Aave Protocol's New Product Takes on $300 Billion P2P Loan Market
Aave's new product enables zero collateral loans on DeFi.
- The collateral posted by one party can be used by another as collateral against which assets can be borrowed on Aave.
- Both parties sign an agreement on OpenLaw that locks in interest rates, repayments terms, and debt covenants.
- This is ideal only if the lender trusts the borrower, unlike Aave's flagship money market which is trustless.
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Aave Protocol’s newest product, credit delegation, allows users to take collateral-free loans using DeFi. This service has the potential to disrupt the $300 billion P2P lending market. However, unlike Aave’s money market, this product isn’t completely trustless.
Aave Changes the Game, Again
Aave’s credit delegation product allows one party to deposit collateral and a second party to draw credit against that collateral. This form of lending and borrowing requires an element of trust but opens up the addressable market DeFi can topple.
Credit delegator could be a DeFi Fund depositing to @AaveAave that is looking for additional credit exposure. Borrowers could be cryptocurrency exchanges, market makers, money lenders, institutions, businesses, NGOs and governments. pic.twitter.com/S6cHjhtvqE
— stani.eth (👻,🌿) (@StaniKulechov) July 7, 2020
Imagine a crypto hedge fund has 100 ETH of undeployed capital just lying around and was only willing to put it to productive use if it can earn a 5% annualized yield at minimum. The hedge fund finds a sizeable retail investor willing to pay them 6% a year in interest but wants to use the ETH as collateral to borrow USDT and farm yields on Curve and Compound.
After ensuring they can trust this investor, the fund sets the interest rate, repayment schedule, and other debt covenants. The two parties sign a binding agreement using OpenLaw.
The hedge fund then deposits the 100 ETH on Aave and delegates the credit line to the investor, who then proceeds to borrow USDT against the fund’s ETH.
Using Aave’s product, the hedge fund doesn’t need to transfer the 100 ETH to the investor and can custody their own funds. The significant risk, however, is if the borrower defaults on interest payments and repayment of principal. The hedge fund will lose a sizeable portion of its 100 ETH collateral.
This is precisely why trust is a necessary component for Aave’s new product.
To minimize this risk, lenders using this function can limit the borrower’s ability by restricting the amount of credit they can draw and restricting them to borrow assets of their choosing. Credit delegation is a non-custodial way of facilitating trusted borrowing.
After pioneering flash loans, Aave has once again proven its mettle by creating innovative use cases that can be trustlessly executed with DeFi.