Crypto Digest #8 DE-FI – WHY?
This is the eighth of our Crypto Digest blogs brought to you by Mezzle Law’s resident crypto lawyers. Subscribe to stay up to date with our short and informative blogs on all things law and crypto (lex cryptographia).
In our fifth issue of this Crypto Digest, we discussed smart contracts and in specific, the use of smart contracts for wills.
In this issue we’ll discuss the use of smart contracts for decentralised borrowing and lending (De-Fi – Decentralised Finance).
In a normal borrowing and lending situation (assuming we are borrowing from the bank), the borrower would approach the bank, apply for a loan and provided the bank approves, the bank would loan the borrower money at a specific interest rate and the borrower would repay the bank pursuant to a repayment schedule. Here the centralised institution has total control and the interest rates are substantial (sometimes up to 14% or even higher), making the final repayment amount a lot larger than the amount actually borrowed.
Through the use of smart contracts, platforms such as Compound, Aave, BlockFi and Celsuis (although there are more) have created a way whereby the institution can be avoided. This means that loans can be received in a matter of minutes and both the borrower and the lender benefit because the interest rates are usually a lot lower but also payable to a person instead of an institution.
But how does this work and is it safe? Let us explain…
Smart contracts are created on a blockchain (usually Ethereum) and are programmed through algorithms to perform certain functions automatically. For example, in a De-Fi situation, the borrower deposits tokens as collateral against the loan the borrower is looking to acquire. The lender having the tokens to lend, lends the requested token amount as the loan to the borrower, the collateral becoming subject to the smart contract. Where the borrower defaults on a payment or other term of the smart contract resulting in a breach of the agreement for example, the smart contract algorithm will automatically trigger and perform the act as agreed between the parties, transferring collateral to the lender to account for the necessary amount for example.
This means that the smart contract will automatically act on the terms agreed between the parties and thereby becomes a trusted means of accountability between parties, providing peace of mind because the terms are automatically enforced (instead of having to engage a lawyer for a breach and/or enforcement for example). It’s important to note that smart contracts cannot be cancelled, which is why failsafe algorithms must also be incorporated when designing them. When considering smart contracts, you should instruct a lawyer who understands how they operate on the blockchain, and of the potential risks that could arise, so that they can work with you and your developer to implement a complete smart contract that is suitable for your requirements.
If one has tokens to lend, there is also the potential to make some extra money… and De-Fi platforms are used for so much more than lending, becoming an interesting topic when used between two parties for a competition as to who will win a sports event for example… but since there are so many other uses for De-Fi networks and/or smart contracts in general, we’ll keep the info coming. But for now, Wills and De-Fi for lending. That’s what we have covered.
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