DeFi’s Zero Credit Risk Model & Transparency Boost for Structured Products – A Game-Changer for Global Adoption

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By BitcoinWiki News

Key Takeaways:

– Credit risk present in traditional markets but not in DeFi
– Traditional financial assets like mortgages, CME corn futures, German bunds, and Amazon gift cards have embedded credit component
– DeFi does not consider credit record
– Borrowing power in AAVE determined by collateral value, not credit
– If collateral value falls below threshold and smart contract functions correctly, position is liquidated
– No recourse, no one to call, no place to explain situation in DeFi

HTML list:

  • Credit risk present in traditional markets but not in DeFi
  • Traditional financial assets like mortgages, CME corn futures, German bunds, and Amazon gift cards have embedded credit component
  • DeFi does not consider credit record
  • Borrowing power in AAVE determined by collateral value, not credit
  • If collateral value falls below threshold and smart contract functions correctly, position is liquidated
  • No recourse, no one to call, no place to explain situation in DeFi

Title: Credit Risk in Traditional Markets vs. DeFi: An Overview

Introduction:
Credit risk is a fundamental aspect of traditional financial markets, wherein various financial assets incorporate credit components. However, decentralized finance (DeFi) presents a distinct contrast, as credit records hold no relevance in determining borrowing power. This article explores the absence of credit risk in DeFi and how it differs from traditional markets.

I. Credit Risk in Traditional Markets:
In traditional markets, virtually every financial asset encompasses credit risk. Whether it’s mortgages, commodities futures, government bonds, or even gift cards, there exists an embedded credit component that affects their cost and overall risk profile. This credit risk is associated with the possibility of default or non-payment by the borrower or issuer.

II. The Irrelevance of Credit Records in DeFi:
In contrast to traditional markets, DeFi operates on a decentralized and trustless system. In platforms like AAVE, the ability to borrow is solely determined by the value of the collateral deposited. DeFi protocols implement smart contracts that automatically liquidate positions if the collateral value falls below a predetermined threshold. This automated process eliminates the need for credit records and credit evaluations.

III. Liquidation Process in DeFi:
In the absence of credit risk assessment, the liquidation process in DeFi is entirely objective and automated. If a borrower’s collateral value falls below the predefined threshold, the smart contract executes the liquidation, and the position is forcefully closed. There is no scope for negotiation, explanation, or recourse for the borrower, as the process is governed solely by the smart contract’s code.

IV. Lack of Human Intervention and Recourse:
One of the key differences between traditional markets and DeFi lies in the absence of human intervention and recourse. In traditional markets, borrowers can communicate with lenders, seek renegotiation, or explain their situations to potentially avoid default. In DeFi, however, the lack of intermediaries and automated liquidation processes eliminates any opportunity for recourse or communication.

Conclusion:
While credit risk is an inherent aspect of traditional financial markets, DeFi presents a contrasting approach. In DeFi, credit records are inconsequential, and borrowing power solely relies on collateral value. The automated nature of DeFi protocols ensures objective liquidation processes without the need for human intervention. Although this eliminates certain risks and complexities, it also removes the potential for negotiation or explanation in adverse situations.

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