The Aave decentralized finance protocol new feature lets users borrow money without posting collateral.
The Aave lending protocol recently launched a new feature called Credit Delegation. This feature allows users to provide peer-to-peer loans with no formal collateral requirements.
Stani Kulechov, the CEO of Aave, explained via Twitter how the system will work. The Credit Delegation feature relies on peers to enter into agreements between each other that allow borrowers to use the lender’s credit line freely.
The two parties must enter into a formal legal agreement that would define terms such as repayment schedule, interest and other necessary conditions. Through an integration with OpenLaw, a project to create legal contracts recorded on a blockchain, these terms can be formalized on-chain.
The use of peer-to-peer intermediaries allows to circumvent limitations inherent to DeFi, where the protocol cannot recover a borrower’s loan outside of the blockchain. All lending platforms require posting more collateral than what is borrowed, heavily limiting the possible use cases of blockchain lending.
The intermediary takes ownership of the risk of insolvency for the borrower, as the protocol can access their collateral. It is then up to the intermediary to recover the loan through other means.
Given the higher risk, the intermediary receives a higher interest rate from the borrower.
DeFi in the real world
The uncollateralized loan model could help bring DeFi into the mainstream as it makes loans more flexible. In a conversation with Cointelegraph, Kulechov said that the initial purpose of the system is to “simplify the matching for Credit Delegators with borrowers that are both either institutions or businesses.” The limitation appears to be coming from OpenLaw, which is currently only usable by businesses.
He promised that if the idea were to be proven, it would be expanded to a larger audience. Aave would in this case become the “lending liquidity backbone for any finance to source liquidity.”
However, he noted that currently DeFi as a whole remains too small and “the industry would need to scale quite a lot” to bring it into the mainstream. He also argued that “it’s important that borrowers are able to convert stablecoins into FIAT with less fees.”
Aave has traditionally placed emphasis on DeFi composability, featuring flash loans and using other protocol tokens as collateral.