Borrowing and lending is the second largest DeFi use-case. Protocols like Maker and AAVE facilitate over-collateralized crypto loans to help increase liquidity in the space. Doing so has led to creation of a healthy DeFi credit market, and strategic lending is a cornerstone of a great yield farm strategy.
For DeFi to truly transcend CeFi, the need for under collateralized loans is a necessity. Soul Loan (SoLo) is a DeFi protocol that seeks to use mainstream credit check apparatus, combined with wallet analysis, to issue loans to those who don’t have the capital but need it, and by doing so create an explosion of wealth in the space as Web3 becomes more widely adopted.
The Issues with Over Collateralized Loans
Over-collateralized loans are not available to everyone. The fact you must lock away more capital than you are borrowing means these loans are only for very specific use-cases, like yield farming or urgent liquidity. For the common user, the idea of loaning less than you stake is not useful at all.
There is a further issue with over-collateralized loans, and that is the systemic risk they pose through cascading liquidations. An over-collateralized loan can be margin called, and that creates a knock on effect through the DeFi system due to its composability – leading to market shocks.
These problems, allied with the fact that in general people need to borrow more than they currently have. This – naturally – is the main reason people want a loan. Under-collateralized loans are of course risky by nature (it’s why interest rates on loans exist), and an entire credit score system exists off-chain to help Tradfi (or CeFi) institutions determine who to lend to and how much is appropriate to lend.
As DeFi is decentralised, how is it going to be possible to assess under-collateralized loans and ensure the risk is sensibly mitigated? Several solutions have been proposed, ranging from on-chain analytics of a wallet, connected digital identities, crypto-native credit scores, NFT collateral, third party risk assessment, and more. These are all nascent developments in DeFi lending, and the problems are legion.
Using Off-Chain Credit for On-Chain Loans
One way to make under collateralized loans is to use the current off-chain system of credit scoring to help make assessments on crypto-loans, while combining this with on-chain wallet analytics to create an accurate picture of a prospective lender. That’s what Soul Loan (SoLo) is aiming to do. The existence of an incredibly rich and sophisticated off-chain credit score system makes using it for crypto-loans eminently sensible. By bringing this CeFi system into a decentralised environment, the SoLo protocol can make under-collateralised crypto loans to those who need it by assessing their general credit-worthiness.
In this sense, the SoLo team are not hardline DeFi anonymists. Their protocol requires KYC and standard credit checks to approve its loans. Yet it also creates a crypto-native portal through which to acquire them, and will act far faster than a traditional bank would when approving a loan. Although assessing your general off-chain credit score, SoLo will also track wallet usage. If a wallet has a history of on-chain participation in yield farming, over-collateralized loans, repayments, and more – it will be more likely to be approved.
SoLo recognises that DeFi must produce effective under-collateralized loans in order for it to become a truly alternate financial system. There is $47.4B in over-collateralized loans in crypto, whereas there is $7.07T under-collateralized loans in TradFi. The gulf is enormous. Yet the simple fact is if DeFi can’t provide standard loans then TradFi will always reign supreme.
Tom G, co-founder of Soul Loan, said “There’s already a powerful system for credit checks that exists. By using TradFi credit systems to facilitate crypto loans, we can help onboard millions of dependable borrowers into Web 3.”
His co-founder, Louis L, went on to add “As Web 3 expands, more of the world’s financial systems will exist on chain. On-chain credit markets that mirror traditional systems are guaranteed to exist, and SoLo will be the first of its kind.”
Benefits of a SoLo loan
Although Solo requires credit checks, it nevertheless allows a user to remain anonymous if the loan is paid back on time. The credit is checked on a zero-knowledge basis, and the personal information is secured and only released and/or used should a user default on their loan. By using traditional credit checks, users can borrow crypto at a rate more akin to that from a centralised provider, but with far less hassle in waiting for the loan to be approved.
It means that a user of SoLo can use their Web2 creditworthiness to obtain value in Web3 quickly and easily, but not expose their information or anonymity if they pay back the loan as expected.
The benefits of a standard loan are obvious. There are some additional benefits that may be more obscure though, such as the ability to organise tax liabilities advantageously by not selling your crypto directly (if collateral is put down). It also means someone with a good credit score but no crypto can quickly gain access and exposure to the Web3 ecosystem by loaning against that pre-established creditworthiness.
How Soul Loans Benefit Lenders and Increase Adoption
SoLo creates an opportunity for crypto-rich lenders to earn TradFi-beating interest rates, become the bank, and loan to a new generation of Web3 adopters, while maintaining the security of using the off-chain credit score system when providing capital to borrowers.
A DeFi protocol that can harness off-chain credit data to execute low-risk crypto loans in a decentralised manner will unleash terrific wealth potential into the crypto space. Solos mission to do this may run slightly counter to received DeFi norms of anonymity, but SoLo does secure personal data and doesn’t use or publish it if the loan is repaid on time.
There are many who are credit-worthy without being rich, and if SoLo can provide effective lending facilities for these people using the efficiencies of the blockchain, they can help bridge the CeFi and DeFi gap and create a crypto-bank that ushers in adoption through mainstream failsafes. It may be a battle for DeFi’s soul, but an under-collateralized loan market is needed for DeFi to progress, and Soul Loans may provide exactly what it is needed.
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