Onchain collateralization is poised to revolutionize loan terms in the crypto space, according to Fabian Dori, the chief investment officer at digital asset bank Sygnum. Dori argues that using onchain crypto assets as loan collateral offers distinct advantages.

What are On-Chain Mortgages?

On-chain mortgages represent a convergence of digital assets and traditional finance, where real estate loans are managed and settled using blockchain infrastructure. Smart contracts automate key processes like loan origination, repayment schedules, and title transfers, leveraging digital assets as credit or payment.

Benefits of Onchain Collateral

Traditional finance (TradFi) relies heavily on credit scores and extensive background checks to determine loan terms. Decentralized finance (DeFi), particularly with the rise of onchain credit scores, is creating a paradigm shift, offering alternatives to TradFi. Onchain collateral offers several benefits:

• Improved Loan Terms: By using crypto assets as collateral, borrowers may access more favorable loan terms, such as lower interest rates or higher loan-to-value ratios.
• Transparency and Efficiency: Blockchain technology provides transparency and efficiency in loan management, reducing processing times and minimizing intermediaries.
• Accessibility: DeFi lending platforms offer alternatives to traditional financial institutions, potentially benefiting the unbanked, underbanked, and overbanked.
• Liquidity: Crypto-collateralized loans allow investors to access the liquidity of their crypto holdings without selling them. This enables them to retain potential price appreciation during the loan term.

How Crypto as Collateral Works

Borrowers can freeze a specific amount of cryptocurrency, such as Bitcoin, Ethereum, or stablecoins, as collateral. In return, they receive a loan in fiat currency or stablecoins, which can be used for various purposes, including purchasing property or refinancing existing mortgages. Platforms like Figure, Milo, and USDC Homes have already launched pilot programs allowing borrowers to buy homes using their crypto assets.

The Role of Onchain Credit Scores

Onchain credit scores are becoming increasingly important in the uncollateralized and undercollateralized crypto lending ecosystem. These scores enable lenders to assess the likelihood of loan repayment without relying on traditional collateral. Platforms evaluate creditworthiness by examining online and onchain social profiles, such as X (formerly Twitter), Lens, and ENS, using them as reputational collateral.

Examples of Platforms

Several platforms facilitate crypto lending:

• Aave, Balancer, Compound, Nexo, Salt, and Yearn These platforms offer crypto-collateralized loans, allowing users to borrow against their digital assets.
• SoFiLend: This platform assesses creditworthiness using onchain and online social profiles, offering loans based on an individual's Web3 reputation.
• Ledn: Ledn offers Bitcoin-backed loans, allowing users to unlock liquidity without selling their BTC. Collateral is held securely in segregated on-chain addresses.

Risks and the Road Ahead

Despite the potential benefits, onchain mortgages and crypto-collateralized loans also involve risks. The volatility of cryptocurrency is a significant concern, as rapid declines in collateral value can lead to liquidations. To mitigate these risks, hybrid solutions are emerging that combine traditional financial companies with DeFi protocols. These solutions may involve banks offering crypto-collateralized loans while using blockchain for back-end processing, or decentralized platforms integrating with centralized identity and credit scoring systems to comply with regulations. The future of onchain collateralization likely involves hybrid models that bridge the gap between traditional finance and DeFi, promoting wider adoption and innovation in the lending landscape.