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Cryptocurrency, its creators believed, could help usher in a new financial system that undermined central banks and national governments while protecting consumer privacy by anonymizing transactions.

So far, cryptocurrencies have failed to come anywhere close to widespread consumer adoption for payments.

Small progress is being made, however. For instance, it is now possible to borrow bitcoins through a process known as “decentralized lending,” RBC’s Mitch Steves writes, using a so-called smart contract.

A smart contract is effectively a way to build the enforcement or performance of a financial contract onto blockchain. The idea is that by building the contract’s elements into blockchain, only the two parties to the contract are required to execute, complete and eventually, terminate the contract. In other words, there is no bank or other middleman.

For instance, in the example of a loan, a smart contract would automatically disperse the funds to the borrower, make adjustments to the terms if the value of the collateral shifted, acknowledge that the borrower had made payments and wind up the contract when the loan had been paid back.

Steves laid out the steps to make a decentralized loan using one specific app, called MakerDAO that uses the Ethereum blockchain. To start, an individual buys Ethereum and that is used as collateral for a loan with a value that can’t exceed a 150% collateral-to-loan ratio. The smart-contract element of the deal comes into effect if the value of the collateral drops so much that the loan exceeds that ratio. If that happens, the Ethereum in the account is automatically sold to pay off the debt, a mechanism that functions somewhat like a margin call. The borrower holds on to the loan but loses collateral.

The loan itself comes in the form of a stable coin called Dai, which trades very close to, but not exactly at, one-to-one with the U.S. dollar.

Why would anyone do this? Steves points out one obvious use: to lever up and use cryptocurrency gains to invest elsewhere. Or, in a more novel strategy, he notes that it could be used to reduce tax liabilities. A loan, would not, he notes, trigger a taxable event, so “if a successful cryptocurrency investor has [$1 million] in taxable gains, this could be loaned out instead of sold to avoid paying taxes.”

Write to Ben Walsh at ben.walsh@barrons.com