The proliferation of DeFi is nothing to brush off. Over the past year we’ve seen explosive growth in all sectors within the decentralized financial space. From permissionless lending markets to derivatives, DeFi has amassed hundreds of millions of dollars in capital. However, relative to the legacy financial system, the current state of DeFi is just a single drop in an absolutely massive ocean of global wealth and value.
According to estimates, the global bond market now exceeds $100 trillion. The global stock market sits at around $64 trillion. According to the most recent data from the Bank for International Settlements (BIS), the total derivatives market is an estimated $542.4 trillion in notional value of outstanding contracts. While this number is significantly higher than the bond or equities market, the gross market value of all contracts is estimated to be much less – approximately $12.7 trillion.
It goes without saying that legacy capital markets are extremely large. As it stands today, the total crypto market cap is just over $300 billion. Not bad but still moderately smaller than legacy capital markets. For many crypto advocates in the space, disrupting legacy capital markets is the driving goal behind the movement. But, in order to disrupt these markets, it will take massive amounts of infrastructure which will likely the majority of the next decade.
In the short term, DeFi will likely need to attract more niche markets within the financial products space. One rising sector is peer-to-peer lending. Given that blockchain technology emphasizes peer-to-peer interactions and the massive growth in the DeFi lending sector, this niche is the perfect fit for DeFi to tap into.
Peer to Peer Lending
The market for personal loans and peer-to-peer loans is small compared to most financial products but is still rather large with respect to the crypto markets. According to Allied Research, the Peer to Peer (P2P) Lending Market is projected to grow at an explosive CAGR of 51.5% from 2016 to 2022 with the total market expected to reach $460 billion dollars by 2022. In comparison, the explosive growth in the cannabis markets in North America is projected to have a CAGR of only 26.3% by 2025.
P2P loans are loans that individuals and investors make—as opposed to loans that come from traditional banks or credit unions. Existing P2P services use a central marketplace matching lenders and borrowers for a wide range of reasons. Typically, P2P lending can be used for:
- Consumer credit loans
- Small business loans
- Student loans
- Real Estate loans
Currently, these systems exist in a centralized fashion with rent-seeking middlemen providing the software for this service. However, by cutting out profit-driven companies and replacing it with open-source protocols, lenders and borrowers could receive better rates than the existing alternatives. As an example, Zopa is a centralized peer-to-peer lending service with APR rates for personal loans ranging from 3.3% to 34.9%.
On the flip side, Compound is a decentralized lending platform where you can currently borrow Ether at a slim APR of 2.20%, without an application or approval process. Other alternatives include borrowing Dai for loftier rate of 18.45%. Even though the rate for borrowing Dai and other stablecoins is rather high, it’s still lower than most credit card APRs.
Drawbacks
Unfortunately, the biggest drawback when leveraging decentralized lending platforms is the need to over-collateralize your loan. This becomes extremely hard when you’re looking to borrow large amounts of money or simply don’t have to capital in the first place to collateralized (which tends to be the driving reason for borrowing the first place). This becomes more clear when looking to purchase real estate, pay your university’s tuition, or jumpstarting your business.
Regardless, as the DeFi lending space matures we hope that these drawbacks will diminish as more alternatives emerge.
Potential of Crypto Peer to Peer Lending
With P2P lending on course to become a $460 billion dollar industry in the next few years, DeFi is in the perfect position to capture a sliver of this market. The current size of the DeFi lending space in total locked value (TVL) is sitting around $400M – a mere 0.08% of the potential market in 2022.
Let’s hypothesize and assume that DeFi begins to draw larger amounts of attention from the peer-to-peer lending space in the next 3 years, ultimately capturing 5% of the $460 billion market and resulting in $23 billion in TVL. This would nearly exceed Ethereum’s current market cap of $24.6 billion as of writing.
The leading DeFi lending platforms, Compound, InstaDapp and Maker would have plenty of room to grow if this was the case and they maintained their growth rates. Assuming MakerDAO and Dai continue to hold its reign, Maker would likely capture a majority of the market. For the sake of this article, let’s assume that the lending space continues to be dominated by these three players through 2022. With that, the current % dominance of each player is as follows:
Current Lending TVL
| Name | TVL | Percentage |
|---|---|---|
| Maker | $311.80M | 64.04% |
| Compound | $100.80M | 20.70% |
| InstaDapp | $30.80M | 6.33% |
| Others | $43.50M | 8.93% |
| Total | $486.90M | 100% |
According to the fat protocol thesis and the importance that Dai currently plays in DeFi, we can assume that Maker, the driving protocol behind Dai, will continue to have dominance in the lending space through 2022. At the same time, it would also be safe to assume that with more and more applications arising, Maker may lose a small slice of its current 70% dominance in the coming years. Let’s assume it drops down to 60%.
With all of these estimates in mind, our $460 billion total addressable market capturing 5% of the market results in $23 billion in projected total locked value in the lending sector.The napkin math results in the lending space would look something like this in the coming years:
Estimated
| Name | Estimated Percentage TVL | Estimate TVL by 2020 (in Millions) | TVL Growth Rate |
|---|---|---|---|
| Maker | 60% | $13,800 | 4325.91% |
| Compound | 22.5% | $5,175 | 5033.93% |
| InstaDapp | 7.5% | $1,725 | 5500.65% |
| Others | 10% | $2,300 | 5187.36% |
| Total | 100% | $23,000 | 4623.76% |
It becomes fairly clear that even capturing a small section of the potential market would drastically grow the lending space, and DeFi as a whole.
Conclusion
Looking at the broader market, it goes without saying that DeFi has the potential to tap into multi-trillion dollar industries. However, even taking a small niche within the financial sector and having the ability to capture a sliver in the market spurs drastic growth in the current DeFi landscape.
As mentioned above, the biggest drawback as of now is the dependency for over-collateralized debt positions in order to successfully access lending markets. With that said, users are not burdened with the lengthy application process, rely on central institutions to disburse the loan and in recent developments, have little chance for their personal data to be compromised.
Analyst at Bankless – one of the leading resources for open finance. Lucas is an active contributor to the DeFi ecosystem with appearances in other notable DeFi outlets including The Defiant and Our Network. He has years of experience working with dozens blockchain and token startups where he focused on token economics, marketing, and growth.