Authored by Ehab Zaghloul, Chief Research Scientist at Tribal Credit
Metaverse, hodl, to the moon, laser eyes – these phrases mean nothing to the average consumer, but to those invested in the depths of the cryptocurrency ecosystem, they mean absolutely everything.
The crypto industry often assumes the role of an exclusive club behind red velvet ropes – one with passwords, hip lingo, and no easy entry in sight. As crypto makes its way into mainstream media, however, retail traders, institutional investors, and traditional finance executives are beginning to penetrate the crypto bubble, and in turn, make crypto more accessible to the masses.
This synergistic energy, brand new to the cryptoverse, has given rise to new ideas, burgeoning partnerships, and perhaps most notably, new buzzwords. So what word will join the list next?
Perhaps not as riveting as terms like metaverse, hodl, to the moon, and laser eyes, this 14th-century word of Germanic descent may be one of the few not coined on Twitter by crypto bots, but rather borrowed from traditional finance, and for good reason.
How Does Lending Apply to Crypto?
Amid all the volatility that has buffeted crypto asset prices this year, one segment of the market has turned in a consistently strong performance: lending. Loan origination in digital lending has shown a 30.1% year-on-year growth.
In much the same way as traditional lending, investors in the cryptoverse can lend their crypto to borrowers in exchange for interest payments. Unlike traditional finance, however, the crypto space removes the need for third-party intermediaries by replacing banks with smart contracts, creating loan processing platforms designed to provide access to capital far more efficiently than traditional financial institutions.
The smart contracts found in most decentralized finance (DeFi) protocols remove major bureaucratic hurdles from lending, therefore drawing tremendous amounts of liquidity into the market. In most cases, lenders utilize DeFi to earn interest on their crypto assets while borrowers unlock the value of their crypto by staking it as collateral for a loan.
Whatever the use, lending is everywhere in the space.
As of August 4, 2021, the DeFi portion of the lending sector alone was worth nearly $20 billion, and DeFi protocols offered high annual percentage yields (APYs) of nearly 40%. Centralized exchanges have tapped into the loan game as well, offering APYs of up to 17% and 9.5% from entities such as Celsius and BlockFi, respectively.
The benefits of crypto lending are not limited to individuals, either. They could extend especially well to SMBs around the world.
SMBs and Crypto: a Symbiotic Relationship
While individuals may have been the first to reap the benefits of lending, they certainly won’t be the last. Many small and medium businesses (SMBs) around the world are beginning to recognize crypto lending as pivotal to their growth and survival.
SMBs are the backbone of the global economy, accounting for 90% of businesses and more than 50% of employment worldwide. Yet, for all their importance and potential, they often have great difficulty accessing cash. There is currently an estimated $5 trillion in unmet capital demand in the developing world, and when SMBs do gain access to much-needed capital through traditional means, that funding often comes with double-digit interest rates.
In the Latin American market alone, unmet capital demand amounts to approximately $1 trillion, and data from the Banco Central do Brasil shows that interest rates charged to credit-worthy SMBs are more than double those charged to large corporate entities.
SMBs in emerging markets simply cannot access credit at affordable rates. Not only does this unmet demand signify an enormous waste of talent and ambition, it is also a missed opportunity for lending services.
But it doesn’t have to be.
As lending emerges as the latest cryptoverse buzzword, it’s positioned to create a radically new symbiotic relationship between investors and businesses by enabling the industry to wean itself off of speculative trading. Now, crypto lending is incentivizing individuals to generate yield based on real, meaningful investments in small businesses and the real people who rely on them.
Traditional lending systems often exclude small businesses or charge prohibitively high fees, making it difficult for SMBs to access crucial funds. In the crypto space, however, under-collateralized loans are emerging as an innovative new service that could give SMBs a fighting chance to secure necessary funds and grow their businesses.
Crypto lending has the potential to create a fairer lending system by creating the potential for lenders to access a data-based credit rating system, helping them assess SMBs’ creditworthiness using statistics and enabling them to offer qualified SMBs access to less punitive interest rates. If lending could be automated using smart contracts, the process could be made even more fair and efficient by cutting out the bureaucracy of traditional banks, making it easier for lenders to engage in emerging markets where banking infrastructures may struggle to keep up with the demands of borrowers.
This approach also benefits the lenders themselves, who can secure sustainable APYs that are not subject to high levels of regulatory and crypto market risk. Because these APYs are based on yield generated by SMBs in the traditional finance (TradFi) sector, they are not contingent on crypto market conditions, making them far more dependable for lenders. Without hurting returns, lenders can shift their focus from over-collateralized loans to under-collateralized loans, opening the door to participation from a wider and more varied pool of borrowers.
Beyond reducing the hefty fees that SMBs currently pay to access capital, crypto can make under-collateralized lending possible, creating more flexibility in credit lines. Credit lines enable high-performing firms to cover short-term needs; they can act like rocket fuel for fast-growing companies while offering lenders access to promising borrowers poised for rapid expansion.
The Future of Lending
Currently, crypto lending platforms offer individuals and businesses faster, more efficient, and more accessible lending options, but much like traditional finance, they only offer payouts to lenders in the form of APYs. What if a lending ecosystem rewarded TradFi borrowers as well?
In a world where these borrowers are rewarded for seeking out credit lines, increased usage could further stimulate the ecosystem while drastically reducing the risk assumed by lenders. SMBs with real business plans and tangible assets would act as a much more sustainable, dependable source of yield, and lenders would continue to earn the high returns to which they are accustomed, but without the same levels of risk.
Envisioning the Ideal
Blockchain-powered ecosystems can transform the vicious cycle of speculative lending into virtuous circles of sustainable, self-reinforcing activity. The more people use these services, the more rewards they receive and the stronger the ecosystem becomes.
Participants can leverage the power and infrastructure of crypto to create financial paradigms in which everyone benefits. In the multi-service ecosystem posited above, borrowers gain access to capital and rewards, while lenders earn attractive, sustainable APYs free from the volatility of the crypto market. But this is just the beginning. Eventually, crypto-powered ecosystems will build an even fairer and more prosperous economy for all.
The real beneficiaries of these new ecosystems will be communities in emerging markets around the globe, whose growth can be accelerated by sustainable crypto financial systems reinforced by well-structured incentives. This will create some of the world’s most vibrant and emerging communities and build vital and dynamic economies that will support generations to come.
So if there’s one word to watch out for in the coming months, keep an eye on lending.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.