What is uncollateralized lending? . Why is Uncollateralized lending called a profitable lending market for venture capitalists? Find out below!
Overview Uncollateralized Lending
What is Uncollateralized Lending?
Uncollateralized Lending is a loan that does not require collateral to back the loan. Banks no longer require customers to provide collateral such as properties, vehicles, stocks, etc., but instead provide loans based on the customer's credit rating.
This is the opposite of a mortgage, when users need to pledge assets such as real estate, vehicles, stocks to secure the loan. If the borrower goes bankrupt, their assets will be liquidated to return the creditors' capital.
For example:
For mortgage loans: In order to borrow VND100 million from the bank, you need to mortgage vehicles, real estate and other assets worth at least VND150 million. If you go bankrupt, the bank will sell the asset at a liquidation price to repay the loan.
For unsecured loans: You don’t need collateral to borrow money. Instead, banks will provide you with a loan based on an evaluation based on your credit history, monthly income, and the purpose for which the funds will be used.
Unsecured loans:
For the economy: Play an important role in promoting economic development by helping people obtain financial resources to invest, shop and consume. It also enhances the competitiveness of enterprises and creates new job opportunities.
For Lenders: Provides lenders with the opportunity to earn profits on loans without collateral. This helps increase profits and improve the financial health of the lender.
For Borrowers: Provides borrowers with the opportunity to obtain financing faster and easier without having to post collateral. This helps meet people’s borrowing needs and helps them carry out personal projects, expand their businesses and invest in different areas.
Benefits of Uncollateralized Lending
Here are the benefits of unsecured loans:
No Collateral Required: This helps borrowers optimize their rate of return as no collateral is required but they can still borrow and reduce the risk of liquidation and asset loss.
Build a credit history: Regularly paying off an unsecured loan can help borrowers build a good credit history, which can make it easier for them to obtain capital financing in the future.
Creating a new market: a market for people who have more capital and accept higher risks in exchange for higher interest rates than if they were deposited in a bank.
Limitations and Risks of Uncollateralized Lending
This is the limitation of unsecured borrowing
Lenders take on a higher risk because the loans are not secured by assets. If the borrower is unable to repay, the lender could lose the principal.
In contrast, borrowers bear high interest rates because unsecured loans often carry default risks.
Credit rating requirements are more stringent and loan terms may be more stringent.
The loan amount is limited based on the assessed credit score.
Negative impact on credit: If the borrower fails to repay the loan on time or does not repay the loan in full.
DeFi Overview Uncollateralized Lending
What is DeFi Uncollateralized Lending?
DeFi Uncollateralized Lending is an uncollateralized lending model adapted to the blockchain to take advantage of the DeFi market. In this way, DeFi Uncollateralized Lending can bring transparency, global user accessibility, transaction fees, and better interest rates by eliminating the involvement of financial institutions.
The difference between DeFi and TraFi Uncollateralized Lending
However, DeFi is very different from Uncollated Lending in traditional financial markets. In traditional markets, Uncollated Lending has two functions:
In the traditional market, if a company has no bad debts, has annual revenue and profits, and has existing assets, such as factories,...
Not only companies, but individuals can also borrow money without collateral, as long as they have no bad debts, stable income, timely loan repayments, and other existing assets, such as houses, cars, etc.
However, there is only one way to DeFi Uncollateralized Lending. more detail:
The DeFi UncollateralizedLending model only supports corporate lending in the crypto market or traditional market, and does not support unsecured lending by individual users.
This is easy to understand, because Lending projects can reduce risks by evaluating the company's credit score through third-party services. In addition, if a default occurs, they can resort to legal intervention, as in the case of BlockFi.
However, for ordinary users in the market, it is impossible to collect debts from Lending projects if they do not repay. Not to mention some projects with KYC requirements, since we cannot know exactly who the owner of the wallet address is, it is also easy to impersonate.
Therefore, DeFi Uncollateralized Lending can only operate in one direction, rather than in both directions like traditional markets.
Benefits of DeFi Uncollateralized Lending
Here are some of the benefits of combining Uncollateralized Lending with DeFi:
Transaction fees are lower than traditional lending options because DeFi platforms run on the blockchain, eliminating the need for intermediaries such as banks or other financial institutions that charge high fees.
Loan processing times are faster because they use automated processes and smart contracts, eliminating the need for manual approval and approval processes.
Improved transparency, as all transactions are recorded on the blockchain, and borrowers and lenders can view the details of the loan agreement, ensuring that the terms are fair and transparent.
Reduce the risk of fraud or make it more difficult for fraudsters to conduct loan transactions. The use of smart contracts ensures that loan terms are automatically enforced, minimizing the risk of fraud or manipulation.
Increase accessibility and liquidity for anyone with internet access, thereby increasing loan liquidity and reducing stakeholder risk.
The combination of Uncollateralized Lending and DeFi can provide huge growth potential for non-traditional financial services. This helps create new investment opportunities and attract new investors to the market.
How Uncollateralized Lending works
The lending process of DeFi Uncollateralized Lending Protocol
Unsecured lending in DeFi is only one-way, that is, users in DeFi cannot borrow and can only lend to other companies after the project team evaluates the risk level.
The operating model of DeFi Uncollatederalized Lending is achieved through the following steps:
(1) Enterprises that want to borrow money need to register with DeFi Uncollateralized Lending (TrueFi, Maple, Goldfinch, ...) for KYC (identity verification) and provide relevant information.
(2) In addition, relevant information must also be provided, such as: loan amount, interest rate paid to the lender, loan term, interest payment time and period, collateral information (attached can be part of tangible or intangible assets, such as company brand ),...
(3) Afterwards, the DeFi Uncollateralized Lending project team will review and risk assess this information to ensure the security and feasibility of the community.
(4) If approved, the loan will be listed on the website, allowing DeFi users to deposit funds (mainly stablecoins) for the borrowing company.
(5) The borrower will be responsible for interest payments and repayment of the loan in accordance with the original terms. The lender will receive periodic payments of interest and principal upon expiration of the term.
(6) If the payment is not made according to the terms, the DeFi lending project will take legal action. However, if the law enforcement agency is unable to recover the debt from the party involved, the lender still needs to bear the risk of losing all funds.
In this operating model, the credit scoring process is the most important stage to minimize the risk of losing capital in the event of insolvency. Next, we will understand the concept of Credit.
credit score
Credit is the ability and permission of an individual, organization or business to borrow money or use financial products and services without paying immediately, but instead at a later date, at a specific time, or in the future.
Credit assessment is the process of determining the level of credit risk to determine the borrower's ability to repay the loan and make decisions on additional conditions such as interest rates, credit limits, regular payments,...
factors in assessing credit
Credit rating factors typically include:
A credit history indicates a borrower's ability to repay debt and their creditworthiness in repaying previous debts.
A client's income indicates the client's ability to repay debt and maintain a stable standard of living.
A customer's existing debt can also affect their ability to repay a new loan.
The client's assets are also considered during the credit assessment process. It can include real estate, cars, investment properties, etc. The property will serve as security or collateral for the loan.
Evaluate the purpose for which the loan will be used. If the intended use is a potential large-scale enterprise, financial institutions may be willing to extend credit at a lower interest rate.
The time remaining on a client’s employment contract also affects Red’s income and thus their ability to repay debt in the future.
Economic conditions can also affect a customer's ability to repay their loan. Financial institutions will assess the current economic situation and predict future economic conditions to decide on extending credit to customers.
These will be factors that the DeFi LendingProtocol management team will evaluate. This is also the information that companies/organizations that want to borrow money need to provide if they want to prove their ability to repay the lender.
Uncollateralized Lending DeFi Project
Currently, there are very few DeFi projects operating in the unsecured lending space because the risks in this industry are higher than in other industries. However, BNB Chain’s investment direction table will be released in April 2022. Binance Labs announced that it will invest in DeFi Uncollateral, as there are currently few projects on the market with potential for development in this area.
There are currently 5 active Uncollatederalized Lending projects in the market, and the users are:
TrueFi
Maple Finance
Goldfinch
Atlantis
Clearpool
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