A Decade of Crypto: How Collateral Change the Way We Borrow
Over its history, secured lending has undergone seismic transformations in technology and process. Unlike most industries and services, innovations in lending never entirely displace existing products and processes. So we have a unique opportunity to compare and choose between different lending models.
CoinLoan represents the latest generation of lending. Creating the company, we have embedded right into our backbone the cutting-edge transformations that cryptocurrency brought. In this article, we are trying to discover what the crypto-backed lending achieved in three years of its existence, and what it could all mean going forward.
Usury: Suspicious Money
Humanity began to lend and borrow before it learned to write and even invented money. Code of Hammurabi, one of history's oldest pieces of writing, included some lending rules.
If you lived thousands of years ago in Mesopotamia, you'd probably borrow from a private enterprise paying 20% for a silver-based or a grain loan.
But there is one thing. To secure your loan, you would pledge your land, house, wife, or child.
In Ancient Greece, you'd probably visit a marketplace for a payday loan from a pawnbroker. Lucky for you, around the 7th century BC debt slavery was abolished.
Banks: Global Money
Game-changing new banks arose almost 1000 years ago in Renaissance Italy by prominent banking dynasties like the Medici. They became intermediaries between depositors (who lend money to the bank) and borrowers (to whom the bank gives money).
Banks borrow from individuals, businesses, financial institutions, and governments to allow you to borrow as much as you need, when you need it, in a form that would be convenient for you.
Starting from 18 century, the primary type of loans shifted from using collateral as a security method to indentured loans. The mid-20th century brought examining financial data (aka credit checks) as a primary method of identifying responsible borrowers.
No wonder that creditors didn’t want to deal with collateral anymore. Although it is often the most obvious form of protection, it causes much trouble to value the asset and turn it into cash in case of non-repayment.
But there is one thing. Using brick-and-mortar banks, you overpay for credit and earn pennies on deposit. A significant part of interest dissolves in the middleman's pocket.
Peer-to-Peer Marketplaces: Cheap Money
The intermediary function of banks that became a breakthrough 1000 years ago now looks like a ballast for some. In 2005-2006 new peer-to-peer lending kicked off the industry in the UK. The ground-breaking idea of P2P was to take a bank out of the equation to match lenders with borrowers directly. The new model brings us back to the ancient individual lending, reinforced by the power of the internet.
Using P2P platforms, you don't pay to the bank. There's only a small and transparent platform fee. As a result, you'll find lower interest rates than the ones typically available through banks.
But there is one thing. Although some P2P providers have features to recover losses such, there is a major risk that a large number of borrowers default on their loans. That means the lender will put your credit report under the microscope before you get final approval.
Crypto Collateral: Secured Money
Thanks to blockchain technology, the model of crypto-based lending arose in 2017. It brings back the concept of collateral but changes the way it works. The thing is, cryptocurrency is the most advanced collateral lending has ever seen. It removes the very concept of default risk. We can speak about ourselves, at least. In almost two years of operation, there wasn't a single default on CoinLoan.
Cryptocurrency, unlike collaterals with material dimensions, in case of non-repayment, can be sold instantly and automatically. A lender gets their investment and earned interest regardless of the borrowers’ repayment or non-repayment.
It means that crypto-collateral is the only guarantee a borrower needs to provide to the crypto-lending platform. Nobody cares about your credit score.
What about crypto's unstable value? An opportunity of the instant sell absorbs this risk. If the price of collateral drops, it can be liquidated to pay off the loan, just like in the case of non-repayment.
We assume that borrowers don’t want their collateral suddenly liquidated if the crypto market goes down. To protect crypto from liquidation, loan-to-value ratio (LTV) exists. It requires borrowers to pledge the collateral with a higher value than the value of a loan amount. In the situation when the price of collateral decreases, it gives the borrower enough time to prevent the sale of collateral before it crawls down to the liquidation point.
But there is one thing. Since pledged crypto is the fuel necessary to carry out this lending model, you can’t get a loan without crypto as collateral.
What Is Next?
The pledge, which expands the possibilities of lending, at the same time, narrows the number of borrowers by crypto holders. Most people have real-world assets but not crypto to secure loans.
CoinLoan’s CEO Alex Faliushin believes that this limitation won't last long. Faliushin reckons any assets would be digitized in the coming decade thanks to the blockchain technology.
For instance, The Global Digital Securities Ecosystem 2019 report provides an overview of the growing market of digital securities. Stablecoins pegged to gold could be considered a significant move toward digitized gold. Other property like real estate and cars can also be turned into tradable digital assets with higher liquidity.
Potentially, any property can serve as "perfect" collateral precisely the same way as cryptocurrencies do now.