Andreas Schweitzer, Founder and Managing Director Artis Trade Invest & Artis Trade House – providing insured or guaranteed trade solutions
Decentralized financial lending platforms are moving beyond high-risk, high-return paradigms and redefining the accessibility and efficiency of global trade. DeFi platforms are poised to reshape trade finance by lowering barriers to entry for a broader range of investors while increasing transparency. Let’s take a closer look at how they’re doing this and the challenges they present.
DeFi Lending vs. Traditional Lending
Both DeFi lending and traditional lending facilitate international access to various investment opportunities, but their similarities end there.
DeFi lending involves peer-to-peer lending using crypto assets, which offers the potential for high returns by appreciating the underlying token with varying degrees of volatility. Traditional lending uses fiat currencies, such as the US dollar, British pound, and yen. DeFi lending contracts are significantly more complex and lengthy, requiring specific legal knowledge in the cryptocurrency space as well as additional review and structuring.
DeFi lending appeals to investors looking for higher returns. The underlying crypto risk is directly tied to the coin or token. Stablecoins are tied to the volatility of the underlying currency. In contrast, other crypto assets may have higher volatility. Traditional asset-backed lending is suitable for institutional investors, mid-sized companies, and individuals looking for stable, uncorrelated, and short-term returns.
Finally, DeFi lending varies depending on national cryptocurrency regulations, which can complicate investments when moving from a cryptocurrency platform or exchange to traditional banks. Fiat-backed lending in trade finance ensures compliance with established regulatory frameworks, preserving investor confidence and compliance with the law.
The Benefits of DeFi in Trade Finance
Lowering barriers to entry
Investing in trade finance requires significant capital, which often limits access to institutional or professional investors. DeFi platforms democratize access by accepting smaller amounts, allowing more participants to invest.
For example, regulated alternative investment funds only provide access to qualified or professional investors, and the minimum investment is typically in the six-figure range. Regulated DeFi platforms allow investors to get started with as little as $100 through DeFi’s specific investment pool, greatly expanding the opportunities for participation.
Although the capital requirements are lower, investing through these platforms requires some technical affinity and familiarity with wallets. You need to officially register with your ID on a regulated DeFi platform and then link your wallet to invest.
Improved transparency
Traditional commercial financial transactions often lack real-time transparency. Blockchain technology, which the DeFi world relies on, improves transparency and ensures visibility into transactions and borrowers’ creditworthiness. Investors can access immutable records on the blockchain, providing a more transparent and up-to-date view of financial health and transaction history.
Efficient investment processes
Smart contracts automate and accelerate operations, which speeds up settlement times and reduces operational costs by eliminating middlemen. This creates smoother transactions. DeFi platforms improve investment efficiency by enabling global transfers at any time.
Global reach
Smaller trade finance operators, such as ourselves, often focus on specialist sectors or regions where they have particular expertise and avoid complex cross-border transactions. Evolving and diverse regulatory frameworks across jurisdictions require investors to exercise caution, highlighting the need to be aware of opportunities and risks, particularly in the DeFi sector.
Improving credit risk management
DeFi platforms like to mitigate credit risk through overcollateralization, where borrowers must provide collateral greater than the loan amount. For example, if a trade finance fund borrows $100,000 from a DeFi platform, it may need to collateralize the loan with real assets worth $130,000. This approach reduces the lender’s exposure to market volatility and increases investor security.
The Risks and Challenges of DeFi in Trade Finance
While DeFi platforms offer benefits for trade finance, they also present challenges and risks that investors are encouraged to consider:
• Regulatory uncertainty: DeFi regulation is still evolving. The lack of uniform global regulations can complicate investments, as platforms may have to comply with various legal requirements, which can affect their stability and legality.
• Specialized knowledge requirements: Investors often need specialized knowledge to effectively navigate the DeFi space. Before getting involved, it is recommended to understand blockchain technology, smart contracts, and the specific mechanics of DeFi platforms. This can limit accessibility for less tech-savvy investors who are used to a more analog approach.
• Market volatility and liquidity issues: While overcollateralization mitigates risk, volatility lies in the value of cryptocurrencies, even stablecoins that are pegged to the market value of an underlying currency like USDT, a USD-pegged stablecoin.
• Operational and security risks: The technology behind DeFi is still relatively new and can be subject to operational issues and security vulnerabilities. Smart contract bugs and platform exploits can result in significant losses for investors if not adequately addressed. Investors should conduct due diligence on the DeFi counterparty, some of which have excellent track records.
Bridging the Gap: How DeFi is Transforming Trade Finance
DeFi platforms demonstrate the power of blockchain technology to provide secure, transparent and efficient financial services and money transfers for trade finance.
By using alternative data sources such as transaction history and digital footprints instead of traditional credit scores, DeFi platforms enable a wider range of businesses to obtain financing, especially in smaller markets. This inclusive strategy has an impact on economic growth and development.
By tokenizing trade receivables or other assets, DeFi platforms improve liquidity and expand the pool of potential investors. This development helps democratize access to trade finance, allowing investors with smaller amounts of capital to participate.
Finally, DeFi is poised to close the estimated $2.6 trillion trade finance gap faster than traditional methods. Its internet-native framework streamlines processes and removes long-standing barriers, marking a milestone in which digitalization overtakes conventional financial models. The adoption of DeFi could herald a new era where greater financial inclusion and technological innovation converge, profoundly reshaping the dynamics of global trade.
The information provided is for illustrative purposes only and does not constitute investment, tax or financial advice. You should consult a licensed professional for advice regarding your specific situation.
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