How Decentralized Finance (DeFi) Lending can Beat Centralized Finance

The current status-quo in a centralized environment is to set fixed rates and earn the difference. For example, if the interest rate for investors is set at 4%, and 10% for borrowers, a bank absorbs the 6%.  Except banks set
their own rates and earn the difference

Conversely, crypto lending proposes a dynamic rate model, where the borrowing rates fluctuate according to a network’s utilization of lender capital. For example, a market with $10,000 pooled by lenders and $100
requested by borrowers should have a lending interest rate lower than a market with $10,000 pooled by lenders and $1,000 requested by borrowers.

The model allows borrowers to pay less when there is less borrowing demand, and for lenders to receive higher rates when demand is high. Furthermore, since crypto lending currently occurs on a collateralized
basis, there is no need for credit checks or KYC processes – smart contracts set the terms, allowing the loan to occur automatically and instantaneously
when conditions are met (typically once sufficient collateral is deposited).

And since there is no agent sitting between borrowers and lenders, interest can be passed on to lenders. In the case of DeFi up to 95% of the interest paid by borrowers is passed to lenders, compared to 20-30% in CeFi15.

In the case of Compound’s DAI market, only around 0.2% of the outstanding borrow amount is kept by the protocol to incentivise governance token holders to perform governance functions, versus overwhelmingly higher fractions in CeFi.

The value extracted by banks in traditional lending significantly outpaces the level seen in DeFi lending protocols because banks incur significant labour costs for their operations, and they are able to extract higher economic rents due to their central position.

Conversely, the lending protocols in decentralized finance (DeFi) have minimal ongoing costs that are there to compensate governance token holders for carrying out their functions. In the case of Compound’s DAI market, only around 0.2% of the outstanding borrow amount is kept by the protocol to incentivize governance token holders to perform governance functions, versus overwhelmingly higher fractions in CeFi.

The value extracted by banks in traditional lending significantly outpaces the level seen in DeFi lending protocols. The main reason for this is that banks incur significant labour costs for its operations and they are able to extract higher economic rents due to their central position, while decentralized lending protocols have minimal ongoing costs, with the only cost being to compensate governance token holders for carrying
out their functions

Learn more about DeFi

What is DeFi (Decentralized Finance) : Layer by Layer

 

Beginner Guide To Decentralized Finance (DeFi)

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