1 min read

Why do people use DeFi loans?

There are a number of lending dApps built on blockchain. I haven't personally used them because I'm typically fairly debt-averse. But blockchain loans are different from traditional debt you would get from a bank.

In the real world, loans can be collateralized or uncollateralized. Collateralized loans are those like your mortgage, car loan, etc. If you default on the loan, you lose the collateral. Uncollateralized loans are those that depend on your personal reputation like credit cards, personal loans, student loans, etc. If you fail to make payments, they can't really do anything to you.

The USA doesn't have debtor's prison these days, so you just tank your credit score, get sent to collections, and maybe have your wages garnished. People with high amounts of debt are much more likely to have bad relationships, be homeless, etc. That's why I'm debt-averse.

But DeFi loans are a bit different. They're usually for a specific purpose/time or are over-collateralized with some other asset. Basically, if you want a loan of $100, you need to deposit $150 or more for the privilege. So, why bother?

These loans are pretty much exclusively used for speculation. It's not the kind of debt that helps someone in poverty start a business. It's just a risky maneuver for people who already have money.

Regardless, there are a lot of interesting financial instruments being pioneered in DeFi. You can pay lower interest rates (usually 5% or less) on debt than you'd get at a traditional bank, and you can make more interest (typically 2-10%) on your money for depositing it. Because DeFi doesn't have a bank in the middle taking a cut, I believe this math will hold true for the foreseeable future.

If DeFi loans can be made accessible to "normal" non-technical, non-rich people, that would severely disrupt the traditional banking industry.


P.S. If you want to know more about the different kinds of DeFi loans, how they work, and when you might want to use them, hit reply and I'll address that in a future series.