Sooner or later, in order for DeFi really to compete with banks, people will need to be able to borrow more than what they own currently. For example, if I want to take a loan to buy a house for a couple of hundred thousand dollars. Right now, we need to own collateral in crypto worth more than the loan we take. Almost no one owns that much. If they did, they could just buy the house directly. There is also a great risk that it gets liquidated prematurely.
The reason this works in CeFi is that there is a certain level of trust between the bank and borrower: The bank knows that the borrower has an income and is probably able to repay the debt, they trust that they can take possession of the house that acts as collateral, they can see a history of the borrower’s financial standing etc etc.
So my question is, how will DeFi completely be able to replace the current financial system that relies on trust, value of physical assets and regulations enforced by institutional authority?
And also, what solution will TomoChain be able to offer to solve this?
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I don’t have a complete solution for you here, but there is one project I read about a number of months back (can’t find the name of it anymore though 
) that was using a solution by which other individuals would pledge a guarantee through their own crypto assets to back the borrower.
So if the borrower defaulted then these assets would be taken from those guarantors to pay back the loan. However if the loan was fully paid back then they would receive interest. The collateral requirements would be low or nil for the borrower as a result.
My memory on the exact rules might be sketchy but I believe this was the gist. If anyone knows the project I’m describing I’d also love to know the name.
For the time being we over collateralize due to low liquidity and volatility of price. I imagine as crypto matures a handful of assets like BTC will become far more stable (like gold). At this point it’ll be easier to lower collateral requirements since the risk of significant price fluctuations will also be closer to assets like gold
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That sounds like an interesting solution @kyn. It would mean that you need to find someone who know you/trust you enough to be guarantor, right?
I have another thought, could a part of the solution be a kind of decentralized credit score? It could be a NFT of some sort, that you can hold in your wallet to prove your credibility and reduce the risk for lenders, which could reduce the need of a high collateral.
The credit score could be calculated by a Machine Learning algorithm (the algorithm would used would be stored on chain and so not possible to manipulate) with the help of data such as total amount of crypto assets, historical transactions to your wallet, fiat income data from your bank (this would need some kind of integration with a centralized bank, maybe through an oracle? Or that your employment + salary could be verified in a secure way), data about historical loan repayments (you increase your score as you pay back loans).
Also, maybe loans could be repayed by small amounts monthly instead of the whole amount at the final date, to further reduce risk that the borrower can’t repay.
Just brainstorming here.
About using physical assets like a house used as collateral, I guess there needs to be some national regulation in place, that can enforce transferring physical assets on the basis of a smart contract or ownership of a crypto token?
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Good thoughts. We met a few groups attempting to do a decentralized credit scoring system. It’s an interesting idea, and could at some point be an extension to what’s already taking place on TomoX with respect to loans. Based on frequency, amount, and consistency of paybacks along with other criteria like the ones you mentioned it could be easier to develop some form of a credit rating.
We’d need to see greater usage of DeFi features being built/used on TomoChain where this would lead to the logical development of a credit rating created by us or a third party. This is what happened with AliPay and WeChat in China as they scaled.
As for paying back loans, I’m sure there could be ways to structure it such that it matches with standard practices in the real world.
And certainly, using physical assets would require tokenizing them on the blockchain, along with some way to authenticate them. It might start off centralized as a stop-gap where registered properties are still maintained by local authorities in a centralized database alongside a digital token. But as time goes on, there will ideally be decentralized structures with consensus structures that provide trust, independently auditable.
Certainly, this is a fun conversation, but again it is entirely hypothetical at this point. Blockchain gives us a lot of opportunities to imagine possible futures for sure
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@Kyn What about a similar solution for TomoChain?
Yeah their new feature is interesting. It is related to our earlier conversation where the system is one built on trust. Loans are delivered by a line of credit being provided through a peer to peer network with no collateral in the middle.
With the solution in the article, there are a number of complexities here with needing legal contracts between the different parties and managing funds that go from the blockchain into the real world via fiat currency.
Collateral requirements and Fiat on/off ramps are certainly deterrents for DeFi. They’re trying to address both though with limited scope to institutions rather than the everyday Joe for the time being. It’s an interesting experiment to watch and learn from.
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