John O'Connor - African Operations Director
Originally published on IOHK.io: November 25, 2021
By integrating digital identity with Cardano, we can create real value and opportunity for people across the globe
"The point of RealFi is to serve real people real finance, and thus be able to innovate and do interesting things.”
When it comes to the story of blockchain’s recent evolution, it is decentralized finance (DeFi) that has taken center stage. DeFi uses ‘smart contracts’ on a blockchain to give anyone access to banking using a public, decentralized, ledger. By removing the middlemen, the bankers, and the brokers, DeFi has brought in a new generation of users and the sector has enjoyed meteoric growth, now estimated to be worth some $100 billion.
DeFi is an open financial network. People do not need to go through any one private enterprise, such as PayPal, Western Union, or a bank, to send, borrow, or lend money. Instead, this is done between individuals, in a peer-to-peer fashion, using blockchain as the underlying ledger to support and enable the transaction.
The basic concept of DeFi is sound. Loans are typically fully-, or over-collateralized. This is because little (or in some cases, nothing) is known about the borrower, and there is little recourse if the loan is not paid. Also, borrowing is normally re-invested in further crypto opportunities. Users interact in a peer-to-peer fashion with no central governing body, relying instead on smart contracts and the inherent transparency and immutability of blockchain-based systems. In this way, most of the usual regulatory constraints around lending and borrowing do not apply, while fees tend to be significantly lower.
"It is our belief that over the next 12 to 24 months the majority of DeFi providers will be systematically upgrading to RealFi, to actually encumber identity, and metadata, to create proper standards and make sure they're secure and functional and to ensure they resolve the issues of regulation and governance, and also they're in the market for new customers."
Among nations with developed economic systems, DeFi has highlighted the potential for blockchain to disrupt financial ‘legacy’ systems and open up access to new users hunting for better yields and moving liquidity around. It has established an entirely new financial paradigm and the $100bn DeFi market is expected to grow significantly over the next few years as models continue to evolve.
However, as much as the age of DeFi is creating fresh markets and driving compelling new use cases, it has also further highlighted the economic divide between people who can easily access financial products, and those who cannot.
Bridging the DeFi divide
Pricing credit is about trying to assess and mitigate the risk of default. Traditional consumer finance and credit reduce risk by understanding how borrowers behave – how much they spend, their income, and so on. DeFi's approach to risk mitigation is different.
A mature credit scoring system is key to delivering credit in developed economies. But it is even more critical in emerging markets. The reason why banks refuse credit or loans in emerging markets is often that they don’t have enough data about the person or organization intending to borrow. The systems are either less sophisticated or simply not there. It is impossible to create an accurate financial picture through a credit score.
However, it is possible to build up a credit score by querying proxies, linked to an identity. You could contact utility companies to check if the customer has always paid their bills, or check with a phone provider to see how often the prospective borrower topped up their mobile. An identity is out there, the problem is how to tie data to the identity. Once that is achieved, the data can be presented to a local bank, microfinance initiative – or a decentralized pool of capital provided by people across the world in the Cardano community.
We have now reached a point when we can enable this through innovations in crypto. All the necessary financial information can be stored and relayed in a verifiable manner through an Atala PRISM ID. The monetary building bricks of DeFi can be used to structure these loans and hedge the currency risk, while scalable payment rails provided by Cardano and various layer 2 solutions will make it possible to transfer capital across the world without friction.
The world has DeFi. Now it needs RealFi
This year we have announced two very significant blockchain agreements. Our partnership with the Ethiopian Ministry for Education is creating a national attainment recording system to verify grades, monitor school performance, and boost nationwide education. Meanwhile, our collaboration with World Mobile in Tanzania will connect the unconnected and enable access to essential online services through blockchain.
Powerful deals like these are the jumping-off point for Cardano's mission to build RealFi: real finance targeted at the people who really need new ways to access finance, creating that real value often missing from DeFi. RealFi is an ecosystem of products that remove the frictions between crypto liquidity and real-world economic activities to offer attractive yields to crypto holders, and cheaper credit/ financial products for real people.
Cardano adds the final piece of the financial puzzle by unlocking real economic value at the end of the transaction chain: personal identity.
Identity is central to everything. Once someone has an economic identity, a world of opportunity and inclusivity opens up. Real opportunity comes with access to essential services that were hitherto out of reach. And real finance, such as loans to open a business or maintain an existing one. RealFi.
Identity can become an asset in so far as it can be a substitute for collateral. A lender's overriding concern is to ensure that loans (plus any interest accrued) are paid back. One way of enforcing this is by collateralizing the loan, but if the lender has enough and clear information about a borrower (if they know the borrower is a high-earner or a long-standing customer), the lender might be more inclined to forgo the collateral.
Reversing financial exclusion
Microlending platforms such as Kiva offer a successful business model, perfectly suited to the African continent's emerging economy. In this environment, small loans can be life-changing for farmers, entrepreneurs, and people with the drive to create and succeed.
But access to finance is only part of a larger picture. Without access to insurance, education, and health services, people would still be exposed to huge risks. RealFi, through the power of blockchain and a digital identity platform like Atala PRISM, offers a comprehensive solution to this quandary. Digital identity enables access to not only financial products but also to services that enable people to thrive on a level playing field with their counterparts in more developed parts of the world.
"Cardano has always been about entering the developing world. We really want to focus on the 3 billion people who don't have reliable access to financial services. If we look at a lot of the markets that we play in, we're super excited to bring those markets in through identity and through wallets into the cryptocurrency space, and then giving them access to RealFi, so for the first time ever, they can participate in a global market fairly."
RealFi will herald a new age of on-chain credit activity. Cardano owners currently hold coins worth $80bn, and many of them will soon be looking for more yield options besides staking. The tangibility of this real-world application of crypto, the provision of real finance to real people, is the switch that can light up Cardano's power and uniqueness. This is the real use case that many people fail to see in cryptocurrencies. RealFi marks a new era of on-chain credit activity. With a validated identity, someone in Rome might have the confidence to make an uncollateralized loan to a business in Kenya, for example.
To start down this road, IO has partnered with Pezesha to facilitate loans to small and medium-sized businesses looking for short-term loans for working capital. These loans have a default rate of just 2%, but struggle to be funded in the Kenyan market due to a lack of local liquidity. The goal is to build simple friction-free tools that enable crypto holders to seamlessly lend into real-world opportunities, receiving repayments in crypto directly into their wallets. We see a world where people can lend into real-world opportunities as seamlessly as they do crypto.
RealFi: democratizing opportunity
RealFi represents the very antithesis of financial exclusion and heralds the arrival of a new era of financial and societal inclusivity in Africa and elsewhere. Through RealFi, Cardano becomes a beacon of identity provision to help people help themselves. RealFi's mission is the creation of real financial value for real people, and the key differentiator between Cardano and other blockchain platforms.
The Ethiopia, Tanzania, and Kenya projects are the first steps of a much longer journey towards global fairness and inclusiveness. The start of a drive to end the marginalization of the disadvantaged whilst offering attractive yields to cryptocurrency holders. Much like DeFi, RealFi will be an ecosystem of products and technologies that reduce the friction between Crypto liquidity and real-world economic opportunities. Through RealFi, we want to make the world smaller, connecting everyone into a global community of capital and opportunity that's now open and welcoming to them.