Opportunities & Challenges of Web3 Loans

Opportunities & Challenges of Web3 Loans

Written by
Shuting Hou
Date published
September 15, 2022

1.7B people worldwide don't have access to bank accounts.

20% of small business loans in U.S. were denied in 2021.

How can Defi banking help alleviate these issues?

Web3 loans aren't perfect, but we're making progress. Here are some key trends you must know:👇


1/ How does traditional banking work? In general, banks' profits = loans - depositsTheir lending capacities are limited by capital requirements below, with RWA as denominator.

Risk assessment plays a crucial role because they directly impact the profitability of a bank.


2/ How do risks get measured?

Depends on human judgement - your credit scores, age, income, current addresses will affect how much money you're able to borrow. Banks may underestimate the riskiness of assets with profit-hungriness.

E.g., The housing bubble back in 2008.

3/ Why DeFi Lending?

- 24/7 Open access to anyone with collateral. No more human bias involved

- no KYC, Privacy preserved

- Transparency to see what's happening to the protocol in a timely manner.

- Leverage: No need to create a taxable event on collateral

4/ We have OG lending & borrowing protocols such as @compoundfinance & @AaveAave, but there're still obstacles:

a. Crypto prices are volatile 24hr, and users get liquidated easily when their deposit collateral falls

b. infectious pools

c. Limited choices of collateral assets

5/ To clarify, when a collateral asset slumps harshly:

- liquidations fail to repay

- other "healthy" assets in the same pool get infected (left with bad debts)Protocols limit their collateral listings for security, but at the same time, restricting money market expansion.

6/ There're alternative methods to solve the issue:

@eulerfinance divides assets into isolation, cross and collateral tiers (most to least risky), enabling and restricting tokens to be borrowed, lended, or as collateral.


7/ It's a great initiative but the assessment of asset risks is still human-based. And again, a wrongly classification of asset may still cause the issue we listed.

@SiloFinance allows users to create money market (Silo) for any token paired with a bridge asset (e.g., ETH).


8/ For example, if token A goes bad, only the bridge asset in Silo A gets affected. The risks are isolated and all the other types of assets stay safe.

But isolated money market is still vulnerable to oracle manipulation.

E.g., Rari Fuse market exploit:

9/ In addition to re-designed money market, new collateral types emerge as well.

For example, @BendDAO allows users to borrow ETH with blue-chip NFTs as collateral. In addition, @PineLoans is experimenting a "mortgage" feature where users get helped with NFT purchases.

10/ However, due to the illiquid and even more volatile nature of NFTs especially during bear times, borrowers may get liquidated more often that crypto-collateral depositors.

Bad debts > Fear > Bank Run. (Liquidations started getting more serious since late 2021)


11/ But there's still potential as the NFT hype cools down and a possible new auction mechanism invented to help improve the capital efficiency in NFT marketplace.

@centrifuge is on-boarding real-world assets (real estates, cars, etc.) to DeFi as collateral in the form of NFT.


12/ Their product unlocks new opportunities, acting as a bridge connecting real-world and crypto.

Still, legitimate NFT as a certificate of real-world asset is a problem.

There're more categorizations, here's a ecosystem landscape of Web3 lending provided by @ClearChainCap


13/ According to the chart below, OG protocols led by MakerDAO, Aave dominates the lending market.

Isolated money market, NFT-collateral oriented protocols are still quite a niche in the space.

We are still at a nascent stage.(The total borrowing volume in NFT is only 174k)


14/ Main takeaways:

- Trusting code other than human judgements opens financial access to another billion users

- There're tons of malicious intentions and behaviors. But instead of banning we think of smart mechanism to discourage them.

- Things change fast. Stay alert.

15/ Shout out to @yb_effect @JackLipstone @cairoeth for help editing this thread! 🍺🍺

What's next? In the following threads I'll talk about why fixed-rate asset products are important, and how EIP 3525, EIP 3475 may change the DeFi space by bringing in bonds.

16/ I hope you enjoy reading the thread.