【ChainNews Selection】What are the risks of the new uncollateralized loans introduced by the DeFi lending protocol "Aave"?

The uncollateralized loan feature of Aave is not suitable for lending between non-familiar parties, but more suitable for institutional lending.

Original Title: "Aave Launches Unsecured Loan Feature, Are DeFi Defaulters Coming?"
Written by: emusher

On July 8th, Ethereum lending protocol Aave announced the launch of a new feature called Credit Delegation, which allows users to provide peer-to-peer loans without collateral requirements. This is significant for the large-scale expansion of DeFi, but it also introduces new risks.

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Aave CEO Stani Kulechov explained how the feature works on Twitter:

Depositors can delegate their credit line, for example, Karen deposits USDT with Aave and delegates her credit line to Chad, who can withdraw funds such as ETH from the Aave protocol.

Karen and Chad agree on loan terms such as repayment, interest rates, and contracts. The signing process of this agreement is executed through OpenLaw, ensuring the enforceability of the loan, similar to signing agreements with DocuSign.

Once the agreement is in effect, Karen creates a CD Insurance Pool smart contract, allowing Karen to set the credit line and currency based on the agreement, while Chad can borrow funds through the borrow function and repay the loan through the repeat function. This open credit line provides flexibility to Chad.

Through delegating loans, Karen theoretically can obtain a higher uncollateralized loan rate when depositing with Aave, and Chad can borrow funds from Aave without collateral.

How to Control the Risk of Defaulters?

We know that in the traditional lending industry, it is very common for borrowers to intentionally default on unsecured loans, and these individuals are often referred to as "defaulters."

Therefore, there have been questions raised about the new feature released by Aave, with Crypto Kenneth commenting:

"How do you punish Chad if he is a defaulter who is not willing to repay? Without complete identification and actual protocol enforcement, Chad can easily borrow funds and then run away."

In response, Stani Kulechov explained:

"You wouldn't want to entrust your credit to someone you don't know, you would only entrust it to someone you are familiar with like Chad."

Implicitly, Aave's credit authorization feature is suitable for unsecured lending between acquaintances. Essentially, this type of lending requires the delegator to fully understand the borrower, or require them to be able to assess the credit risk of the borrower.

Regarding the risks associated with the new feature, DeFi Dude also raised his concerns:

"Is there a way to limit the credit amount? If I delegate my credit line to Chad but don't want him to use all of my available credit, is that possible? Will the credit Chad withdraw affect my liquidation price?"

In response, Stani Kulechov explained:

"Yes, you can (1) limit the amount you want to authorize, (2) set the currency you want Chad to be able to withdraw, (3) close the credit line so that Chad cannot withdraw any available delegated credit. The amount he can withdraw is only within the loan-to-value ratio range of Aave."

The Significance of Unsecured Loans for DeFi Expansion

Currently, the vast majority of DeFi lending protocols adopt over-collateralization mechanisms. For example, if I collateralize $10,000 worth of ETH, I can only borrow approximately less than $7,000 worth of DAI, which significantly limits the potential use cases of blockchain lending. The peer-to-peer intermediary approach adopted by Aave theoretically can bypass this limitation, allowing the protocol to reclaim the borrower's loan outside the blockchain.

However, the current solution implies that it is not suitable for lending between non-acquaintances and is more suitable for institutional borrowing. DeFi investor Stefano ₿ernardi also expressed his views on this:

"Can more people contribute to Karen's CDV? Or can people pool funds through Aragon DAO and then use proxies to open CDV?"

According to Stani Kulechov, initially, there will be a B2B relationship between the delegator and the borrower, but theoretically, expansion can be achieved through an asset pool model to diversify risks.

However, compared to over-collateralized loans, this new DeFi lending service will entail more risks.

Furthermore, Kulechov pointed out in an interview with the media that DeFi as a whole is still too small, and the industry needs more measures to make it mainstream. He also added:

"It is important that borrowers can convert stablecoins into fiat at a lower cost."

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