It sounds like a bet you cannot lose. You lend money to a borrower who provides collateral of higher value than the loan, and then you earn interest of about 20 percent. What could possibly go wrong?
That is the idea behind “DeFi,” or decentralized finance. These are cryptocurrency platforms that let one person, a lender, deal directly with another, a borrower, without involving banks.
DeFi has grown a lot during the COVID-19 health crisis.
Loans on such platforms have risen more than 600 percent since March to $3.7 billion, says DeFi Pulse, an industry website. It says investors are seeking higher returns since central banks have cut interest rates to support economies hurt by the COVID-19 coronavirus.
The DeFi platforms operate on free code services. They use information systems that process interest rates in real-time based on supply and demand. Some industry experts say the ease and effectiveness of these platforms are the future of borrowing and lending.
But others warn that DeFi operations carry high risks.
Lawyers and observers say the websites can have weak security that leaves them open to computer system problems and attacks. They also say most platforms are untested and operate without any governmental supervision. As a result, they offer few if any legal protections to users.
In 2017, investors put billions of dollars into ICOs, or initial coin offerings, a way to buy cryptocurrency. Many crypto companies raised money by making new “virtual” coins. But most of the companies failed to get enough investors and those that did invest lost a lot of money.
“These are experiments in finance,” said Preston Byrne of the law office Anderson Kill in New York. He added that most of the projects are not truly legal, but may become legal in the future.
However, DeFi continues to grow in popularity.
Seven years ago, Brice Berdah made plans to retire in his mid-30s through traditional investment methods. He knew he would need to save 1.7 million euros.
“My plan was to make 5 percent on my capital,” he said. But low interest rates do not permit such a rate of return.
“By 27, I had only saved about 0.5 percent of the required amount,” said Berdah. He works at a new company that makes online storage centers for digital coins. “It was an obvious failure.”
To restore his dream Berdah has turned to DeFi. He has changed his retirement plans again.
Berdah has bet 90 percent of his money on DeFi. “Returns are about 20-25 percent over the last six months ... and I’m on track just now,” he said.
DeFi is rooted in an industry hostile to traditional financing. But some of DeFi’s aims, like lower business costs, have caught the attention of traditional financing companies.
For their part, major banks are looking at how the new technologies can be used with traditional finance processes. Goldman Sachs, for example, appointed a new chief of digital assets to look at how it can exist on blockchain technology, a spokesman said earlier this year.
There is “an actual value” on what is being built on these websites, said Maya Zehavi. She is a blockchain expert and board member of an Israeli blockchain industry group.
Most DeFi platforms are based on the ethereum blockchain. It is the second largest cryptocurrency after bitcoin.
Loans are recorded, the money is released and controlled by contracts. Borrowers must often sign collateral, also in cryptocurrency, usually worth more than the loans they take out.
DeFi is not for those easily frightened. One such borrower is Antoine Mouran, a computer science student at university in Lausanne, Switzerland.
“My portfolio is a couple of thousand dollars,” the 18-year-old told Reuters news agency. She added “I trade for fun, to discover new technologies, such as decentralized finance.”