DECENTRALIZED LENDING AND BORROWING

One of the most common services offered by the financial industry is the lending and borrowing of funds, which was made possible by the concept of credit and collateralization.

It can be argued that the invention of commercial-scale lending and borrowing was what brought about the Renaissance age as the possibility for the less wealthy to acquire startup funds led to a flurry of economic activity. Thus, the economy began to grow at an unprecedented pace.

Entrepreneurs can borrow the upfront capital needed to establish a business by collateralizing the business while families can get a mortgage for a house that would otherwise be too costly to buy in cash, whilst using the house as collateral. On the other hand, the wealth accumulated can be lent off as capital to lenders. This system reduces the risk of borrowers absconding with the borrowed funds.

However, this system requires some form of trust and an intermediary. The role of an intermediary is taken up by banks and trust is maintained via a convoluted system of credit, whereby the borrower must exhibit the ability to repay the loan in order to be qualified to borrow, among a laundry list of other qualifications and requirements by the banks.

This has led to various challenges and shortfalls of the current lending and borrowing system, such as restrictive funding criteria, geographical or legal restriction to access banks, high barriers to loan acceptance, and the exclusivity of only the wealthy to enjoy the benefits of low-risk highreturns lending.

In the DeFi landscape, such barriers do not exist as banks are no longer necessary. With enough collateral, anyone can have access to capital to do whatever they want. Capital lending is also something that is no longer enjoyed only by the wealthy, everyone can contribute to a decentralized liquidity pool of which borrowers can take from and pay back at an algorithmically-determined interest rate. In contrast to applying for a loan from the bank where there are stringent Know-your-customer (KYC) and Anti-money laundering (AML) policies, one only needs to provide collateral to take a loan in DeFi.

We will explore just how such bankless lending and borrowing mechanism is possible with Compound Finance, a Defi lending and borrowing protocol.

Original article is taken from Coingecko's book "How to DeFi"

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