Navigating Student Loan Refinancing in the Blockchain Era

Navigating Student Loan Refinancing in the Blockchain Era

Blockchain News
June 6, 2024 by Editor's Desk
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Student loan debt continues to soar in the US, increasing sharply in recent years to become among the fastest-growing forms of consumer borrowing. The loans continue to appeal to the population because of the proven benefits of a college education, which include increased earning potential and a better career trajectory overall. Bachelor’s degree holders have
Navigating Student Loan Refinancing in the Blockchain Era

Student loan debt continues to soar in the US, increasing sharply in recent years to become among the fastest-growing forms of consumer borrowing. The loans continue to appeal to the population because of the proven benefits of a college education, which include increased earning potential and a better career trajectory overall.

Bachelor’s degree holders have been found to earn an average of 55 percent more versus those armed only with a high school diploma. Pursuing postgraduate education increases earning potential further.

Those holding master’s or higher degrees earn 21 percent more than their bachelor’s degree-holding contemporaries. The double-digit differences in earnings and future opportunities outweigh higher education costs in most cases, despite concerns about a weak job market and lingering debt.

The system supports student loans, as economists see these programs benefit the US economy by maintaining its competitive edge. Nonetheless, there are questions about how far the federal government should get involved as student loans hit a new record high.

In September 2023, federal student loans reached over $1.6 trillion. If you include private loans, total student loans hit $1.7 trillion. Student loan debt exceeds US credit card and total auto loan debt and is second only to home mortgage debt at over $12 trillion.

Apart from applying for student loan forgiveness, what options do students have to alleviate this burden? We look at various ways of refinancing. Traditional lenders may offer student borrowers multiple options to repay their loans.

However, alternative options promise to disrupt the refinancing model altogether. Given the rate of innovation in the fintech space, innovative online platforms and blockchain-powered systems might be the answer.

Blockchain and Student Loan Management

Blockchain is a networked and distributed ledger system that enables decentralized, transparent, and immutable records of transactions. It is borderless and allows participants worldwide to stake, trade, or exchange their assets.

Smart contracts are self-executing programs that automate agreements or contracts between parties. They work like any regular contract, except they don’t need central authorities, legal witnesses, external enforcement mechanisms, or other authority-based proceedings to take effect. They rely on code. Smart contract transactions are executed automatically once the conditions of the blockchain contract are met.

Moreover, the parties don’t need to know each other. Blockchain enables trustworthy agreements without the need for knowledge of the other party or trust as defined in conventional contracts. It uses a code to verify eligibility.

Applied to loans, blockchain technology and smart contracts can provide several advantages. Technology can revolutionize how student loans are originated, serviced, and repaid in loan management.

With less need for user verification and documentation, blockchain technology could speed up the application and origination process. Traditional loan management systems can be cumbersome and low, involving manual processes and multiple intermediaries. With blockchain, the application and origination process could be streamlined and verified by confirming the borrower’s ability to provide collateral.

Blockchain can automate loan disbursements, enforce repayment schedules, and facilitate loan refinancing with minimal human involvement. It can also make the entire process more transparent.

As everything is recorded on a public immutable ledger, borrowers can view a clear record of their loan terms, agreed repayment schedules, and interest rates. Transparency can also build greater trust between lenders and borrowers.

DeFi as an Alternative Means of Repayment

DeFi stands for decentralized finance. It is a new concept in financial technology, developing new financial ecosystems on the blockchain.

Its purpose is to provide transactional models beyond centralized financial institutions like banks and offer access to novel financial services with the power of blockchain technology and smart contracts.

Smart Contract Types in DeFi

Several types of smart contracts exist in DeFi. Each is meant to cater to a specific function, financial service, or application. These types of smart contracts include:

Lending and borrowing contracts

Lending and borrowing contracts facilitate P2P or peer-to-peer lending and borrowing, negating the need for traditional intermediaries. These contracts define the terms set between users or lenders and borrowers. The agreement may include collateral requirements, interest rates, and other vital conditions. These smart contracts facilitate the automated execution of the loan agreement.

Popular DeFi platforms like Aave and Compound utilize such contacts to allow users to avail of DeFi loans.

Yield farming contracts

Contracts for yield farming manage reward distribution in DeFi protocols. They facilitate the complex mechanisms involving user participation in a platform or protocol’s liquidity pool.

Some platforms apply smart contracts to optimize yield farming strategies across different DeFi protocols.

DEX (Decentralized Exchange) smart contracts

The smart contracts behind decentralized exchanges or DEXs compete with centralized exchanges for users. They allow participants to trade or swap crypto directly without needing a centralized exchange to hold their crypto in company-owned wallets.

DEX smart contracts manage exchange functions like order matching, fund custody, and trade settlement but do it in a way that is automated, trustless, and independent of a central authority.

Insurance smart contracts

In DeFi, it is possible to secure your funds with blockchain-based insurance. DeFi insurance smart contracts protect against financial, security, and protocol risks. Such contracts are built to define insurance policy and premium payment terms and facilitate automated payouts in covered events.

These types of smart contracts may play a role in blockchain loans, especially lending and borrowing contracts.

How Blockchain Redefines Student Loans

While it has immense potential, blockchain remains an experimental alternative for paying off student debt. Nonetheless, some students are already using it in ingenious ways to help repay their debts.

 

If you already own crypto, the most straightforward way is to take out a loan through a DeFi lending platform and use it to pay off federal or private student loans. Similar to what you do in conventional refinancing, you can pay off the new DeFi loan with new terms, which should ideally be more flexible with lower interest rates.

How Blockchain Redefines Student LoansPhoto by Traxer on Unsplash

 

Instead of selling crypto gains or assets to pay student loans and incurring taxes on your profits, you can opt for a DeFi loan, pay your student loan, and pay your new DeFi collateralized loan in crypto.

Some advantages of DeFi loans include lower interest rates and independence from the conventional banking system. Moreover, because it doesn’t reflect on your banking and credit record, a DeFi loan cannot impact your credit score.

To provide collateral for DeFi loans, you must be familiar with crypto and own enough to front as a guarantee. The collateralized crypto will be held in a smart contract until the obligation is paid. Note that DeFi loans are usually overcollateralized. This mechanism is in place to cushion the volatility in crypto markets.

The lending platform sets the percentage of overcollateralized assets needed for the loan. After the DeFi loan is approved, the borrower receives the amount in stablecoins. These stablecoins are exchanged for US dollars to pay for the student’s federal or private loans.

DeFi loans could lower the cost of borrowing or extend the loan term, depending on the user’s needs.

However, these loans have their downside. One of the most significant risks to the borrower is when the crypto drops below the loan value. This event triggers liquidation in the smart contract. Other risks involve the security of the issuing platform. Users must screen for the most trusted and robust platforms to ensure the security of their crypto assets.

Fintech-based Refinancing Options

While blockchain remains a nascent technology for refinancing student loans, fintech has evolved to maturity and provides excellent solutions for those seeking assistance with student loans.

Fintech apps and platforms already provide well-designed solutions for student loan refinancing. SoFi, for instance, offers competitive fixed rates, zero fees, and budget-friendly terms. Because of the lower overhead of running a digital business, online lending platforms can afford to remove origination fees and other costs associated with traditional systems.

The innovative culture in fintech services means apps constantly improve their user experience, making it faster to assess your credit status and secure a loan. Better terms, especially lowered interest rates, reduce the overall cost of a loan.

Seek Out Alternative Platforms for Better Student Loan Terms

The consequences of high student debt extend beyond the individual borrower. The burden of this debt can prevent graduates from exploring all the opportunities available, such as launching their businesses, investing in appreciating assets like property, and building their net worth.

Furthermore, this economic restraint also has the potential to impact the broader economy, slowing growth. Students must explore novel solutions.

Addressing the student loan crisis may require a multifaceted approach. For individuals, it will require resourcefulness and strategic planning. Exploring innovative financial models, alternative platforms, and emerging technologies like blockchain can provide new pathways to pay off student loan debt faster and cheaper.