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About Undercollaterized loans (Extract from internet Article):
Reprint from: https://selfkey.org/undercollateralized-loans-the-future-of-defi/
Undercollateralized loans or lending is already being touted as the future of DeFi. Although it might seem like a farfetched idea, DeFi platforms have already started offering this service.
So what are undercollateralized loans and why are they important for consumers?
Anyone who has secured a loan both through a traditional channel or DeFi platforms will have heard about collateralized loans. Collateral is any asset that has a value and is accepted as a security by the lender from the borrower. Any loan that is sanctioned with the security of fully backed collateral is effectively deemed as a collateralized loan. In other words, the collateral more than covers the loan, or principal.
Conversely, an undercollateralized loan is any loan that is not fully collateralized. That is to say that if the loan were defaulted, the collateral would not fully cover the principal. Although the concept of undercollateralized loans may raise some questions and concerns, it is conceived in a way to protect the interests of both the borrower as well as the lender.
Undercollateralized loans could be enabled through credit delegations. Credit delegations can be explained through a hypothetical scenario between Mary and Sam.
Let’s assume that Mary has deposited US$100,000 into a DeFi lending platform providing undercollateralized loans. Mary could use the DeFi platform to lend the whole amount using collateralized loans to other users of the DeFi platform and get a good return on her investment. However, Sam needs some urgent financial support, and Sam is well-known to Mary and is trusted by her. Hence to help Sam, who cannot obtain collateral to get his loan sanctioned, Mary helps him with an undercollateralized loan.
To achieve this, Mary will have to delegate her credit to a particular borrower, in this case, Sam. And once Mary delegates her credit, Sam can use the DeFi platform to obtain a loan without depositing collateral.
The critical factors that need to be accounted in these scenarios are:
Mary trusts Sam; it is one of the recommended criteria that credit delegation should only be provided to someone whom the lender can trust.
Secondly, both Sam and Mary have to be located in the same jurisdiction, so that in the event of a default, Mary can proceed with a legal procedure against Sam.
Undercollateralized loans can further increase the popularity of DeFi, as this new addition of product further improves and differentiates DeFi from traditional financial products.
