We’ve seen the crypto economy undergo exponential expansion in the past year as heaps of money poured into various cryptocurrencies, decentralized finance (DeFi), nonfungible tokens (NFT), crypto indices, insurance products, and decentralized options markets.
The total value locked (TVL) in the DeFi sector across all chains has grown from $18 billion at the beginning of 2021 to $240 billion in January 2022. With so much liquidity in the ecosystem, the crypto lending space has also grown significantly from $60 million at the beginning of 2021 to over $400 million by January 2022.
Despite the exponential growth and the innovation in DeFi products, the crypto lending market is still only limited to token-collateralized loans, i.e., pledge one cryptocurrency as collateral to borrow another cryptocurrency.
A few platforms, such as Nexo and Genesis, provide NFT-collateralized loans, but the service is mainly for institutional clients with blue-chip NFTs. There isn’t much more than just token-collateralized loans for the retail masses.
If the crypto economy wants to grow to a size that is compatible with any real economy, it will have to reach out to the mass of retail consumers and provide financing options to them.
Here are the essential components that need to develop before crypto banking infrastructure can rival banks’.
Diversity of goods and services
One of the most commonly asked questions from someone new who wants to enter the crypto economy is — what can I buy? There is not much other than NFTs, DeFi products, staking, and liquidity provision in the current infrastructure.
In a traditional economy, currencies exist because exchanging goods for services, or vice versa, generally does not have a 1:1 ratio, so coins serve the purpose of facilitating transactions of goods and services. In the crypto economy, currencies exist before goods and services become widely available to customers. It makes cryptocurrencies hard to evaluate and unstable.
An economy needs to have sufficient goods and services available to create enough supply and demand so consumers can use currencies to exchange for these goods and services. With only NFTs and DeFi financial products in the current crypto ecosystem, attracting the ordinary Joe or Jane into the economy is challenging because it is not much to consume.
A healthy and functional banking system also relies on a sufficient supply of liquidity from customer deposits and adequate demand from customers to borrow. With more digital goods and services, especially non-financial ones such as art, music, real estate, or gaming gear in the metaverse, the banking system will utilize them as collateral to provide a diversity of secured loans. Similar to car loans or mortgages, consumers in the crypto world will be able to own these products by paying periodically in the future.
A reliable credit scoring system
No credit check or credit scoring system is needed for customers to borrow any cryptocurrency in the current crypto lending market. The loan is over-collateralized with a strictly monitored loan-to-value (LTV) ratio. As soon as the LTV goes above the liquidation LTV threshold, the collateral will be sold at a discount to recover the loan. The collateral value is never fully utilized, and there is always a large buffer reserved in case of sudden collateral value depreciation.
In traditional banking, customers have a credit score based on their past transactional behavior and financial condition, i.e., annual income, savings, loan repayments, and investments. It is almost impossible in the crypto lending market because the wallets are created anonymously, and anyone can create as many wallets as they want. It makes it very difficult to track transactional behaviors and challenging to build a credit score.
For the current structure to change, users need to be incentivized to build a good track record of all the activities within a wallet and be loyal to the wallet. There are scores such as LUNAtic Rankings for Terra to rank order engagements within a specific chain. Still, there doesn’t seem to be any credit-specific scoring to rank order wallet owners’ financial condition.
As more jobs are created in the crypto space, and more people are paid in cryptocurrency, wallets show a long healthy track record of constant cash inflow, continuous stable balance, or regular repayments to a crypto loan should be rewarded. The reward could be in the form of gaining access to larger loans with lower interest rates, gaining access to longer-term loans, or even in the form of airdrops of governance tokens.
A robust credit scoring system would benefit both the lender and the borrower. The lenders can earn more fees with lower risk by providing more loans to trustworthy borrowers; the borrowers can have access to lower rates, longer-term loans, and other potential rewards. Most importantly, a credit scoring system could help form a more transparent and healthy crypto lending market and attract more consumers to the ecosystem.
An actively managed collateral evaluation system.
Given the highly volatile nature of cryptocurrencies (at least for now), the collateral value needs to be assessed much more frequently than in a traditional secured loan. Unlike conventional collateral such as cars or houses, whose values are more predictable and do not change dramatically during a short time, the collateral in the crypto world, such as NFTs or cryptocurrencies, could encounter sudden downside movements in just one day. Therefore, lending platforms need to have robust collateral evaluation systems that can estimate the market value of any asset at any time.
It is not difficult to evaluate the market value of NFTs or cryptocurrencies minute-by-minute. But as more goods and services become available in the crypto ecosystem and more types of assets become eligible as collateral, having a high-frequency collateral evaluation system can be costly.
Alternatively, lending platforms can create something similar to the concept of risk-weighted assets (RWA) in the banking world to give more risk weights (lower liquidation LTV thresholds) to riskier collateral and less to safer ones they don’t necessarily need to have a high-frequency collateral evaluation system.
For example, blue-chip NFTs such as the Bored Ape Yacht Club (BAYC) can be given a higher liquidation LTV threshold and evaluated less frequently. As more historical NFT prices become available, more data points can be collected and used to derive a more accurate risk weight metric.
As more goods and services become available in the crypto economy, a reliable credit scoring system and an actively managed collateral evaluation system will enable crypto banking infrastructure to provide more financing options other than token-collateralized loans.
The future outlook of crypto finance depends on the types of goods and services available to the crypto economy. It can only rival the scale of traditional banks when the crypto economy grows into a more diversified and appealing market space to more consumers.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk, and you should conduct your research when deciding.
Amp Future Digital Token and Its Opportunities
On the Flexa crypto network, payments are made quickly, securely, and with the lowest fees, finally providing merchants with a meaningful, usable, and valuable alternative to traditional payment networks. Where we may have once dreamed about using cryptocurrency to buy an ice cream cone or the latest edition of Grand Theft Auto, Flexa is making that vision a reality — and opening up a whole new world of utility for the asset class.
The Flexa model benefits both sides of a transaction. For crypto holders, Flexa brings digital assets to the real world, further establishing cryptocurrency credentials as money and unlocking value in the form of specific tender for goods and services. For merchants, the many advantages of Flexa include reduced costs, faster settlement, elimination of fraud, and access to the growing crypto market.
In the United States, around 86% of retail payments happen offline in physical stores. Capturing significant market share for cryptocurrencies among those payment transactions has been the key to mainstream adoption.
Flexa’s instant payment authorizations are made possible via Amp, the network’s native token co-developed by Flexa and ConsenSys. Payments are collateralized by Flexa’s ERC-20 token Amp, which can be staked as collateral that receives additional Amp as a staking incentive. As a fixed-supply, Ethereum-based ERC-20-compatible token, Amp works as crowd sourced collateral to completely decentralize payment risk, rewarding those who provide collateral with even more Amp tokens for every successful payment transaction.
Although the material contained in this website was prepared based on information from public and private sources that AMPRaider.com believes to be reliable, no representation, warranty or undertaking, stated or implied, is given as to the accuracy of the information contained herein, and AMPRaider.com expressly disclaims any liability for the accuracy and completeness of the information contained in this website.