Decentralised Finance: Defi Use Case - Lending and Borrowing

Decentralised Finance
Introduction DeFi use case – lending and

Decentralised Finance, or "DeFi", refers to the borrowing
world of financial applications that are built on
blockchain networks. They are 'decentralised' as the Perhaps the most popular use case currently in
inherent nature of blockchain allows these DeFi is lending and borrowing, as outlined
applications to operate without intermediaries, in simply below:
this case, financial institutions.
1. Party A deposits an amount of
Many DeFi applications operate on the Ethereum cryptocurrency into a DeFi lending protocol
public blockchain as they involve the use of smart built on the Ethereum blockchain, accessed
contracts, this enables them to operate on a peer- through an app on their phone.
to-peer basis.
2. Party B, seeking a loan, accesses the
This briefing note is intended to be a high-level lending protocol and sees the availability of
overview of DeFi, covering what it is, an example Party A's cryptocurrency deposit.
use case, and potential issues.
3. The two parties enter into a loan agreement
For more in-depth content on a variety of
in the form of a smart contract governing
blockchain topics, please visit our Blockchain in
the terms of the loan including what
Focus webpage.
collateral will be provided (usually in the
form of another cryptocurrency or asset),
What is DeFi? the interest rate and the repayment date.
As stated above, DeFi is the collective term for Both parties are able to negotiate flexible terms
decentralised finance applications built on that are of a mutual benefit, at a much faster
blockchain networks. rate than a conventional bank loan.
Currently a whole host of financial applications are without the need for a financial institution to
on offer, the common theme of which is a lack of determine a borrower's eligibility and process
centralised body or trusted intermediary that sits in the transaction.
the middle of the financial transactions that occur.
• Marketplaces: users of blockchain marketplaces
DeFi applications include: can trade digital assets and financial products
on a peer-to-peer basis. Parties can enter into
• Banking services: traditional banking services smart-contracts to transfer digital assets,
such as money transfers and loans can all be ranging from crypto-currencies to synthetic
effectively deployed over blockchain. The use of real-world financial products, directly between
these products often involves stablecoins, digital wallets, cutting out the need for a trusted
crypto-currencies that are pegged to the value intermediary such as a bank or clearing house.
of real-world currencies, predominantly USD.
• Borrowing and lending: borrowing/lending

applications allow for peer-to-peer lending
DeFi – issues to consider Advantages of DeFi

Despite the advantages that DeFi brings to the There are some very tangible advantages of
world of financial services, there are some issues DeFi applications over traditional financial
that users need to be aware of. models, these include:
1. Know Your Client ("KYC") 1. Speed: DeFi users who wish to obtain a
loan, for example, can process this with far
DeFi allows access to financial services for users greater speed through a blockchain-based
who may otherwise be excluded due to lending protocol than through a traditional
circumstances such as a bad credit rating. Although bank loan.
this opens up the market to a wider pool of users
than traditional financial models, participants 2. Accessibility: DeFi on blockchain,
should be wary when entering into peer-to-peer particularly DeFi lending, will open up
lending arrangements. finance to a much wider market of users
who might otherwise be excluded due to
The general lack of KYC on public, permissionless location or circumstance.
blockchains means that users/institutions who lend
crypto-assets should be aware that they may be 3. Transparency: blockchains are transparent
lending to individuals who will use these crypto- and immutable. Once a financial
assets for criminal purposes, or to individuals who transaction or smart contract has been
may be unable to repay the loan. recorded onto a blockchain, its terms are
visible to participants and cannot be
In the absence of a trusted intermediary managing altered.
risk, we recommend that where possible, parties try
to identify the counterparty that they are This transparency and immutability also
contracting with. provides security to users, the clear audit
trail makes it more difficult for funds to go
KYC with regards to cryptoassets and blockchain is
missing.
an area that is gaining increasing attention from
regulators and, currently in the UK, businesses
carrying on cryptoasset activity need to be
registered with the Financial Conduct Authority.
rights of recourse and enforcement against the
2. Smart Contracts counterparty to a smart contract, as smart contracts
often form the basis of DeFi transactions and
As discussed in our previous briefing note, whilst govern what happens if something goes wrong.
under English law smart contracts may constitute a
legal contract, it remains to be seen if they are We recommend that agreements between parties
capable of acting as a complete substitute for relating to smart contracts are based on a natural
natural language contracts. language contract which then incorporates by
reference the relevant, agreed smart contract code.
Users of DeFi products should therefore make sure Off-chain dispute resolution procedures should also
that they are comfortable and familiar with their be considered.
For more information or a free initial meeting, please contact:
Key contacts
Jonathan Emmanuel Gavin Punia

Partner Senior Associate
Tel: +442074156052 Tel: +442030176884

[email protected] [email protected]
Ash Shah Thomas Hepplewhite

Associate Associate
Tel: +442074156606 Tel: +442074156777

[email protected] [email protected]
Charles Hill
Trainee Solicitor
Tel: +442074156745
[email protected]
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area, advising on innovative matters in payments, crowdfunding, open banking
and blockchain."
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Decentralised Finance

Introduction DeFi use case – lending and

• Borrowing and lending: borrowing/lending

DeFi – issues to consider Advantages of DeFi

For more information or a free initial meeting, please contact:

Jonathan Emmanuel Gavin Punia

Tel: +442074156052 Tel: +442030176884

Ash Shah Thomas Hepplewhite

Tel: +442074156606 Tel: +442074156777

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