The journey of credit markets from their inception in ancient civilizations to the contemporary landscape of DeFi is a fascinating story of innovation and adaptation. Credit systems have evolved significantly over centuries, shifting from simple barter systems to on-chain lending protocols. What is the next step?
From Clay Tablets to Credit Cards
Credit’s earliest forms were rooted in barter systems, where goods were directly exchanged without any standard medium of value. However, as societies grew, the limitations of such systems became apparent, giving rise to more structured credit forms. By 1750 BCE, civilizations like Mesopotamia had started documenting loans on clay tablets, showcasing early forms of structured lending.
Once the current banking system started shaping up, the next wave of loans were introduced in the early 1930s — housing loans. Insurance companies, not financial institutions, implemented the idea as a way to take advantage of borrowers during the Great Depression. If a borrower failed to keep up with their payments, they would gain ownership of the property.
The next major milestone was the advent of credit cards in the mid-20th century, with the introduction of the Diners Club card in 1950, which enabled easy collateral free loans for the first time in the real world.
Transition to DeFi Lending Markets
The launch of Bitcoin in 2008 marked the beginning of the blockchain age, introducing a new asset class that provided value storage without central authority oversight. Ethereum’s emergence in 2016 further expanded blockchain’s capabilities, enabling programmable contracts and decentralized applications, setting the stage for DeFi.
DeFi began to gain significant traction in 2020 during the DeFi Summer, powered by on-chain lending and borrowing protocols.These platforms enabled transactions without traditional financial intermediaries, using overcollateralized loans similar to secured loans like housing or vehicle loans in the traditional credit market.
Overcollateralized Lending is Limited
Despite its growth, DeFi has been predominantly limited to overcollateralized loans. Aave and Compound, two of the leading DeFi lending markets, employ a model where loans are secured by crypto assets that borrowers must deposit. Typically, these platforms require borrowers to lock up collateral worth more than the loan they are taking out — often between 125% to 150% of the loan’s value.
The Limitations:
1. High Entry Barrier: This model favors users who already possess substantial capital, alienating potential users with fewer assets.
2. Capital Inefficiency: Overcollateralization ties up a significant amount of capital that could otherwise be utilized for further investments or spending.
3. Liquidation Risks: In a volatile market, the value of collateral can quickly depreciate, leading to liquidation. This not only results in losses but also discourages risk-averse individuals from participating.
While Aave and Compound have provided robust platforms for secure lending and borrowing, the overcollateralization model limits market participation to those with significant capital, sidelining a vast number of potential users who could benefit from DeFi.
This model mirrors the early stages of traditional credit systems where loans were secured against physical assets. However, it misses a crucial segment of the credit market that has been instrumental in the modern economy: unsecured or personal loans, which rely on borrower reputation and creditworthiness.
The Future of Credit in DeFi with Zeru
Zeru introduces a paradigm shift in DeFi by offering zero collateral loans, leveraging on-chain data and algorithms to assess creditworthiness. Unlike Aave and Compound, Zeru does not require borrowers to take overcollateralized loans,it enables access to credit with less capital lock-up but also enhances the use of borrowed capital through up to 15x leverage on dedicated strategies, powered by AI.
Key Innovations by Zeru:
1. ZScore: A decentralized, 100% credit score that assesses a user’s creditworthiness based on their on-chain activities and financial behavior. This score is crucial in determining loan eligibility without the need for overcollateralization.
2. PCV (Protocol Controlled Value) Credit Reserve: This user generated reserve acts both as a mitigation pool to cover defaults and a liquidity provider, ensuring the system remains stable and secure.
3. AI-Generated Strategies: Go long or short on assets with up to 15x leverage on Uniswap V3 LP, LRTs and more.
This is only the beginning. We invite you to stay connected with us as we continue to innovate, refine, and expand our offerings. Exciting developments await on our roadmap, and we’re committed to sharing every milestone with you.
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Originally posted on Medium on May 7, 2024: