One of DeFi’s original promises was finance without intermediaries. For overcollateralized lending, that promise largely held. For undercollateralized credit, the kind that funds real businesses, it did not. Protocols that tried to lend without collateral kept rebuilding the functions that banks and intermediaries perform.
Why overcollateralized lending needs no intermediary
When every loan is backed by more collateral than it lends, the protocol never needs to know who the borrower is. If the borrower disappears, the code sells the collateral. That is why DeFi lending pools can run permissionlessly.
What changes without collateral
Remove the collateral and the lender suddenly needs answers to traditional questions: who is the borrower, can they repay, and what happens if they do not? Answering them requires functions that smart contracts cannot perform alone:
- Underwriting: assessing financial statements and repayment capacity.
- Identity and compliance: KYC and KYB checks to know who is borrowing and lending, and to meet anti-money laundering rules.
- Legal recourse: enforceable claims on assets if the borrower defaults.
- Onboarding: helping non-crypto businesses handle custody and conversion between stablecoins and local currency.
How hybrid lending protocols work
Several protocols that started as fully on-chain, undercollateralized lenders later added off-chain layers to make credit work. The most common changes are:
- A focus on real-world businesses with recurring short-term liquidity needs, such as trade finance and revenue-based financing providers.
- KYC or KYB-gated pools that limit participation to verified lenders and borrowers.
- Legal structures such as special purpose vehicles that give lenders a claim on assets if a borrower defaults, often overseen by a security agent.
- Third-party underwriting and credit scoring of borrowers.
- Onboarding services that handle custody and conversion between stablecoins and local currency for non-crypto businesses.
The broader lesson
On-chain credit did not eliminate intermediaries. It changed what they do. Blockchain handles funding, settlement and transparency; underwriters, legal structures and compliance handle credit risk. Today’s larger on-chain private credit platforms follow a similar hybrid model. Read more in our on-chain credit overview and the evolution of private credit.
