Since the beginning of time, innovative ways to invest in a brighter future have been considered by entrepreneurial spirits. Some repaid their debts with portions of the next harvests, while others defaulted and were compelled to work to repay outstanding debt.
While decentralized finance does not impose such severe measures, the essence remains the same: people still require means to access funds, and lenders desire repayment with minimal risk. Or do they?
In this article, we will explore a novel approach to collateralizing decentralized finance loans and the pivotal role PWN could play in the decentralized lending space.
Overcollateralization vs. Undercollateralization in DeFi Lending Protocols
As you may know, DeFi borrowing and lending still largely follows the ancient pawnshop model, where borrowers provide collateral worth more than the loan amount, known as ‘overcollateralization’.
This safety mechanism allows the collateral to be liquidated if its value drops significantly, a necessity for some given the wild world of cryptocurrency volatility.
An undercollateralized loan, on the other hand, differs from an overcollateralized loan in that the loan amount is not fully backed by the collateral provided. Which means that if the borrower defaults, the collateral does not fully cover the outstanding principal.
However, this practice is more capital efficient. If it were up to PWN, using this in a decentralized manner could ultimately lead to replacing traditional finance entirely – which is still a place where even the most extremist crypto natives still have to resort to when they need more capital than they own.
DeFi Mortgages by PWN
A DeFi mortgage, a concept uniquely introduced by PWN, works through smart contracts and makes it possible to secure a loan for a specific item with undercollateralization or no upfront capital at all.
In a simple example, a borrower who only has $500 (downpayment) wants to purchase an Axie, which is an NFT used to play the Axie Infinity game, worth $1,000. A lender sees the offer and is willing to lend the other $500 (credit).
In one transaction, the smart contract would combine the funds to purchase the NFT, whereafter the NFT would then be immediately locked as collateral.
Resulting in a 50% loan-to-value ratio, similar to traditional mortgages where the borrower did not have the full amount to pay for the NFT but could purchase it anyway. Importantly, the borrower did not need the full funds upfront to make the purchase.
Benefits of a DeFi Mortgage
A DeFi mortgage provides several key benefits over traditional financing:
- No upfront capital needed: Borrowers do not need to have the full purchase amount to initiate a loan. This allows financing of digital and potentially physical goods with just a minimal deposit.
- Ability to use collateral actively: With self-custody of collateral, borrowers can continue using assets pledged, like playing games tied to NFTs or accessing domain names. This provides additional utility compared to traditional locked collateral.
- Flexible collateral bundles: Smart contracts allow for combining various asset types into a single collateral bundle. This provides more options than limiting collateral to a single asset class.
Conclusion
By introducing crypto mortgages, PWN is committed to transforming the way decentralized lending protocols use overcollateralization as the only way to provide loans to even the most crypto natives. By using smart contracts, loans with little to no upfront capital could become a way to utilize our crypto wealth and use it to secure long-term financing.
While these DeFi mortgages currently function primarily in digital spaces, the endgame is to apply the same mechanics to real-world financing as well, making traditional ways obsolete.
The post Lean, Mean, Lending Machine: PWN’s Role in Undercollateralized Loans in Decentralized Finance appeared first on YourCryptoLibrary.