As we step into a new year, the hot topic surrounding DeFi is that of undercollateralized loans. Whereas 2019 paved a solid foundation for the successful deployment of overcollateralized loans (think Maker Vaults requiring 150% collateralization), it should come as no surprise that those often looking to take out loans do not have much (or any) capital to post as collateral.
With this concept in mind, the conversation then becomes – how can we guarantee loan repayment without requiring over-collateralization?
In this article, we’ll be taking a look at Zero Collateral Loans – a new product created by FarbX Blockchain to do just that.
Launched with an intuitive interface to quickly mint fake Dai (fDAI) paired with an easy to follow FAQ, interested individuals can explore the look and feel of the system here.
Simply put, lenders supply Dai to a contract in exchange for zDai (similar to how Compound issues cTokens). Those lenders are then able to claim a pro-rata portion of the redemption pool whenever their capital has earned interest.
Let’s explore how it works.
Zero Collateral Borrowing
Perhaps the most novel aspect of this solution is the notion of earning trust or reputation over time.
“Borrowers must only maintain collateral equivalent to the value of the loan minus the amount of total interest paid from all previous loans. With frequent loan repayments, the required collateral needed for borrowing eventually drops to zero.”
Unlike something like Maker in which 150% over-collateralization is required for all loans, this product allows frequent users to gradually diminish the need for collateral as their reputation (tracked by the ability to repay outstanding loans) increases.
All loans are capped at 30 days with a predefined interest rate of 20%. Each wallet can only hold one outstanding loan at a time, thus diminishing the potential for malicious activity.
Similarly, maximum borrowing capacity increases by ½ of the interest rate following the successful repayment of a previous loan. For example, if the first borrow is 1 DAI, then the following maximum borrow will be set at 1.1 DAI (50% of 0.2 interest on the 1 DAI loan).
As we mentioned above, less collateral is required after each successful repayment. It’s theorized that borrowers will not need collateral after 8 borrow and payback cycles (of the maximum borrow).
In the event that a borrower DOES NOT repay his loan, the underlying collateral is held in a redemption pool and the collateral limits are reverted to a base of 1 DAI with 100% collateral required.
For lender’s reading this article, you may be wondering why you’d take the risk on undercollateralized loans.
For one, the interest to be earned is theoretically much higher than something like Compound or the DSR due to a higher risk premium. Paired with a predefined interest rate of 20%, there are far more fees to be shared (in the form of interest payments) than other liquidity income opportunities such as Uniswap’s liquidity pool.
Furthermore, the added parameters surrounding short-term loans with only one loan per account *should* make it far more difficult for users to try and game the system.
Powered by DAOs
Also weaved into this announcement is the intention to launch a Zero Collateral Loan DAO to governs crucial aspects of the protocol.
Similar to how Kyber DAO and Synthetix DAO are supposed to function, it’s likely that Zero Collateral Loan DAO owners will be responsible for setting parameters such as interest rate percentages, collateral reputation and maximum borrowing capacity.
Why is This Unique?
As we look for novel ways for DeFi to make its way into the mainstream, Zero Collateral Loans provide an interesting solution for users to take out autonomous loans with less readily available capital.
While the interest rates are quite high, this solution should allow users that need short-term capital to act in a more efficient manner, gradually returning to the platform to further increase their borrowing capacity while reducing their collateral needs.
It’s quite possible that we may see Dai lenders emerge that continually meet loan repayments allowing for instantaneous lending with no collateral needing to be posted. In this scenario, we can envision a future in which external or contract accounts can compose solutions to automatically lend Dai at dynamic rates based on specific loan requests. (i.e. I’ll pay 10% interest and have the loan repaid in a day).
Perhaps even more important is the project’s founders interest in exploring how these solutions can be gradually introduced to centralized finance solutions such as NerdWallet and Credit Karma.
“Loans offered on the Zero Collateral Protocol can even be specialized like mortgages or student loans. Real-time data, for example, home activity or student grades, can be streamed to the protocol. Bank spending data can further be used as collateral itself against the decentralized loan.”
If one thing is for certain, we can see a clear trend of stablecoin loans becoming easier and easier to obtain, thus gradually reducing the barriers to entry for less affluent individuals.
In the meantime, you can stay up to date Zero Collateral Loans via their official Twitter account.
Until next time, be sure to stay in the loop on all things DeFi here.
Cooper is focused on building compelling blockchain products. He currently works as the managing director at Fitzner Blockchain Consulting and is a contributor to DAOs like MetaCartel and Moloch. He is an active member of the Ethereum community and has a strong interest in for-profit businesses such as The Block Crypto and Messari.