Defi or decentralized finance is an alternative way to traditional finance. It sounds fancy, but it does not work in reality. Here is why:
You cannot ignore the innovation of securitization that gives banks a further push on their asset management and expand their operation into more risky asset management in modern finance.
In the past, banks heavily relied on deposits from users, but with securitization, banks can turn illiquid assets into liquidated assets while raising more cash to make more loans.
In theory, a bigger pool with more loans can reduce default rates and make such financial instruments more secure.
In reality, it will trigger a chain reaction and melt down the entire finance in a second.
What makes security secure? It is a way to make the default rate as accurate as possible, giving a higher security grade than the lower ones.
A lower grade of loan means a higher potential of default because there are not as straightforward as of default rate whoever originated can be calculated.
There are many ways to calculate loan grading however, there are some factors, include:
- The borrower's credit history.
- Quality of the collateral.
- The likelihood of repayment of the principal and interest.
- Cash flow of borrower that can sustain
The loan grade is automatically low when you allow everyone to get loans from the smart contract without sharing financial background because there is no information about how likely the loan will be the default.
Also, the pool is open to all who can get in and out quickly, which makes it even harder to provide sustainable management of such loans.
Defi is very similar to subprime Morgage-backed securities.
The digital finance product is like a shell company with fake value stocks that attract investors to buy in with the high return rates and risk of defaulting at any time.
There is no innovation in preventing default rates but in speeding up cash flow transactions.
Defi only conveniences the money pooling process but has not improved the prevention of possible default and provided sustainable solutions for long-term gains. Instead, it just repackaged the bad loans and sold them for liquidity.
And even worse, Defi will have no mechanism to force investors to repay loans.
Photo by Akinori UEMURA
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