Here’s what will happen when DeFi is applied to real world lending

An age-old proverb reminds us:

If you give a man a fish, you feed him for a day.
If you teach a man to fish, you feed him for a lifetime.

But there’s a missing element: Capital. A last line is needed:

If you lend him money, you enable him to start today

Let’s explore the stories of Luca and Jessie, individuals whose aspirations have been stifled by limited access to capital.

Luca, a talented apprentice fisherman on a minimal wage, possesses all the skills required to run his own fishing business but lacks the funds to break out and acquire a boat and equipment, leaving him trapped in an endless cycle of unfulfilled potential.

Meanwhile, Jessie, a determined and hardworking student, spends exhausting hours delivering food on her bicycle — struggling to pay her way through college. She tried to double her delivery earnings by buying a scooter, but the loan was rejected due to a lack of credit history.

Their experiences reflect the limitations of traditional financial services, or TradFi.

TradFi has reached its plateau

Traditional finance has plateaued on its innovation S-curve. Applause goes to the current generation of leaders for passing the inflection point. But future leaders face a flattened slope with limited potential upward progress without adopting a new S curve. See this article for more.

Web2 fintech lending: Exploitative loopholes and lopsided beneficiaries

Compared to TradFi, Web2 fintech startups have made more progress in micro-lending, but more in their own interests than for people like Luca and Jessie.

Led by Jack Dorsey, Block used its proprietary Square POS data to shift its revenue base from low margin payments into high margin small business loans. Just like Facebook hoards and monetizes personal data, Block does the same with business data. The Goliaths of the web2 era boast not of being as tall as six cubits and a span, but rather of collecting petabytes of personal data every day. That’s rather daunting for any David-sized startup with no such treasure trove of data.

Square’s success is commendable and defined fintech in the Web2 era. But they operate a closed network that retains not only the data but also the profits. Shareholders love this walled garden, as it bolsters sustainable economic rent. Block is unlikely to dismantle this wall. And their value proposition may eventually disseminate to Luca and Jessie, but the margins will always be tilted in favor of Goliath.

Their forays into blockchain will likely continue to be walled, despite renaming the company to Block. But Block has been the good guy compared to other web2 fintechs.

Buy-now-pay-later unicorns like Klarna, Affirm, and Zip were the posterchilds of fintech lending in the 2010’s — using a virtuous cycle of overbidding on merchant recruitment, pumping their stats, raising ever higher VC rounds, and repeating.

Their business model was more exploitative than revolutionary. They discovered a loophole in consumer lending regulations and used it to exploit the compulsive itch for instant gratification, charging victims exorbitantly.

Marketers led the innovation, not cryptographers or engineers. It was more circus than science. This has caught up to them. From their 2021 peaks, their market caps dropped in less than 2 years by 85%, 90%, and 95%, respectively. It’s a story of revelation, not revolution.

Enter Decentralized Lending

Dapps that apply DeFi protocols to real world lending will someday eliminate the need for centralized intermediaries like banks and fintech unicorns, fulfilling the Internet’s original promise of directly connecting many to many — in this case borrowers and lenders.

To establish this tokenized lending economy, significant infrastructure must be developed. The proceeds from Luca’s fishing expeditions and Jessie’s earnings will be conducted on blockchain platforms. Utilizing advanced technologies like zero knowledge proofs, lenders will be able to evaluate their creditworthiness without compromising their privacy. On-chain data, including payroll and location history, will be privately revealed, safeguarding sensitive information.

Let’s see how this plays out.

How Decentralized Robo-Lending Works

AI robo-investors will seek investment returns for their principles by originating loans to borrowers. One man’s debt is AI’s asset.

This lending will use programmable blockchains like Ethereum, so AI can completely manage it on-chain via smart contracts, avoiding off-chain manual and legal processes.

When fully deployed, AI + crypto — or neural finance — will transform all 5 components of lending: Accessing, Assessing, Processing, Dispossessing, and Repossessing

1. ACCESSING borrowers

In the future, borrowers won’t walk into a bank to get a loan. They will likely get it inline during a purchase — which will be conducted online via on-chain payments even if the purchase is in-person.

AI robo-investors will fund these loans. The funds can flow directly to borrowers, or indirectly via retailer, manufacturer, and other intermediary channels. The process of matching a lender to a borrower doesn’t have to go through a traditional bank or even a crypto bank. It can flow directly from a retail investor whose AI has indicated an open “order” to invest in a loan that meets specific criteria. This decentralized lending is the hallmark difference between traditional and AI + crypto lending.

Borrowers will have the assistance of AI to instantly identify the most favorable loan offer from a worldwide pool of potential lenders. This fosters competitive dynamics that lead to significant enhancements in loan terms for borrowers, surpassing the conditions available today.

Honda will bundle financing together with their tokenized sales, e.g. a scooter will sell for 2 years of streaming payments. This is similar to BNPL — buy now, pay later — startups like Klarna and Affirm. However, they will not just be integrated into the retailer checkout, but will be vertically integrated with manufacturers via asset tokenization.

But it won’t just be global manufacturers like Honda that benefit. A one-man boat builder will be able to tokenize each boat with a unique dynamic NFT that is registered on-chain with the local dock.

Manufacturers who fully tokenize the distribution and sales of their products will benefit from increased access to AI and crypto based financing. A virtuous cycle will generate flywheel effects — each tokenized sale generates more financing; each financing generates better data; better data attracts increased AI investment; more financing generates more sales.

2. ASSESSING borrower credit worthiness

Traditionally, lenders assess borrower creditworthiness via internal financial records, external data like credit scores, and more recently personal data like social media and e-commerce activity.

In the future, credit scoring will be based on on-chain data.

To preserve privacy, the data will be shared anonymously via technologies like zero knowledge proofs. This encourages deeper sharing of personal data.

Jessie can share her delivery earnings, co-signing from parents, zero-accident driving record, frequency of driving over the speed limit, and top grades in pre-med.

Luca can share his daily work logs, GPS heatmap, associated catch revenues, progressive roles in the org chart, and peer attestations of who will jump ship to join him if he gets his own fishing boat.

3. PROCESSING the loan

In the era of AI and crypto lending, the loan processing stage will become highly streamlined.

In Jessie’s case, the ownership of her scooter is tokenized in a dynamic NFT, which transfers back to the lender instantly upon full default. Repossessing the collateral — the scooter — becomes easier through the activation of GPS trackers embedded in the scooters, lying dormant until this critical moment. Tampering with this tracker blocks the scooter from paying tokenized road tolls or using tokenized curbside battery swap stations.

The use of smart contracts and programmable blockchains will automate and expedite the execution and servicing of loans, reducing manual interventions and paperwork.

Like with previous systems, AI will monitor and report on payment delinquencies and defaults. However, transparency will be revolutionary (and someone will figure out how to solve the privacy problem). If the Great Financial Crisis had such transparency and constant AI monitoring, it would have never happened.

4. DISPOSSESSING the loan from the books

AI robo-investors will use the multiplier effect to repeat the lending process. After making a loan, the lender can securitize and/or sell the loan, generating cash to make further loans. This seamless transition from one loan to another facilitates the efficient recycling of capital.

5. REPOSSESSING the underlying collateral

What if, despite their best efforts, Luca or Jessie encounter setbacks and struggle to repay the loan? Here, decentralized lending showcases its true power.

Ownership of assets will be tokenized in order to streamline the repossession process. If a borrower defaults, ownership transfers through automated processes via smart contracts. All regulatory compliance will be built-in, e.g. foreclosure proceedings.

For non-regulated assets, ownership can instantly transfer back, holding borrowers like Jessie and Luca accountable for their obligations. That’s only fair.

The instant the ownership transfers on-chain, GPS trackers on the boat or scooter would switch on, transmitting its location. A repo man’s job would be 10x easier. His fees would drop dramatically.

If they hide, they won’t have a clean title. So, they won’t be able to have their registration renewed, electronic bridge toll passes function, get serviced by a certified mechanic, or be sold to another buyer.

This mechanism ensures a fair and efficient resolution without undue hardship for either side.

It results in cost savings across the life cycle of the loan, which will impact the entire ecosystem. The result will be 10x improvements in availability and loan terms — for borrowers and lenders alike. Luca and Jessie will get their loans easily, quickly, and at good terms.

Neural Finance

Luca, with the financial support from a decentralized lender, starts his fishing business and experiences remarkable success. The lender, seeing his track record on-chain, offers him a low interest rate on another boat loan in return for a 5% revenue share until the loan is paid off — all facilitated automatically via smart contracts. This mutual arrangement relieves the financial burden on Luca while providing the lender with a share of his growing profits.

Jessie, on the other hand, turns her initial scooter loan into a loan for a fleet of scooters. With her increased income, she not only funds her college tuition, but also enables dozens of incoming freshmen to join in her delivery business.

Based on progressively improving performance stats and better economics, participants will increasingly trust neural finance over traditional finance.

Over time, the ripple effect of decentralized lending will permeate and improve the lives of billions like Jessie and Luca worldwide.

This is another preview of the upcoming book QUADRILLION — The Playbook for Humankind’s Largest Market Opportunity: Asset Tokenization.
Follow me or DM to help with a peer review of the book.

All characters in this article are fictional. Any resemblance to actual persons is purely coincidental.