The Development Direction of the On-Chain Lending Market: From Speculation to Practicality

On-chain lending protocols serve as the cornerstone of Internet finance, with the vision of providing fair access to capital for users worldwide. This model helps to create a more equitable and efficient capital market, driving economic growth.

Despite the enormous potential of on-chain lending, current users are still primarily limited to the native crypto community, with most use cases being speculative trading. This greatly restricts the market size it can cover. This article will explore how to gradually expand the user base and transition to more productive lending scenarios, while addressing the challenges that may arise.

The Current Status of On-Chain Lending

In just a few years, the on-chain lending market has evolved from the conceptual stage to several mature protocols that have been tested by the market, experiencing multiple severe fluctuations without generating bad debts. Currently, these protocols have collectively attracted $43.7 billion in deposits and issued $18.6 billion in outstanding loans.

The main sources of demand for current on-chain lending protocols include:

1. Speculative trading: Cryptocurrency investors use leverage to purchase more crypto assets.
2. Liquidity Acquisition: Investors obtain liquidity for crypto assets through borrowing, avoiding the taxes generated from selling assets.
3. Arbitrage Flash Loan: A very short-term loan used by arbitrage traders to take advantage of temporary price imbalances in the market.

These applications primarily serve crypto-native users and are mainly speculative. However, the vision for on-chain lending goes far beyond this. Compared to the total global outstanding debt of 320 trillion USD, or the total household and non-financial corporate loans of 120 trillion USD, the current 18.6 billion USD in outstanding loans from on-chain lending protocols represents only a negligible portion of that.

As on-chain lending gradually shifts towards more productive uses of capital (such as financing for small businesses, personal car purchases, or home loans), its market size is expected to achieve several orders of magnitude growth.

The Future of On-Chain Lending

To enhance the practicality of on-chain lending, two major improvements are needed:

1. Expand the range of collateral assets

Currently, only a few crypto assets are available as collateral, which greatly limits the number of potential borrowers. In addition, to compensate for the high volatility of crypto assets, existing on-chain lending usually requires collateral rates of up to 2 times or higher, further suppressing lending demand.

Expanding the range of acceptable collateral assets can not only attract more investors to use their portfolios for lending but also enhance the lending capacity of on-chain lending protocols.

2. Promote ultra-low collateral lending

Currently, most on-chain lending protocols adopt an over-collateralization model, which means that the value of the collateral assets provided by the borrower must be higher than the loan amount. This model leads to low capital utilization efficiency, making it difficult to realize many practical application scenarios (such as small business financing).

By adopting ultra-low collateral lending, on-chain lending can cover a wider range of borrowers, further enhancing its practicality.

The difficulty of implementing these improvements varies; some are relatively easy to implement, while others pose new challenges. However, the optimization process can progress gradually from easy to difficult.

Expand the Range of Collateral Assets

Compared to other asset classes globally, the total market capitalization of the cryptocurrency market is only $3 trillion, accounting for just a small portion of global financial assets. Therefore, limiting the range of collateral to certain crypto assets significantly restricts the growth of on-chain lending.

Combining asset tokenization with on-chain lending allows investors to leverage their entire investment portfolio for borrowing, rather than just a small portion of crypto assets, thus broadening the potential borrower base.

The first step in expanding the range of collateral assets may begin with highly liquid and frequently traded assets, such as stocks, money market funds, and bonds. In the long term, expanding to less liquid physical assets, such as tokenized real estate ownership, will offer enormous growth potential.

Ultimately, on-chain lending may evolve to the extent of mortgaging real estate for loans, where the loan issuance, property purchase, and the deposit of the property into the lending agreement as collateral can be completed atomically within a single block. Similarly, businesses can also finance through lending agreements, such as purchasing factory equipment and simultaneously depositing it as collateral into the agreement.

Promote Low-Collateral Lending

Currently, most on-chain lending protocols adopt an over-collateralization model, which, while ensuring the safety of lenders, also leads to inefficient capital utilization, making it difficult to realize many practical application scenarios.

In the crypto industry, the initial demand for low-collateral lending may come from market makers and other crypto-native institutions. However, early decentralized low-collateral lending attempts mostly handled lending logic off-chain or ultimately switched to an over-collateralized model.

The biggest growth opportunity for on-chain lending products lies in markets that traditional banks cannot effectively cover, such as:

1. Personal Lending Market: In recent years, non-traditional lending institutions have seen a continuous increase in their share of the personal low-value mortgage market, especially among low-income and middle-income groups. On-chain lending can serve as a natural extension of this trend, providing consumers with more competitive loan rates.

2. Small Business Financing: Due to the smaller loan amounts, large banks are often reluctant to lend to small businesses. On-chain lending can fill this gap, providing a more convenient and efficient financing channel.

Challenges to be addressed

Although the above improvements will greatly expand the potential user base for on-chain lending, they also introduce a series of new challenges, including:

1. Handling debt positions backed by non-liquid assets
2. Liquidation issues of physically collateralized assets
3. Determination of Risk Premium
4. Decentralized Credit Risk Model

Other challenges include on-chain privacy, adjusting risk parameters as the collateral pool expands, regulatory compliance, and making it easier to use borrowed gains for real-world utility.

Conclusion

In the past few years, on-chain lending protocols have laid a solid foundation, but they have yet to truly realize their full potential. The next phase of on-chain lending will be even more exciting: protocols will gradually transition from scenarios primarily based on crypto-native and speculation to more efficient and real-world relevant financial applications.

Ultimately, on-chain lending will help eliminate financial inequality, allowing all businesses and individuals, regardless of their location, to access capital equally. This will be a goal worth striving for!