Decentralized finance became a trend, no one can deny it. Investors and traders now started to recognize the potential it has in the years to come and to put more money in the game. It does include lending and borrowing crypto assets, for sure. However, over-collateralization is a recurrent problem amid the market, so Fabrx Blockchain launched a new project to solve this issue. Zero Collateral is a new protocol/tool that allows users to get a loan with as little as zero collateral.
How Does Zero Collateral Work?
Zero Collateral is an undercollateralized lending market on the Ethereum blockchain.
It gives users the possibility of taking a loan (based on cryptocurrency) without having to back the loan with absurd overcollateralized rates (Maker Vaults sometimes require up to 150% collateralization, for example).
The protocol works by interoperating financial data with the Ethereum-based lending market. The network determines the risk profile based on the user’s credit history within the ecosystem.
Within this platform, borrowers must only keep collateral equivalent to the value of the loan minus the total amount of interest paid from all previous loans.
It means that with frequent loan repayments, the required collateral for a user that wants to borrow crypto again (and has paid his debt faithfully) will eventually drop to zero.
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The cycle begins when lenders deposit DAI stabilecoins into the market and receive zDAI in return. They can redeem their zDAI assets for DAI by withdrawing supply from the market.
Specific factors such as the interest rate, maximum loan size, and minimum collateral requirements are determined individually for each user, all based on the provided data, so the interest rates can be established.
The risk profile (or credit score) is built based on the data provided by the new users. The platform analysis each credit history to determine the collateral for new loans.
Let us say some user has a projected income of $100k per year. It means that this guy might be able to get loans up to $5K, for example.
But what if a user has full anonymity (very usual among several DeFi and blockchain users)? In this specific case, reputation is built from on-chain actions. An initial way is that collateral will decrease according to the interest paid back.
The platform is frictionless, meaning users are free to connect their credit history with their Ethereum wallet, which makes the processes easier.
Zero Collateral is 100% trustless and transparent, as each borrowing/ lending transaction is fully audited, and it has no centralized party controlling the lending/borrowing process.
How to Ensure Loans Will be Repaid?
Some people might question how borrowers cannot just take the money and escape if the system was designed aiming no-collateralization.
Besides the risk profile analysis, Zero has a system to ensure the amount that was borrowed will be paid.
If a loan is never paid back, a liquidation process is automatically run on the user’s wallet. The wallet is reset, so the maximum borrowing rate and collateral go back to their initial amounts (1 DAI max borrow and 100% collateral).
The assets are not lost since the borrower has contributed to the redemption pool with interest payments or has kept collateral deposited on the system.
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Any collateral is sent straight to the redemption pool. Lenders will receive the total value accrued composed by summing collateral deposited and redemption pool interest, minus the borrowed amount.
In the case of loan default, the total interest paid would be up to 106% of the borrowed amount.
The defaulting borrower will exit the market with 6% less money than when he took the loan, and lenders will receive their initial funds plus 50% of borrow interest.
Zero Collateral has plans to become a Decentralized Autonomous Organization (DAO), as it was designed since the beginning to be a community-run protocol.
The so-called Zero Collateral DAO would look similar to other projects, such as Kyber Network or MakerDAO, but with further possibilities for users.
Overcollateralization was a real problem for users who wanted to get loans using DeFi. Although other protocols managed to make it happen, collateralization rates could be as absurd as 150%.
Zero Collateral brings a new approach by offering a protocol where users can increasingly lower their collateral rates to borrow with better conditions, with rates reaching zero over time.