“There’s no way anonymous lending can work.” – Anonymous
“Anonymous lending won’t happen any time soon.” – Anonymous
“The future is faster than you think.” – Peter Diamandis, Co-Founder, Singularity University
True cryptocurrencies allow us to exchange value across any distance, without a middleman, and without permission. A little over ten years ago, this wasn’t possible. Today, a whole range of sophisticated financial services are being built on top of this extraordinary new infrastructure. Crypto lending services are now common.
People have invested heavily in cryptocurrencies, hoping that they’ll be worth significantly more in the future. If you’ve acquired crypto for that reason, you aren’t in a hurry to sell it, even though some fiat liquidity might be useful. For that reason, many crypto owners are using this asset as collateral to take out fiat or stablecoin loans, using a financial instrument called a Collateralized Debt Position or CDP.
The origin of CDPs
CDPs have only existed since 2014. They are managed by smart contracts[efn_note]Code that runs on the same blockchains that hold cryptocurrencies.[/efn_note] that allow anyone to deposit a digital asset as collateral against a crypto loan. The borrowers and lenders may be anonymous. The borrowers and lenders may or may not be people. They may be people, corporations, or smart contracts[efn_note]Smart contracts are truly autonomous entities. Once they are deployed, they cannot be “turned off”.[/efn_note].
CDPs were popularized by the MakerDAO (“Maker”) project. Maker allows Ether[efn_note]The cryptocurrency of the Ethereum blockchain.[/efn_note] holders to mint Dai, a stablecoin[efn_note]Stablecoins are designed to hold a relatively constant value against a single or basket of fiat currencies. Dai’s value is kept relatively close the USD using a complicated mechanism called a “dynamic stability fee”.[/efn_note], by pooling their Ether. They can remove up to 66% of the value of their Ether in Dai, and can get it back by paying back the Dai, removing it from circulation. In the token world, this is called “Burning” a token. Dai can be exchanged for fiat currency, thereby providing fiat liquidity to anyone who locks up their Ether.
The birth of an ecosystem
CDPs are now considered a critical financial product in the crypto world. Maker’s ideas were quickly imitated, with many variations. Many other distributed projects and companies now issue fiat and crypto loans, secured by crypto. Some of these, such as Compound and Dharma, are completely anonymous and automated. Others, such as Nexo and SALT, are custodial[efn_note] Which means they own or managed the borrowed assets.[/efn_note] and require KYC/AML[efn_note] Regulator-approved identity verification mechanisms.[/efn_note]. Much of the industry’s lending volume is still conjecture, but our early estimates from media, self-reported volume, and publicly available data puts the volume of loans originated at about USD 3.4B.
Anonymity is one of the foundational features of blockchain transactions. Maker, Compound, and DyDx are totally autonomous. No personally identifiable information is asked of lenders or borrowers. This presents unique opportunities, as well as challenges.
Currently, these platforms require that customers over-collateralize their loans, so they can only borrow up to 66% of their crypto’s value. This allows the platforms to make sure that if the price of the collateralized asset drops, the collateral can be seized (with fees) before the value of the collateral drops below the value of the loan. This protects lenders, but also makes the product less appealing to potential borrowers. Lenders are currently seeking ways to safely lower the necessary amount of collateral without increasing their risk. Since the borrower is anonymous, the tools to do this need to rely on historical data associated with a borrower’s wallet address.
The future, it turns out, is now.