The traditional car finance market, which includes loans and leases, is ever growing in size. Research estimates show that the market was $1.29 trillion in 2019. The projections expect it to grow to more than $2.3 trillion by 2027. The growth translates into a double-digit CAGR of 14.3% between 2020 and 2027. Financing companies or specialist car manufacturers provide these loans, distributing them through original equipment manufacturers or OEMs, banks, credit unions, brokers, and other financial institutions. Each of these channels is to grow in size and capability between 2019 and 2027.
DeFi loans stand for decentralized finance loans. The growth of decentralized finance has been even steeper. On January 2, 2020, the DeFi market had a size of US$8.6 billion. Within less than two years, the total USD value locked in DeFi reached nearly 91 billion. While the growth in DeFi loans has been one of the most prominent highlights in the blockchain and cryptocurrency market, the auto market has also come under its purview. To understand how these two lending models compare to each other, we would first have a brief overview of how each of them works.
Traditional Car Financing Models
Secured Vs. Unsecured
Traditional auto loans can be secured or unsecured. In the case of secured car loans, the lender puts a lien on the asset that the borrower is about to buy — the car, in this case. This lien allows the lender to repossess the asset in case the payment is not made as agreed.
Unsecured loans do not keep a provision of repossession if the borrower misses the payment. Although, there are other ways to go after a borrower in case of delinquency. An unsecured loan is beneficial for the borrower in the sense that the borrower does not have to go through the hassle of liens. However, this benefit comes as a trade-off for raised costs and interest rates.
You can take a secured auto loan for a new car or a used car. Usually, the older the car, the higher the interest rate. That way, the newest cars have the lowest rates.
There can be different varieties of secured loans. For instance, balloon loans come with a unique payment structure. It asks for small payments for the first few years of the loan followed by one large payment. Traditional car financing models also help business consumers with their business and fleet auto loans. These business entities may go for commercial truck financing, small business auto loans, or commercial fleet financing. There is also the provision for a home equity line of credit or HELOC. These are home equity loans that one could use to purchase a car. The only risk here is that you put up your house as collateral.
Simple Interest Vs. Precomputed Interest
A simple interest loan in the traditional auto loan scheme of things is where you pay the largest chunk of the interest at the beginning of the loan. The benefit of this category is that the quicker you repay the loan, the less interest you pay.
The precomputed interest loan keeps everything flat. There is no incentive for those who are eligible to pay large chunks at the beginning. The amount of interest you pay remains the same with each payment. The interest amount does not change even when you pay off the loan earlier.
Auto DeFi Loans
A review of traditional car loans shows their benefits as well as their limitations. The processing of these loans involves an intermediary. There is a centralized authority that approves or disapproves these loans, depending on whether it feels the borrower would be able to repay these loans and the availability of the documents.
These centralized authorities can be banks, credit unions, brokers, or other financial institutions. Each one has its rule and non-compliance results in the unavailability of loans.
Decentralized auto loans come in handy here.
Auto DeFi Loans: The Working Model
DeFi loans leverage blockchain technology. And, blockchain is known for its properties of decentralization. The auto DeFi lending platforms offer loans to their members without requiring the presence of an intermediary or a centralized authority like the bank, OEM, or credit unions. These platforms also offer an avenue to purchase cars with crypto, the concept behind Carnomaly’s blockchain startup. On the other end, the person who works as a lender contributes to the platform’s loan pool and gains the interest that otherwise would have gone to the bank. Here the exchanges are peer-to-peer, and the benefits are shared among the lender and the borrower.
The arrival of the Auto DeFi loans (learn how they work here) is beneficial for people who can not access the highly regulated avenues of traditional car loans. The control of the assets that come through the lending avenues and the risks associated with it are shared equally by the lender and the borrower. The power center shifts from the banks, dealers, and brokers onto the holders themselves. Regardless of a person’s financial background and credit history, DeFi auto loans make everyone eligible to raise money for a car purchase.
The Convenience That Comes With Auto DeFi Loans
There is the obvious benefit of DeFi lending lowering the barriers to entry to the traditional financial world that is often controlled by the borrower’s status, wealth, occupation type, affiliations, and several similar factors. Another upside that comes with these benefits and frequently stays under-discussed is the elimination of administrative or fixed costs inherent to the functioning of these institutions.
It also negates the scope varying rates across institutions and volatility in rates within an institution from time to time, and more. The process is transparent, and the authority is on the parties involved in the transaction.
Some platforms also offer the flexibility to choose from a credit-based or an asset-backed loan. With their payment history becoming strong and verified over a period, platforms also allow the lowering of interest rates.
Many crypto holders look for avenues to earn a passive income with their idle holdings. Auto DeFi platforms prove worthwhile in this regard. A holder of crypto assets can easily become an investor by adding his/her assets to the investment pool from which the loans are disbursed. These pools are also known as liquidity pools. Once the borrower pays back with interest, the lender receives his share of the money, along with the interest, in proportion to his/her stake in the pool.
There is also one additional advantage of investing in these crypto liquidity pools. There are lower risk-lending pools where your returns are average. But, if you are into risk-taking, some liquidity pools would bring you higher returns.
While it is true that traditional car financing is still much larger compared to its DeFi counterpart and is evolving with new products and features each day, auto DeFi loans — like those available through CarrDefi — have been a significant disruptor. They have made car financing more transparent and inclusive and transferred greater power in the hands of the participants.
To learn more about our mission to make car-buying with crypto a seamless experience, visit CarrDefi.com.