Hello, I am a student doing a research about DeFi lending platforms and I wanted to ask a couple of questions. Could you walk me through the process of lending? And why do you need collateral in order to offer loans? What alternative are there to the need for collateral?
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In traditional finance, you have both over-collateralized , undercollaterized, and non-collaterized loans. For example, in many countries, mortgage is overcollaterized loan as people can put their real estate as collateral to get a loan. You can of course also get a loan based on credit without any collateral. But less collaterized a loan is, the riskier it is as the borrower can choose not to pay back the loan. If you had the overcollaterization, then in such case if needed, you can liquidate the collateral to force to recoup the loan.
Now in DeFi, there are both forms of lending but collateralized loan is more popular and more secure as DeFi in “pure” form wouldn’t have KYC or ability to pursue the loss offchain if one borrowed without a collateral and simply not pay back. But if there is collateral for example such as Maker or AAVE, then the system can liquidate such collateral if a loan falls under certain threshold to recoup the loan.