How Decentralized Finance (DeFi) Can Create Credit Unions
DeFi, General, Lending - August 25, 2020
One of the biggest problems DeFi is aiming to solve is credit unions. Credit unions can be seen as banks on a micro-level. That is why people often compare credit unions versus banks. In this video, we explain how DeFi is making credit unions and banks better.
A credit union is a union of a few individuals who give credit to each other. This means they lend money to each other. The money pooled is lent out to one person. The borrower will pay back periodic interest and a lumpsum at the end of the period. This is a form of debt financiang. The other indivduals of the union do not own any part of the business.
Typcially, one member takes a greater risk to ensure the process is smooth. He underwrites the financing process, receives a greater reward if the money is paid back in time, but incurs a greater risk if it isn’t. In the traditional financing model, this member would be the bank. Since the bank is taking a greater risk, and everything is going through the bank, it can charge highs fees. This also creates friction in the credit process.
In the DeFi system, the credit union can function without a bank. Individuals would set up their digital wallets. These wallets would hold digital currencies like Bitcoin or stablecoins like USDC or DAI. They would be sent from the lenders to the borrowers via blockchain. This process can be automated through smart contracts, which are automatically executed electronic contracts.
As the borrower earns income through his business, a certain amount is paid out directly to the borrowers. Once the borrowing period is over, the lumpsum is automoatically distributed.
This process is not only seamless but has no bounds. The borrowers and lenders can be in any part of the world. With no bank, the fees are friction are reduced. This allows the borrower to receive a greater loan, and the lenders a greater interest.
Other potential additions to this process can be – pooled insurance, liquidity for higher loan amounts, collateraliztion for increased security and more.
Companies like Maple Finance are already doing this.
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