How And Why Can Collateral Be Used For Financial Services?
Shine Li May 05, 2021 07:35
As the cryptocurrency industry provides access to financial products such as loans, it is essential to understand the importance of collateral.
As the cryptocurrency industry provides access to financial products such as loans, it is essential to understand the importance of collateral. Without collateral, it is impossible to obtain a loan. However, the concept of collateralizing one's loan can differ from one service provider to the next.
The Traditional Purpose of Collateral
At its core, the cryptocurrency and traditional finance world are not too different for lending and borrowing. Both industries require the use of collateral. A user needs to pledge something as a "security" to repay a loan, although this security can be forfeited if they default on the loan. Without money or other assets at your disposal, it will be difficult - if not impossible - to obtain a loan, regardless of which industry one aims to explore.
Although one could theoretically use collateral for many purposes, the main use case is loans. Unless the user can repay the loan at the agreed-upon date, they will have their collateral taken from them. In the financial world, it is common to put up a tremendous amount of assets to acquire a mortgage, for example. The assets can be financial or even the item one is buying with the mortgage, such as a car or house.
Things are a bit different in the cryptocurrency world. As there are no tangible items to serve as collateral, users have to rely on their assets. Thanks to ongoing developments and advancements, the supported assets now span cryptocurrencies, tokens, and stablecoins. With these assets, users can take out decent-sized loans, allowing them to build a better future for themselves and their families.
The Appeal Of Crypto Loans
Contrary to what most may think, crypto loans are not too different from traditional loans. The big difference is how there is no approval process from centralized entities, such as banks. Instead, users will often interface with smart contracts capable of automating the process. As long as the user can provide the necessary collateral, they can borrow as much as they need.
By removing the need for intermediaries and paperwork, there is much room for customization. It is entirely possible to apply for a crypto loan and complete the entire process in a matter of minutes. As there are no credit checks to contend with, it is merely a matter of supplying sufficient collateral. Everything else will be taken care of automatically, although one is still obligated to adhere to the loan terms for repayment.
What About Stablecoin Collateral?
One of the aspects that makes cryptocurrency unique is how there is a unique use case for collateral outside of loans. Stablecoins, for example, need some form of "backing" to retain their value. This backing can consist of fiat currencies, crypto assets, or something else entirely. In most cases, issuers will base their stablecoin issuance on these financial reserves, ensuring the supply can never be greater than the reserves being held.
In the current landscape, the majority of stablecoins are backed by fiat currency. Examples include USDT, USDC, BUSD, and PAX. DAI, the native stablecoin of Ethereum, is different, as it uses crypto assets as collateral. However, these currencies do not have liquidity pools supported by real cash flow. Moreover, the assets backed by fiat do not offer decentralized issuance or public info on collateral, leaving much to be desired.
An intriguing take on this concept can be found with NFT marketplace Hoard.Exchange.
Hoard incorporated lending and borrowing using NFT functionalities.
More specifically, by using Non-Fungible Tokens as collateral for crypto loans - borrowers put up their NFT as a collateral - provides more options to this competitive space. if the borrower fails to repay the loan, they will lose the NFT put up as collateral in the foreclosure process.
Bondappetit Takes A Different Approach
There are other options to explore for issuing stablecoins.
BondAppetit, for example, uses real-world assets as collateral for its Appetite USD (USD) stablecoin. Going down this route unlocks multiple benefits, including decentralized issuance like DAI, and more transparency regarding the holdings used as collateral.
More importantly, USDap is the only stablecoin to have liquidity pools supported by real cash flow. Having this aspect in place confirms the ongoing evolution of the cryptocurrency and decentralized finance industries. Collateral is a very interesting albeit versatile concept that can be used for very different purposes.
Closing Thoughts
Many people see collateral as a tool for loans, but it can serve many other purposes as well. Stablecoins are an exciting example, as they too require assets to give them value. Steering away from crypto assets and fiat currency collateral in favor of real-world assets can introduce many people to these concepts. As everyone has real-world assets they could use for this purpose, many use cases to be explored.
It is pertinent to bridge the gap between real-world assets, cryptocurrencies, and decentralized finance. An asset like USDap can serve as a precursor for what the industry may have in store over the coming months and years.
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