The Economics of Lending On-Chain w/o financial collateral

[Jomari]

Given that there is $2 Trillion Dollars in unmet financing need and the microfinance industry is $100 Billion dollars and grows 15% per year approximately. This means that there are billions of people with low or non-existent credit histories who would benefit from access to financing. These financing range from the extra income to survive until a job starts to assistance with cash flow for a cash strapped business. The needs are varied and while collateral matters, there needs to be option for those who need a space to access credit who don’t have the resources to use leveraged debt.

Thus, I am curious what peoples perspective is on anonymous and pseudo-anonymous lending.  There have been some attempts to answer this question in the market, but none were truly scalable systems.  What are your thoughts.

Based on my research, I believe there are three big hurdles to overcome:

• Adverse Selection
• End-Game Issues
• Market Fit

and there is also the additional issue of the risk premium that can be associate with it.

However, I believe it can be done and I outline my theory in the link below. I would love to discuss this seemingly very difficult question. I personally am very interested in this question because it is a way to empower people financially on a global scale. I think if done right it could completely change the game.

https://medium.com/the-digital-reserve/designing-sustainable-pseudo-anonymous-lending-a9350e1dceeb

[1713488417]

1713488417

[1713488417]

1713488417

[1713488417]

1713488417

[1713488417]

1713488417

[krishnapramod]

Interesting article. Pseudo-anonymous lending in a decentralized environment without any collateral is a recipe for trouble. Yeah, around 2.5 billion people are unbanked without having access to any financial services, no credit history at all. It's a huge market, Blockchain could be a medium to connect some big businesses/financial institutions with these 2.5 billion people. A few Blockchain startups are working on this. Apart from SALT, there is ETHLend, not only collateralized lending, but they also provide no collateral, reputation-based lending using credit tokens. It's not impossible to create and maintain a pseudo-anonymous rating system based on creditworthiness to mitigate some risk, but as mentioned in the article, the problem lies in end-game issues.

Peter Swire admits here that it is theoretically possible to create a pseudo-anonymous system along these principles. The bad credit risks will default on smaller limits and the protocol can focus on building those with good credit risks. However, the pitfall is around the gradual or sudden manifestation of credit defaults. This can lead to unacceptable credit losses and render the system potentially insolvent. The primary issue to consider is the ability of the system to sustain a systemic or sudden defaults. This issue can arise due to exterior economic issues or coordinated malicious borrowers.

[Jomari]

I definitely appreciate the read. And I totally agree, the endgame issue is definitely significant. Especially with potential collusion by multiple parties.

This is why the combination of a reserve system and a macro approach is important. If a system is designed that maximizes the entire networks return over a period, then once a certain point is reached defaults could have a potentially negligible impact. For example if the endgame is around 7k units and the total return through increased network productivity and interest payments was 7.2k then the net impact on the chain economics would be positive. Especially if you consider increased circulation and utilization as important to the network.

There are some assumptions that have to be made about how people behave, but with responsive parameters and considerations, it is difficult but possible. This is what I am working on with the Digital Reserve team. We are working to bring: this concept to fruition: an on-chain uncollateralized approach to scalable microlending as a base protocol. The base protocol will use a 100% reserve system initially, but the ability to operate varying reserve levels will be an option for those who are more risk tolerant. This is meant to provide a foundation for more advanced financial products that increase financial inclusion while maintaining profitability.But it is a tightrope game, that is why I am very interested in the thoughts and perspective of others.

Introducing the Digital Reserve a Decentralized Financial Institution to empower and increase onchain economic productivity and provide financial inclusion.

[Jomari]

Yes, We Created A More Sustainable and Equitable Currency With Denarii

Over the past 6 months, the Digital Reserve team has analyzed various approaches to increasing financial access. We looked into the spectacular work of Nobel Prize Winner Muhammad Yunus and the various theories around financial empowerment. We also started to investigate the various fintech solutions to financial inquities. We were impressed and inspired by the work of Juvo , Insikt, Inc. and Viola Llewellyn of Ovamba , True Accord and Kiva to name a few. As leaders in their respective spaces, we saw the opportunity take the next step in their work with a product owned by its users, global by design and responsive to market conditions.

Therefore, we are thrilled to announce the Digital Reserve’s vision to create a scalable and sustainable solution through leveraging an incentive based cryptocurrency. We can become the decentralized platform of financial services that empowers disenfranchised communities while still maintaining profitability for users within the network.

How did we combine blockchain/cryptocurrency with social impact?


It is all about the balancing of incentives. Cryptocurrencies based on Bitcoin in their simplest form are a series of redundant ledgers with a very rigid monetary system based around an explicit cap. These ledgers are updated based on a few simple rules and underlying assumptions.
https://cdn-images-1.medium.com/max/600/1*YgSOavWYBoYq2679LK2upA.png

• Transactions must be broadcasted to be included
  Transactions are checked against the ledger and validated/invalidated
  Blocks are created from transactions
  Blocks are checked for validity
  A reward is given to block creators who send valid blocks and meets the submission criteria
  The block becomes the foundation for the next block

This fundamental structure is the basis of blockchain. However, it is powered by the desire of users to have their transactions accepted and block creators (miners) to win a reward for facilitating those transaction. This basic incentive system thrives under the deflationary systems which are the status quo within most cryptocurrencies.

The solution was revealed within a lot of the academic and practical work around Proof of Stake. Proof of Stake is a system of validating transactions where the reward is given to those who use their funds as collateral to demonstrate their intent of honesty. Currently, these implementations just have the funds sit in a bonded status. This decision further places deflationary pressure and removes capital from circulation. For all intents and purposes the money is buried.

https://cdn-images-1.medium.com/max/800/1*vlMRAWOfpw1NxV7_EhA1yA.jpeg
https://www.youtube.com/watch?v=CTcPlYSSp7A

Within most monetary systems, which tend to be inflationary, buried money is foolish. It is foolish because the value of each unit decreases in purchasing power over time. However, within many cryptocurrencies the value of each unit should increase because new value accrues to the current holder. This is great on the short term, but in the long term it leads to stagnation of the economic system.

Therefore, there is an economic benefit to making the bonded / collateralized funds available for lending without collateral. However, you then have to deal with defaults on those loans, so a reserve system is necessary. Within the Digital Reserve Network, this reserve is created through our cost-based Proof of Stake System. We apply a cost because one of the weaknesses of Proof of Stake(POS) is called nothing at stake. Vitalik Buterin calls out this issue in one of his early blogs on POS systems. Applying a cost within our system allows us to create an incentive for people to minimize their broadcasting of transactions to only the relevant and accurate information instead of risking their funds.

So if you are reading carefully, at this point we have now created a system to provide collateral free lending. To take our work to the next step we also included a borrow centric auction system for underwriting. What this means is that borrowers are able to bid on loans in a way that reflects their financial capabilities.

https://cdn-images-1.medium.com/max/1000/1*bY0c5vA5t-o8Mop9dO6pJQ.png
https://westagilelabs.github.io/tdr.github.io/dashboard_component/dashboard.html#
This empowers the user and also creates a system to develop financial literacy through the process while mitigating predatory lending and interest rates they don’t feel comfortable.

The final piece of this puzzle that really solidifies the balance of incentives and crypto-economic system is that the monetary policy is not a deflationary system like Bitcoin. Through the adoption of machine learning processes and interest feedback rules, we are able to create a controlled monetary supply that reflects market conditions. This is important because it allows investment to accrue to those actively participating in the network.

So yes, through intentional design, we have managed to craft a cryptocurrency that will be accessible to communities around the word and ripe for mass adoption. So while Bitcoin has a date set on its viability, we are building a currency that can grow with its user and change the world for the better, while still being profitable.

If you are interested in being a part of redefining how people interact with money and making the world a little better, check out the website www.thedigitalreserve.org

[jeronimosuykens]

This can certainly happen.
The base protocol will use a 100% initial stock system, but the ability to operate different stock levels will be an option for those who are more vulnerable.
This is meant to provide a platform for more advanced financial products that increase financial inclusion while maintaining profitability.
Therefore, it is necessary to adapt to the market.

[zakariajaki]

I am very helped by reading the above article by looking more broadly and deeply about an economic problem as well as on the level of a person's social life will be a debt or credit that he has done before, but when trying to enter economic and social problems when the society is not using capital should obtained from the forest or work more time in order to get the money to become more capital, or it is just a form of game that then someone entered it, sorry just my opinion only may be useful and successful for all of us