Microlending: Traditional Finance vis-à-vis Decentralised Finance
Microfinance is the buzzword of recent times but we could trace this term back to the 1800s when a theorist, Lysander Spooner wrote extensively about the large benefits of the small credits to a magnificent group of farmers and entrepreneurs to bring them out of poverty.
It was introduced with the aim to offer loans to poor people through a market-based enterprise. In the 20th Century, a microfinance and community development bank was founded in Chicago. Likewise, several other banks were founded in different countries like Germany.
It is quite stupendous to know that, in the 21st Century, around 16 million people were served by around 7000 microfinance institutions altogether in different countries, And around 500 million families are benefited from such microlending initiatives. Back in 2005, the Economic and Social Council of the United Nations announced the Year 2005 as the “International Year of Microcredit”.
What is Microlending?
Microlending or microfinance is the type of banking service that offers microloans — loans of smaller amounts to several low-income individuals or groups who do not have much access to traditional banking services.
Different individuals and groups of people who belong to the underprivileged sector are able to take microloans at the nominal rate of interest. Several microlending services are consistent and use ethical lending practices. It gives a loan directly to the needed individuals and groups.
Microlending has made it attainable for different entrepreneurs to get easy access to working capital that contributes, eventually, to the economical development of society. Microfinance has opened up a wide range of options for people, the IFC has abet to improve the credit reporting for an array of developing nations.
Although microloans and microcredits offer several benefits, and yet have different drawbacks. The first and foremost drawback is the high-interest rates, although lower than credit cards, they are significantly higher than banking and can lead to inflation. A global average interest rate and fee rate is around 37% and fee rates can be as high as 70% in different locations.
Getting a microloan from the traditional financial institutions could be full of hurdles. It causes huge delays and you need to wait for a long time since a large number of businesses apply for the microloans. Due to poor schemes by the financial institutions, different borrowers are under debt and not able to pay the installments to repay the loan.
Even though Microlending has opened up a significant amount of opportunities for the underprivileged sector of the society, several deterrents like these keep it from becoming mainstream and truly unleash its potential for the people and not corporations.
Blockchain & DeFi to bring revolution in the microlending sector
Blockchain-enabled Decentralised finance ecosystem solves a variety of challenges in the existing microlending infrastructure. Different Decentralised finance platforms offer peer to peer financial services without any intermediaries and a clear set of large incentives.
Unlike traditional financial institutions, the decentralized finance ecosystem does have low operational costs and huge profitability. Different DeFi based platforms have lower overhead costs. It charges a lower fee since operational costs are less.
The traditional peer to peer lending where two parties lend and borrow money, is prone to fraud from any side, either from the borrower or lender. But the probability of such a case in the DeFi ecosystem is lower as all the transactions are recorded in a distributed ledger and validated by the set of nodes called validators.
Defi enabled Microlending offers a more transparent, trust base and frictionless alternative in which different participants earn and build trust by allocating their capital to different borrowers.
How DeFi enabled microlending could help different small scale businesses?
In different countries, millions of people do not have access to the financial system. Different SMEs, both unbanked and banked, face financial pressure in order to pay for different goods and services. Although traditional microfinance has supported different businesses in developing countries, the market is ripe for disruption.
Crypto sphere microfinance would resolve several issues around funding community-backed borrowers. Different business borrowers can unlock a huge capital from different cryptocurrencies like BTC, ETH, stable coins, and many more.
DeFi enabled micro-lending platforms to allow users to borrow the money in the form of digital assets where everything is transparent. Users can choose their own duration of the loan and put some collaterals as security to the lender.
Decentralized Finance could blossom the field of microlending that will allow a completely new financial industry possibly lifting a significant amount of people from poverty. Different microfinance and micro-lending platforms have led unbanked people to access banking facilities.
With more research going on in the decentralized finance ecosystem, a large number of crypto-based tools for microlending are proliferating. Different microlending platforms have enabled businesses to tokenize several illiquid assets and realize the value of such platforms that can be leveraged for the financial revolution.