Opinion by: Jason Delabays, blockchain ecosystem lead at Zama
Despite the recent revival of decentralized finance (DeFi), significant capital in traditional finance is still inaccessible. While many cite scalability, regulation, or subpar user experience as the culprits, the real issue is much more fundamental: a lack of confidentiality. Address this, and trillions could be unleashed.
At its peak in December 2021, DeFi’s total value locked (TVL) reached a staggering $260 billion. However, when viewed from a broader perspective, this amount appears minor, especially considering that the global financial system transacts trillions daily. The foreign exchange market alone witnesses over $7.5 trillion in trades every single day, and the global bond market is valued at more than $130 trillion.
Following the crash between 2022 and 2023, DeFi has rebounded. Lending protocols have demonstrated resilience, and TVLs are on the rise once more. However, DeFi is still only beginning to tap into the vast pool of global capital—not due to scalability issues, but because it lacks a critical component that traditional finance relies on.
The encryption technology lowering the biggest barrier
For most institutions and high-net-worth individuals, confidentiality is essential. Every deposit, loan, and withdrawal is publicly visible on blockchains. Although this transparency may excite crypto enthusiasts, it is a dealbreaker for serious capital holders.
That’s why many believe the promise of DeFi—offering seamless, open, institutional-grade finance—still seems far off. Recent advancements in technologies like Fully Homomorphic Encryption (FHE) indicate that this dream might be closer than anticipated.
FHE has gained notable attention and is no longer just an academic concept.
This privacy-preserving technology allows data to be processed without decryption, keeping sensitive information secure even during use. This means institutions can engage in DeFi without revealing their trades and positions.
Uncollateralized lending and beyond
Take uncollateralized lending, which is arguably one of the most significant applications for FHE in DeFi, reflecting how credit functions in traditional finance. Whereas traditional finance seldom depends on overcollateralization, DeFi does, requiring assets to manage risk, which restricts its capabilities.
FHE alters this dynamic. Here’s a potential workflow: A user provides encrypted credit or Know Your Customer (KYC) data to a protocol. A smart contract then verifies that data using FHE—asking questions like, “Is their credit score above 700?”—without ever decrypting it. If approved, the user can borrow without collateral, and confidentiality is maintained. In case of default, the lender could gain the rights to decrypt certain data for off-chain legal action.
In any scenario, institutions assessing risk and issuing credit can finally enter the on-chain arena without disclosing positions or exposing client information.
This privacy-centric lending model makes DeFi more adaptable, inclusive, and in alignment with traditional finance. Uncollateralized lending is just the beginning. The potential of FHE can fundamentally reconstruct DeFi lending.
Imagine today’s leading protocols rebuilt with confidential ERC-20s at the core, combined with encrypted credit scores, hidden loan amounts, and protections against maximal extractable value (MEV). This isn’t merely an upgrade; it represents an entirely new lending paradigm.
Related: SingularityNET and Mind Network introduce encryption for AI agents
For institutions, this could create private collateral pools where positions remain confidential, alongside options for credit-based lending. Retail users could secure loans without collateral, shielded from front-running and MEV bots. For lending protocols, this offers a route to evolve into confidentiality-first systems that can finally scale to trillions while maintaining trustlessness.
Public blockchains have always excelled in terms of openness and interoperability compared to private blockchains. However, private chains have traditionally provided better confidentiality, making them more appealing to institutions that require data privacy. With FHE, public blockchains have the potential to achieve the same level of confidentiality as private ones without sacrificing their inherent advantages.
Challenges to overcome, but no reasons to relent
While all of the above sounds promising, if DeFi is ever going to scale and attract the trillions still trapped in traditional finance, more than just private credit scores and confidential lending pools are necessary. A completely new foundation must be built, and there are several design challenges to address first, such as liquidation triggers. Encrypted values complicate these mechanics. While FHE supports comparisons, private notifications for liquidators may require encrypted events or off-chain relays.
Credit systems introduce further complexities. Structuring encrypted KYC and enforcing defaults needs both legal and technical alignment; the challenge lies in balancing confidentiality with accountability.
MEV protection also requires additional focus. Concealing transaction amounts is a good starting point, but pairing encrypted amounts with batching or time-locks to further obscure patterns may be essential for complete defense.
Liquidity will be impacted as well; cWETH may split from Wrapped Ether (WETH), yet yield incentives or seamless wrappers could help bridge this divide. From a user experience standpoint, decryption tools must be straightforward.
Finally, oracles present a unique issue. Although public prices can hint at values, FHE-compatible oracles can potentially address this challenge later.
None of these hurdles are insurmountable; they are simply puzzles to be solved before DeFi’s maximum potential is realized. Institutions will hesitate to participate if every transaction is public, and retail users shouldn’t be forced to relinquish privacy or overcollateralize to obtain credit. With rapid advancements in FHE, the convergence of DeFi efficiency, Swiss-bank confidentiality, and real-world credit—all on-chain—may soon be within reach.
Opinion by: Jason Delabays, blockchain ecosystem lead at Zama.
This article is for general informational purposes and is not intended to be, nor should it be seen as legal or investment advice. The views, thoughts, and opinions expressed here are solely those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
