Will DeFi Lending Threaten Traditional Lenders?

Decentralized finance lending is a big trend today, but it doesn’t enjoy a market without certain challenges, including regulatory hurdles for many of the businesses trying to evolve and grow this segment.

Yes, investors can get some concrete benefits from DeFi lending, but they also have to look out for some obstacles.

On the other hand, since many of the roadblocks to DeFi lending are solvable with the right amount of due diligence and deliberate exchange construction, many top analysts and finance professionals believe that DeFi lending will absolutely threaten traditional lending practices, with their inherent costs and often complicated logistics.

“(A) foundational DeFi benefit is that it simplifies borrowing for personal purposes,” tweeted entrepreneur Mark Cuban recently, describing why he feels DeFi is going to challenge old models and old ways of doing things. “It’s a hassle to borrow money from a bank … and DeFi allows anyone with funds to be a lender, as well.”

This, in a nutshell, is a lot of the philosophy of those who feel DeFi lending is going to end up going places.

Benefits of DeFi Lending

One of the biggest benefits of DeFi lending for lenders is that they can get much higher interest rates than they can get in traditional markets.

Part of this involves the Federal Reserve Bank slashing interest rates to near zero. That means it’s difficult to get more than 1% to 2% on the traditional market, without incurring some major risk.

By contrast, even safer cryptocurrency lending programs, for example, those related to stablecoins, can return interest in the double digits.

On the other side, part of the biggest value for borrowers is that defi lending can be nearly seamless and immediate, where traditional lending involves all kinds of hoops and red tape.

Regulatory Problems with DeFi Lending

As some analysts mention when talking about the value of DeFi lending, part of the appeal is that it offers so many different options to lenders and borrowers. That blizzard of options, in fact, can become overwhelming.

In the US, federal agencies have tried to solve this problem partially through aggressive regulation. When SEC chair Gary Gensler or someone else in a similar position says that stablecoins could be unregulated securities, it’s assumed that part of that playbook involves regulating lots of new DeFi lending opportunities out of existence and walling off that pool of legitimate lending activity to make things easier for everyone who likes things the old way, including the legislators and regulators themselves.

Whether that will work is a different question.

The SEC, for example, is already hung up in a case with Ripple where it seems to be losing based on its inability to show why the formerly third leading cryptocurrency is different in a regulatory sense than Bitcoin or Ethereum.

DeFi Lending Risks

For those who believe that the regulators will ultimately cave, that’s not the only obstacle to smooth and safe DeFi lending.

Experts have identified a few major risks that investors should know about.

One of these is the specter of impermanent loss, where changes in the value of a lending token or coin can change over time in ways that compromise the lender’s interest and capital gains.

As mentioned at Coindesk, the best way to deal with this is to only lend through a DeFi program that involves tokens or assets with less volatile prices, such as stablecoins.

Another one of these DeFi lending risks to look out for is flash loan attacks.

Essentially, bad actors can go on to a lending platform and borrow an enormous amount of money, using it in ways that compromise the system.

Looking out for this involves keeping an eye on price fees and disallowing certain kind of DEX exchange activity.

A third major risk is in the form of DeFi rug pulls. This one can be fairly easy to avoid through not lending over a new and untested platform.

Why DeFi Wins in the End

Let’s go back to why so many people feel that DeFi lending is going to be the future.

Even before the blockchain emerged as a major part of finance, peer-to-peer lending platforms were competing with traditional banks and often winning.

The Internet itself enabled all sorts of lending opportunities, where individuals with capital could lend directly to borrowers in ways that circumvented the traditional bank loan process.

And as everybody knows, the bank loan process can be laborious and frustrating for everyone involved. The banks are notoriously tightfisted with their money and create all sorts of red tape and bureaucratic processes for borrowers. It often seems almost punitive, and borrowers rebel by seizing any alternative opportunity they can get even family loans, or off-the-books loans like that.

DeFi lending essentially means that they don’t have to resort to these measures, because there will be a steady queue of lenders competing for their business. It’s such a liberating idea for borrowers that the emergence of better DeFi lending platforms is likely to open up the floodgates in a major way.

Some bankers are scared, and the above-mentioned regulatory hawkishness is one result.

In the crypto world, companies are getting ready for the new proliferation of DeFi lending contracts

For example, Soda Protocol is using Solana blockchain protocol to drive a new credit rating system for DeFi lending. That’s taking the same tools inherent in the traditional lending market and replicating them on DeFi platforms. It’s another indicator that we’re pretty far toward a new way of doing business with money that makes an end-run around traditional banks and all their shortcomings. Look for these sorts of innovations to come your way sometime soon.