Unlocking Trillions: The Key to Confidential Lending in DeFi
Despite the recent resurgence of Decentralized Finance (DeFi), most traditional financial capital remains out of reach. According to Jason Delabays, Blockchain ecosystem lead at Zama, the main obstacle is not scalability, regulation, or user experience, but rather the lack of confidentiality. Solving this issue could unlock trillions of dollars in traditional finance. At its peak in December 2021, DeFi’s total value locked (TVL) reached $260 billion, but this number seems small compared to the trillions of dollars traded daily in foreign exchange and the global bond market, which is worth over $130 trillion.
The Limitations of Public Blockchains
For most institutions and high-net-worth individuals, confidentiality is non-negotiable. However, every transaction, loan, and payout on public blockchains is transparent, making it a significant hurdle for serious capital. This level of transparency may appeal to crypto purists, but for traditional finance, it’s a deal-breaker. Recent technical developments, particularly in Fully Homomorphic Encryption (FHE), suggest that confidential lending in DeFi may be closer than it seems.
How FHE Can Revolutionize DeFi
FHE enables the processing of encrypted data without ever decrypting it, allowing sensitive information to remain private during use. This technology can bring institutions to DeFi, enabling them to keep their positions and customer data confidential. Consider non-collateralized lending, which is one of the most significant applications for FHE in DeFi. Traditional finance rarely relies on over-collateralization, but DeFi requires assets to manage risk, limiting its scope. FHE changes the equation, enabling users to borrow without collateral while maintaining confidentiality.
Unlocking New Possibilities
With FHE, institutions can finally enter the on-chain world, evaluating risk and issuing loans without exposing positions or customer data. This type of privacy-preserving lending makes DeFi more flexible, inclusive, and appealing to traditional finance. Uncollateralized loans are just the beginning. By rebuilding the basics of DeFi lending with FHE, we can create a new primitive for lending, enabling private collateral pools, loan-based loans, and maximum extractable value (MEV) protection.
Addressing Design Challenges
While FHE offers tremendous potential, there are design challenges to overcome, such as liquidations, credit systems, and MEV protection. Encrypted values make trigger mechanisms difficult, and FHE-compatible oracles may be necessary to solve these issues. Additionally, structuring encrypted KYC and standard enforcement requirements demands legal and technical expertise. Reconciling confidentiality and accountability is crucial, and MEV protection requires further work to defend against dark patterns.
A New Foundation for DeFi
To solve these challenges, a new foundation for DeFi must be created. This requires addressing liquidations, credit systems, and MEV protection, among other issues. With the rapid advancements in FHE, DeFi efficiency, confidentiality, and real lending on-chain are within reach. As Jason Delabays notes, institutions will not participate if every step is public, and retail users should not have to sacrifice privacy for loans. By overcoming these hurdles, DeFi can unlock trillions of dollars in traditional finance, creating a more inclusive and confidential lending ecosystem.
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