How are Lending and Blockchain Connected?
General, Lending - August 25, 2020
What makes the world go round?
If your answer is “money,” you’d be partially correct. The complete answer is “borrowed” money. In the financial world, borrowed money is also called ‘debt.’
So, the complete answer would be – debt makes the world go round. Right now, the total debt in the world is $250 trillion. That’s a big number, that’s 250 followed by 12 zeros. On paper it looks like this:
Now when we talk about debt, we don’t mean the $10 you owe your local grocer, but the billions that companies and countries owe each other. But what’s the basis for debt? And what is the basis for debt that has grown to this massive number?
The basis for debt is simply – trust or the lack of it.
See, debt is based on trust. One party gives a bunch of money to the other party, knowing that they won’t blow it all away. The party receiving the money i.e. the borrower will pay a regular ‘interest’ to the lender, and at the end of a particular period, the borrower will pay back the entire borrowed sum to the lender. Simply put, there’s trust between the parties.
But if there’s a lack of trust, external third-parties come in to enforce it. Third-parties like banks, insurance companies, reinsurance companies, underwriters, hedge funds, private-equity companies, legal firms, government agencies, and the list goes on and on. Inevitably, when trust is outsourced to external third-parties, they have to be paid. And when they are paid, the lender will lend less and the borrower will receive less.
In the blockchain world, this ‘trust’ is outsourced to ‘code’ and not companies. Systems and protocols built on code and run according to algorithms can enable a seamless and efficient lending platform. These systems will be decentralized, meaning they will be operated by computer programs, charging smaller fees than companies would.
We’re already seeing this form of lending with Bitcoin. Bitcoin is a digital currency, but from the perspective of lending, it’s an asset that can be collateralized. And what’s more, it can be collateralized electronically.
This has opened up a whole range of capabilities allowing assets to be put on the blockchain. Once an asset is put on the blockchain, it can be used for more than just collateralization. It can be loaned out, it can be used to pay and receive interest.
Bitcoin is just the start. With smart contracts, cryptocurrencies can be sent and received once certain pre-decided conditions are met. With security tokens, real-world assets like real estate can be put on the blockchain and used as collateral.
Blockchain and digital currencies are building an entire financial ecosystem, and lending is just the start!
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