One of the most difficult tasks that most blockchain developers are confronted with, is to understand which real life problems can be solved using a fully decentralized system, that a conventional database was not able to solve in the past. Well, one obvious application has so much disruptive potential, that it is almost untouched by the broad community: fully decentralized peer-to-peer lending using smart contracts on the Ethereum blockchain.
In order to understand, why decentralised lending is the next logical step in the development for financial solutions on the blockchain, we need to understand what our current lending system fails to achieve.
Conventional lending is centralized and limited to the locations where banks and financial institutions operate. There is no worldwide system that gives people direct access to a global lending market. Conventional lending is institution-to-people, institution-to-institution or people-to-people, but supervised and regulated by an intermediary.
Fully decentralized lending on the blockchain gives the power to the people, encourages competition, discourages monopolistic power and allows the access to a global lending market. Anyone has the ability to participate, independent from his/her location, circumstances, believes, appearance or whatever the reason might be for getting rejected. Someone from Canada has the possibility to lend or borrow from someone in China instantaneously. Therefore, lending is no longer restricted by local markets.
This inconvenient centralized structure creates another fundamental hurdle for global lending: interest rate differences! Today, the inflation-adjusted interest rate in different countries varies based on the available liquidity. In high liquidity markets such as Europe, interest rates are between 0.5–5 percent, in Russia 12–15 percent, in India 12 percent and in Brazil 32 percent. This shows a clear inequality on how access to the lending market is distributed. Interest rates for micro loans are on average between 30–40 percent, making borrowing in underdeveloped countries almost impossible. Interest rates for decentralized lending on the blockchain are solely agreed upon participants, which means that people from underdeveloped countries have the same access to lending as people from highly liquid markets and more importantly, competitive interest rates!
Inefficiency and trust is another flaw, which can be solved using decentralised lending backed by Smart Contracts. Traditional lending requires a lot of bureaucracy, human capital, supervision and time. Even the most efficient P2P-lending FinTech companies consume up to three days until a loan request is processed. This process can be automatized using a lending platform that works with Ethereum Smart Contracts, which can provide on-demand lending and secure collaterals in the Smart Contract, that automatically distribute funds back to the lender in the case of a default. The fact that Smart Contracts are secure by design, eliminates the need for a trusted party that supervises the loan agreement.
In the current state, lending is unfair and not everyone has equal opportunities to participate in the financial market. Looking at the extreme case, we have over 2 billion people without access to finance. The most common reason is that people from poor countries have no official identification as well as registration documents and thereby no bank account. Other reasons include innocent civilians that suffer from political tensions between governments, often being excluded due to sanctions, corruption or even war. Decentralized lending on the blockchain enables financial global inclusion and can bring an end to the obstacles created by governments. It is statistically evident that countries who experienced financial inclusion, are more likely to developed positively, than those who are excluded from finance. These obstacles can be cured by the adoption of decentralized lending.
Sergej Stein is the financial advisor at ETHLend, a decentralized lending application running on Ethereum Network.