Hey Lykkers! Let’s play a quick word association game. I say “get a loan,” you probably think: banks, credit scores, paperwork, waiting, anxiety. That whole stressful routine can feel baked into the process. But what if the future of lending has nothing to do with a branch manager or a traditional credit score?

Now imagine a system where borrowing can be automated, secured by digital collateral, and executed by software rules rather than human approvals. This is the decentralized, algorithmic direction finance has been exploring—where lending can run continuously, with transparent rules and real-time updates.

Goodbye middlemen, hello self-executing code

At the core of this shift is the smart contract: self-executing code recorded on a blockchain. In conventional lending, a lender evaluates risk, holds collateral, and releases funds. In the decentralized model, those steps can be encoded so that collateral, borrowing limits, interest calculations, and repayments are handled automatically based on predefined conditions.

Instead of submitting an application, a borrower can deposit digital collateral into a shared pool. The system can then allow borrowing up to a set percentage of that collateral’s value. Pricing can adjust dynamically depending on supply and demand in the pool, meaning borrowing costs can rise or fall as liquidity changes.

The central tension: over-collateralization

Here’s the twist: these loans often require you to lock up more value than you borrow. On its face, it can sound counterintuitive. But over-collateralization solves a core challenge of digital lending: trust without identity. The system doesn’t need to “know” the borrower. It only needs to know the loan is protected by collateral that can be liquidated automatically if risk increases.

That mechanism can make the structure resilient for lenders, but it also limits who benefits most. It can be less useful for someone trying to borrow without assets, and more useful for someone seeking liquidity without selling long-term holdings.

When automation turns harsh

Automation is efficient, but it can also be unforgiving. If collateral prices fall quickly, an account can approach liquidation thresholds in minutes. As Alfred Lehar, a finance researcher, writes, “This contagion leads to negative feedback loops: loans are liquidated which leads to downward price pressure on collateral and more loans are then liquidated.”

In other words, forced selling can push prices down further, triggering more liquidations in a chain reaction.

Security is another core risk. Smart contracts can contain bugs, and attackers may exploit weaknesses through complex transaction structures. When issues happen, the experience can look very different from traditional finance: there may be no support desk to call, and recovery may depend on technical responses rather than customer protections.

A hybrid horizon

The likely future isn’t a simple replacement of one system by another. Instead, lending may move toward hybrid models: traditional institutions adopting blockchain-based settlement tools, and regulated digital systems combining automation with identity checks to support more flexible underwriting. Meanwhile, tokenized claims on real-world value (such as invoices or property-linked instruments) may expand the kinds of collateral that can be used in digital markets.

Ultimately, the promise is clear: more transparent rules, faster execution, and broader access where infrastructure allows. The tradeoff is equally clear: users must understand collateral risk, liquidation mechanics, and smart-contract security before treating these tools as everyday finance.