Opinion by: Jason Delabays, blockchain ecosystem lead at Zama
Even with the recent revival of decentralized finance (DeFi), a significant portion of capital in traditional finance remains inaccessible. Many attribute this to scalability issues, regulatory constraints, or poor user experiences. However, the fundamental obstacle lies in a lack of confidentiality. Addressing this could unlock trillions.
During its peak in December 2021, DeFi’s total value locked (TVL) soared to an impressive $260 billion. Yet, when viewed against the backdrop of the global financial system, this amount appears minuscule, especially as trillions are transacted each day. The foreign exchange market alone trades over $7.5 trillion daily, with the global bond market valued at over $130 trillion.
Since the crash of 2022-2023, DeFi has rebounded. Lending protocols have demonstrated resilience, and TVLs are on the rise again. Nevertheless, DeFi remains at the fringes of global capital, not due to scalability issues, but because it lacks a key component that traditional finance requires.
The encryption technology is lowering the highest hurdle
For many institutions and high-net-worth individuals, confidentiality is a must. Every transaction—deposits, loans, and withdrawals—is visible on public blockchains. While this level of transparency may excite crypto enthusiasts, it poses a major issue for serious investors.
Consequently, for many, realizing the full potential of DeFi—seamless, open, institutional-grade finance—feels like a distant dream. However, recent advances in Fully Homomorphic Encryption (FHE) indicate that this reality may be nearer than anticipated.
Having gained traction in mainstream discussions, FHE is no longer a mere academic concept.
This privacy-preserving technology allows data to be processed without ever requiring decryption. Sensitive information stays encrypted, even while being utilized. This enables institutions to engage in DeFi while keeping their trades and positions private.
Uncollateralized lending and beyond
Take uncollateralized lending, which stands out as one of the clearest applications of FHE in DeFi, mirroring the credit processes of traditional finance. While conventional finance rarely relies on overcollateralization, DeFi typically does, requiring assets to be locked up to mitigate risk, thus limiting its reach.
FHE transforms this landscape. Here’s how it could function: A user first shares encrypted credit or Know Your Customer (KYC) information with a protocol. A smart contract then verifies this data using FHE—for instance, by asking, “Is their credit score above 700?”—without ever revealing any decrypted information. If the verification succeeds, the user can borrow without needing collateral, ensuring confidentiality. In cases of default, the lender might be granted the right to decrypt specific data to pursue legal actions offchain.
In either scenario, institutions can evaluate risks and extend credit within the onchain environment without exposing their positions or customer information.
This type of privacy-centric lending enhances DeFi’s adaptability and inclusivity, aligning it more closely with traditional finance. Uncollateralized lending is merely the beginning. By leveraging FHE, we could fundamentally reinvent the landscape of DeFi lending itself.
Imagine modern protocols being reconstructed with confidential ERC-20s at the foundation. Encrypted credit scores, concealed loan amounts, and protection from maximal extractable value (MEV) could then be layered on top. This move wouldn’t just be an upgrade—it would establish a new fundamental approach to lending.
Related: SingularityNET and Mind Network introduce encryption for AI agents
For institutions, this shift could create private collateral pools where details remain confidential and credit-based lending becomes an option. Retail users would be able to access loans without collateral, shielded from front-running and MEV bots. For lending protocols, this presents a route to evolve into confidentiality-focused systems capable of scaling to trillions without sacrificing trustlessness.
While public blockchains traditionally excel at openness and interoperability, private blockchains have provided enhanced confidentiality, making them appealing for data-sensitive institutions. With FHE, public blockchains can achieve the same level of confidentiality without sacrificing their inherent strengths.
Challenges to address, yet no reason to abandon hope
While all this sounds promising, if DeFi is truly going to expand and tap into the trillions still unreachable within traditional finance, more than just private credit assessments and confidential lending pools is necessary. A brand new foundation needs to be established, and multiple design challenges must be addressed first, such as those related to liquidations. Encrypted values complicate protective measures. FHE facilitates comparisons, but discreet notifications for liquidators may require encrypted events or offchain communications.
Credit systems introduce another layer of complexity. Structuring encrypted KYC processes and enforceable defaults necessitates legal and technical harmony; achieving a balance between confidentiality and accountability is crucial.
The need for MEV protection also requires additional attention. While concealing transaction amounts is a good starting point, combining encrypted figures with batch processing or time-locks can further obscure patterns to provide comprehensive defense.
Additionally, liquidity becomes a factor; cWETH diverges from Wrapped Ether (WETH), yet yield incentives or seamless wrappers could help mitigate this issue. From a user experience perspective, decryption processes must be made wallet-friendly.
Finally, oracles present a distinct challenge. While public pricing may hint at certain values, FHE-compatible oracles could provide solutions later on.
None of these hurdles are insurmountable; rather, they are challenges to be resolved. Until these issues are addressed, DeFi’s complete potential remains untapped. Institutions are unlikely to engage if every transaction is public, and retail users shouldn’t need to sacrifice privacy or overcollateralize to secure credit. With rapid advancements in FHE, the combination of DeFi efficiency, Swiss-bank-level confidentiality, and real-world credit— all onchain—may soon be attainable.
Opinion by: Jason Delabays, blockchain ecosystem lead at Zama.
This article is for general informational purposes only and should not be perceived as legal or investment advice. The opinions expressed here are solely those of the author and do not necessarily represent the views of Cointelegraph.
