Confidential Lending Will Unlock Trillions for DeFi Markets

Opinion by: Jason Delabays, blockchain ecosystem lead at Zama

Despite decentralized finance’s (DeFi) recent resurgence, most capital in traditional finance remains out of reach. Most will blame scalability, regulation or poor UX. The real blocker is far more fundamental: a lack of confidentiality. Solve that, and trillions will be unlocked. 

At its December 2021 peak, DeFi’s total value locked (TVL) hit an incredible $260 billion. Zoom out, however, and that figure starts to feel small, especially when the global financial system moves trillions every day. Foreign exchange alone sees over $7.5 trillion traded daily, and the global bond market’s worth more than $130 trillion.

DeFi has bounced back since the 2022-2023 crash. Lending protocols have shown staying power, and TVLs are rising again. DeFi is still, however, only scratching the surface of global capital, not because it can’t scale, but because it lacks something traditional finance can’t live without.

The encryption tech is pulling down the tallest hurdle 

For most institutions and high-net-worth players, confidentiality is non-negotiable. Every deposit, loan and withdrawal is, however, out in the open on public blockchains. That level of transparency might thrill crypto purists, but for most serious capital, it’s a Kdealbreaker.

That’s why, for so many, the thought of unlocking DeFi’s promise — frictionless, open, institutional-grade finance — still seems distant. Recent tech developments, specifically in Fully Homomorphic Encryption (FHE), suggest that reality may be closer than it looks.

Having gained more mainstream attention, FHE is no longer just an academic curiosity. 

Privacy-preserving technology enables data to be processed without ever decrypting it. Sensitive information remains encrypted even while in use. Institutions can be brought into DeFi to keep their trades and positions private.

Uncollateralized lending and beyond

Consider uncollateralized lending, as it is arguably one of the clearest use cases for FHE in DeFi and mirrors how most credit works in traditional finance. While traditional finance rarely relies on overcollateralization, DeFi does, locking up assets to manage risk, which limits its scope.

FHE changes the equation. Here’s how it could work: Firstly, a user shares encrypted credit or Know Your Customer (KYC) data with a protocol. A smart contract then checks that data using FHE — for example, asking, “Is their credit score above 700?” — all without ever decrypting it. If approved, the user can borrow without putting up collateral and confidentiality holds. If they default, the lender may gain the right to decrypt specific data to take legal action offchain. 

Either way, institutions assessing risk and issuing credit can finally step into the onchain world without revealing positions or exposing client data.

This kind of privacy-preserving lending makes DeFi more flexible, inclusive and aligned with traditional finance. Uncollateralized lending is just the start. One can go further with FHE, rebuilding the foundations of DeFi lending itself.

Let’s consider taking today’s leading protocols and rebuilding them with confidential ERC-20s at the core. Now layer on encrypted credit scores, hidden loan amounts and maximal extractable value (MEV) protection. This isn’t just a feature upgrade — it’s a new primitive for lending.

Related: SingularityNET and Mind Network bring encryption to AI agents

For institutions, it would lead to private collateral pools where positions remain confidential, with the option for credit-based lending. Retail users could access loans without collateral, shielded from front-running and MEV bots. For lending protocols, it would offer a pathway to evolve into confidentiality-first systems that can finally scale to trillions without compromising trustlessness.

Public blockchains have always been better than private blockchains when it comes to openness and interoperability. Private chains have, however, traditionally offered stronger confidentiality, making them more attractive to institutions that need to keep data private. With FHE, public blockchains can match private chains on confidentiality without giving up their core strengths.

Challenges to solve, but no reasons to give up

All of the above sounds great, but if DeFi is genuinely going to scale and bring in the trillions still stuck in traditional finance, more than just private credit scores and confidential lending pools are needed. An entirely new foundation must be created, and there are several design challenges to tackle first, such as liquidations. Encrypted values complicate triggers. FHE supports comparisons, but notifying liquidators discreetly might need encrypted events or offchain relays.

Credit systems are another area of complexity. Structuring encrypted KYC and default enforcement needs legal and technical alignment; the challenge is balancing confidentiality and accountability.

MEV protection also demands further work. Hiding transaction amounts is a good start, but pairing encrypted amounts with batching or time-locks to further obscure patterns may be needed to fully defend.

Liquidity is affected, too; cWETH splits from Wrapped Ether (WETH), but yield incentives or seamless wrappers could bridge this gap. From a UX standpoint, decryption tools must be wallet-simple.

Finally, oracles pose a unique problem. Public prices might hint at values, but FHE-compatible oracles could solve this later.

None of these are dealbreakers, simply puzzles. They must be solved before DeFi’s full potential is reached. Institutions won’t show up if every move is public, and retail users shouldn’t need to give up privacy or overcollateralize to get credit. With developments in FHE moving fast, perhaps DeFi efficiency, Swiss-bank confidentiality and real-world credit — all onchain — is almost within reach.

Opinion by: Jason Delabays, blockchain ecosystem lead at Zama.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts, and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.