Before diving into DeFi, it’s essential to understand how traditional lending and borrowing work. Traditional systems rely on intermediaries like banks, which manage the funds, assess creditworthiness, and handle the lending process. Borrowers usually need to provide collateral or have a strong credit history to get loans. This system, while established, has several drawbacks:

• High Fees and Interest Rates: Intermediaries add costs, making borrowing expensive.

• Slow Processes: Loan approvals can take days or even weeks.

• Exclusivity: Strict credit requirements exclude many potential borrowers.

• Centralization: Control rests with financial institutions, leading to potential biases and inefficiencies.

The Birth of DeFi Lending Markets

The Early Days (2017–2018)

The emergence of DeFi platforms like MakerDAO and Aave in 2017–2018 marked the beginning of decentralized lending and borrowing. These platforms introduced several groundbreaking concepts:

• Over-Collateralized Loans: MakerDAO allowed users to lock up assets like ETH as collateral to mint DAI, a stablecoin, providing a way to leverage cryptocurrency holdings without selling them.

• Liquidity Pools: Aave introduced liquidity pools where users could deposit assets to earn interest, while borrowers could access these pools by providing collateral.

The Very First Summer (2020)

The summer of 2020, often called “DeFi Summer,” saw a massive influx of users and capital into DeFi platforms. Yield farming and liquidity mining became popular strategies, attracting retail investors looking for high returns. TVL in DeFi protocols skyrocketed, highlighting the growing trust and interest in DeFi.

What’s the problem?

DeFi summers showed us again and again that lending markets are the backbone of the onchain economy. Howevew, over-collateralized loans by design lead to under-utilization of lent assets (to a tune >69%); because to be able to borrow, you need to lend much greater value. This is done to protect protocols from defaults and volatile market conditions.

Data Reference: Aave , ZeroLend , Spark

Consequently, borrowing becomes less attractive as users must deploy complex strategies like looping and jump from one protocol to another which results in poor user experience.

‘Pure borrowers’ DO NOT exist in the DeFi system today.

Absence of Pure Borrowers in DeFi

In the current DeFi system, “pure borrowers” — those who receive zero collateral loans— are non-existent. This presents several issues for those to participate in DeFi:

• Capital Constraints: Pure borrowers, often at the bottom of the funnel, have limited capital and seek to maximize their earnings from crypto investments.

• Risk-Prone Behavior: Many resort to leverage trading on centralized exchanges (CEXes), often underestimating the associated risks.

• Complex User Journey: Those aware of the risks and aiming to optimize earnings through DeFi face a convoluted journey. Only a small percentage can effectively use strategies like looping on Aave or LPing on Uniswap.

The Importance of Pure Borrowers

Pure borrowers are crucial for the mass adoption of DeFi. They represent the retail mass adopters that DeFi currently lacks but desperately needs. However, the existing DeFi infrastructure is not really equipped to onboard these users, creating a vicious cycle that hampers the sector’s growth.

The TradFi Contrast

In traditional finance (TradFi), collateral-free loans have driven the growth of the consumer economy through credit cards, personal loans, educational loans, and more. In DeFi, zero-collateral loans are only possible for institutions enabled by protocols like Maple and Goldfinch.

To fuel the next wave of DeFi growth, zero-collateral loans must be accessible to retail users.

The Game-Changing Potential of Zero-Collateral Loans in DeFi

The potential market size for zero-collateral loans in DeFi is enormous:

• Immediate Impact: At the current size of DeFi lending markets, introducing zero-collateral loans could create a market size of $20.25 billion, assuming the same percentage of collateral-free loans as TradFi.

• Long-Term Potential: If DeFi captures just 10% of the $4.4 trillion collateral-free lending market in TradFi, the market size could reach a staggering $441 billion.

References: DeFi Lending Market (DeFi Llama), TradFi Lending (Skyquest)

The Paradigm Shift

Zeru Finance introduces a paradigm shift in DeFi by offering zero-collateral loans, leveraging on-chain data and algorithms to assess creditworthiness, along with integrated DeFi strategies. This approach not only lowers the entry barriers but also enhances the use of borrowed capital.

Key Innovations by Zeru:

1. ZScore: A decentralized, 100% on-chain credit score that assesses a user’s creditworthiness based on their on-chain activities and behavior. This score is crucial in determining loan eligibility without the need for over-collateralization.

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-Powered DeFi Strategies: Users can deploy borrowed capital to go long or short on assets with up to 15x leverage on Uniswap V3 LP, Maxi Pools, LRTs, and more.

4. Zero Collateral Loans: By lending, borrowing, and deploying capital into these strategies, users generate value for the protocol, earning a zero-collateral loan. The loan amount is equal to the value the user generates for the protocol (fees) measured by credit tokens and ZScore.

Conclusion

As DeFi continues to evolve, embracing zero-collateral loans will be key to attracting and retaining the retail segment, ultimately driving the sector towards mainstream adoption.

We have more exciting updates in the pipeline that we can’t wait to share with you. Stay tuned for these announcements, as they will bring even more enhancements and features to Zeru.

Thank you for your continued support and trust. We are committed to delivering a protocol that meets your needs and exceeds your expectations.

Stay connected, stay excited.

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Originally posted on Medium on June 7, 2024: