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Decentralized Lending and Borrowing: What the Future Holds for Banks

Technology has improved borrowing and lending experiences and empowered consumers so that they no longer have to battle old systems. The rise of fintechs and the adoption of the blockchain are most responsible for changing the way consumers interact with financial services. The question then that a stakeholder in the relevant industries must battle with is what the future of lending looks like.

Way before there were banks, people still gave each other loans but there had to be trust between borrower and lender. With time and with the breakdown of trust third parties were introduced into the equation. These middlemen served to protect the lender but in so doing, extra layers were added into the process and along with them came higher fees.

Enter the blockchain

The very nature of the blockchain is decentralization which has made it possible to transfer assets without needing intermediaries. This attribute promises to redeem peer-to-peer lending and perhaps even grow it to new heights of fame.

For individuals who have had to jump through many hoops to get access to credit, accessing hard money loans becomes easy. If they have an option to get a loan without having to rely on financial metrics, then people take it. It is no wonder ICOs and crowdfunding have been on the rise. They demonstrate the willingness of people to work with hard money lenders as long as they lend based on ideas and the people behind them.

No need for middlemen and proprietary ratings

Essentially, blockchain lending is an improvement on the old peer-to-peer lending. It gets rid of the bank so that individual businesses and borrowers can connect seamlessly. Without geography as a constraint, the borrower is able to access competitive financing from anywhere in the world.

Owing to smart contracts, the lender verifies the legitimacy of the borrower and validates the transactions. They do this almost instantaneously and so the costs are low. All the transactions can be audited and every address can receive a rating almost immediately. In fact, transactions can be analyzed in detail based on the address each one is assigned. This means eliminates the need for metrics like credit scores.

A battle looms

It is unlikely that banks will just watch passively as peer-to-peer lenders take a bigger chunk of their pie by the day. As it is, the major banks are not feeling threatened by technology. In fact, some of them are willing to embrace it and work ways to add it to their systems.

Banks have the advantage over individual lenders in that they have the resources to optimize and streamline their operations fast. Other than that, the benefits are pretty much the same. The blockchain connects the party to the customer and guarantees real-time data, transparency and an immutable ledger. For both, there is a lesser need for due diligence (which pushes on the cost to the borrower).

A bank with the complete history of transactions can make lending decisions easily. They can run checks for creditworthiness using algorithms. Smart contracts will generate instructions in code and lower errors for margin significantly. Ultimately, efficiency is improved as the process is almost automated. Additionally, auditors, investors, and regulators are able to access data without compromising its safety for the consumer.

This move will put banks on a competing platform with individual lenders. If it works, only the best will survive.

It is still an idea

While all this sounds amazing, one must not lose sight of the fact that this model of lending is still new. There could be many things standing in the way of global adoption, most of them related to KYC (know-your-customer) rules and establishing creditworthiness.

There is a real challenge when it comes to collecting loans that are made on the blockchain. It will test smart contracts and their legality. It will definitely put urgency on the need for global regulations for peer-to-peer lending. As you might guess, some countries may be more reluctant to make it legal than others.

The distributed ledger notes that there has been a transaction but evaluating and managing risk is still uncharted territory. The blockchain is still young and the tools are not very user-friendly. Yet, entrepreneurs can fix this issue to send lending and borrowing to newer heights.

Meanwhile, banks will need to be answering the question of whether the masses are ready for a new lending model.