? Add your comments below.