DeFi's holy grail of lending: underfunded mortgages

原文标题：《 不足额抵押贷款：DeFi 借贷的下一个圣杯 》

原文来源： W3.Hitchhiker

Under the narrative of "real rate of return", insufficient mortgage loan income is increasingly studied and sought after in DeFi. Recognizing that existing crypto media coverage of this topic has been excellent, we at Treehouse Research also wanted to share our thoughts on a few different perspectives.

In this article, we'll first look at what credit is and why it matters to the economy and business. Then, research the popular DeFi credit agreements and their advantages and disadvantages compared to TradFi/CeFi lending. We will summarize a few points that we believe are critical to the next stage of DeFi credit market growth.

Credit: The modern way of borrowing money

Lending is one of the oldest social and economic behaviors in human society, dating back to ancient Mesopotamia. Loans began in ancient times as pawnbrokers. They were simply loans secured by items considered valuable. Early forms of credit arose because resource owners lent productive materials to working workers in the expectation of repaying the goods. If the borrower does not pay, his family risks being used as slaves.

Credit is now important for businesses and the economy as a whole because it allows economic units to raise working capital without diluting equity. This leverage leads to increased investment, capital expenditure and consumption, which leads to rapid economic growth.

In TradFi, credit can usually be divided into secured loans and unsecured credit loans. A mortgage is a secured credit because the loan is secured against property. Credit cards are a type of unsecured credit, or they can be viewed as collateral against the creditworthiness of the borrower. Credit creation means balance sheet expansion. In a typical mortgage, for example, the buyer makes a down payment of 10-50% of the market value of the property and financing the rest from a bank. The difference between the property value and the down payment is credit created by commercial banks. In the grander scheme, the Fed buys US Treasuries, which is the act of borrowing from the US federal government - credit created by the Federal Reserve (the central bank) to sovereign countries (governments).

In contrast, most of the existing lending agreements in DeFi are based on excess collateral, similar to the pawnshop approach to lending, which does not involve the creation of credit. If Elon Musk had to put down $1 billion worth of Tesla stock to borrow $500 million to buy a villa, that would be equivalent to an excess mortgage in DeFi -- not very attractive to someone who already has $1 billion, Because he could easily find a bank willing to lend him US$10B.

Credit as a financing channel for enterprises

Traditional enterprises have two financing methods: debt financing and equity financing. Equity financing involves diluting ownership, which founders avoid, especially in the early stages, to avoid losing equity upside. Equity financing does not create credit because companies sell "a piece of themselves" for cash.

In order to maintain majority control over their operations and business decisions while raising working capital, companies opt for debt financing. Debt financing creates credit because lenders provide cash or other working capital in exchange for future repayment of principal plus interest, rather than a controlling stake. Lenders also avoid equity risk because they have claims on borrowers' assets, while equity holders do not. This form of financing or loan is usually provided after the business or company has managed to clear all the demands made by the financial institution.

What prevents credit creation in DeFi?

As mentioned earlier,DeFi lendingIt still largely follows the old pawnshop model, in which borrowers put down something of value as collateral and then withdraw cash that is less than or equal to the value of the collateral. This is ultimately because DeFi lending agreements are permission-free, which is procedurally efficient and does not bias any borrower. However, this hinders the pre-loan credit check and Know Your Customer (KYC) procedure that is usually done before the credit is initiated in the TradFi world. Because mainstream DeFi lending agreements are unable to know the true identity of borrowers and assess their credit risk, they have to over-pledge to ensure lenders remain intact at all times.

Excess mortgages provide the financial sector with many trading and hedging strategies. Because they do not create credit, their use case in non-financial businesses is limited, since only asset owners can borrow and the poor cannot leverage up. Even for asset owners, there are more effective ways to leverage than engaging in DeFi lending. For example, someone with $10 million worth of crypto assets might be able to borrow $20 million from a CeFi agency that performs KYCs and credit checks. In essence, the core DeFi principle of not needing permission prevents the growth of the DeFi lending market.

The emerging DeFi credit agreement

Currently, as of December 5, 2022, the cumulative DeFi borrowing agreementTVLIs US$13.96B, with monthly borrowing over the past year ranging from US$9.37B to US$32.46B. While this figure has held steady even during the recent market contraction, the size of the money market is still dwarfed by the TradFi market.

The size of the credit market in TradFi is about $91T, larger than the TradFi stock market and DeFi money market. This is largely due to inefficient capital and a lack of means to assess and price DeFi credit risk.

The introduction of credit agreements into the DeFi sector has attracted keen interest from institutional borrowers and lenders, especially at a time when liquidity has been drained from the global financial system by central banks.

The size of the credit market in TradFi is about $91T, larger than the TradFi stock market and DeFi money market. This is largely due to inefficient capital and a lack of means to assess and price DeFi credit risk.

The introduction of credit agreements into the DeFi sector has attracted keen interest from institutional borrowers and lenders, especially at a time when liquidity has been drained from the global financial system by central banks.

Credit agreements made loans totaling $4.2B in 2022, and institutional borrowers increased.

In addition, defaults by large CeFi lenders such as Celsius have resulted in an overall credit contraction in the crypto finance sector, as risk appetite among CeFi lenders has decreased, leaving crypto institutions with fewer options for accessing credit. Thus, the emerging DeFi credit agreement can seize the market share vacuum left behind. For example, Maple Finance noted in its second quarter report that demand from lenders remained strong throughout the year, with 23 per cent of lenders adding to their loan positions, increasing the need for borrower capital. Clearpool also reported that its total liquidity provision peaked at $145 million in September 2022, a 30 per cent month-on-month increase, while DeFi's total liquidity declined 26.7 per cent. The excess growth initiated by DeFi credit often corresponds to a CeFi credit crisis.

DeFi Credit agreement business model

Most DeFi credit agreements do not currently issue loans directly, but act as credit infrastructure providers by connecting borrowers and lenders. The main source of income for these credit agreements is similar to that of their excess mortgage agreements, i.e. a portion of interest income from outstanding loans. Once a resident institution starts making loans, these credit agreements typically take either a percentage of the interest income generated by those loans or a small fee when the loans are made. For example, Clearpool uses a pool and loan model, with 5% of all interest payments collected as an agreement fee. A protocol that runs a loan business setup model, similar to Maple, with a 1% setup fee when the loan is originated by any institution that has a pool of capital on the platform. 67% of this fee is sent to Maple DAO as agreement revenue.

Over the past year, credit agreements have successfully generated a total of $10.9 million in revenue. This revenue growth has been relatively stable because the institutions using these agreements need constant liquidity.

Despite the contraction in cryptocurrency liquidity more broadly, the three largest credit agreements by volume of monthly loans: Maple Finance,TrueFiandGoldfinchHas generated a relatively stable monthly income over the past year.

The two main groups of institutions to which these credit agreements provide funding are crypto native institutions and enterprises in emerging markets. The cryptographic institutions currently actively lending on these agreements are mainly hedge funds and trading firms. These companies, while having similar (if not similar) performance to their TradFi peers and healthy balance sheets (although we did see surprises in the FTX drama), cannot get loans through traditional institutions such as banks.

Emerging markets are another group of borrowers financed by these credit agreements. Throughout 2022, demand for exposure to private debt continued to grow, with emerging debt markets following this trend as the start-up and technology ecosystem in the sector grew.

Emerging debt markets offer investors a favourable risk-reward portfolio, creating demand for exposure to such debt instruments. However, investors may find it difficult to access the debt markets of emerging economies. Therefore, to solve this problem, certain credit agreements provide access and benefits by connecting potential lenders and borrowers. Goldfinch notes that in order to minimize the risk and uncertainty of providing credit to sectors that are still in a growth phase, they only provide loan financial performance to established credit funds and fintech organizations with a stable history. In addition, ensuring that borrowers meet satisfactory standards for Goldfinch and Credix, as the total default rate has been 0% since inception.

Credit agreement infrastructure

The current process of providing credit for these agreements is relatively similar, with some nuances in terms of the mechanism of the agreement and the administration of the loan.

Protocol level

Credit agreements typically act as an infrastructure layer, providing the necessary risk assessment and credit scoring expertise before a loan is made, as well as protocol-level decisions such as setting interest rate mechanisms. While such credit risk assessment decisions may make some aspects of these agreements more centralised than in other DeFi money markets, they are essential to ensure that the quality of borrowers on the platform meets certain criteria to minimise credit risk.The agreement either has a team with years of credit experience or uses something like CredoraSuch a centralized credit rating provider assesses the financial position of each potential borrower.

Agreements are also typically responsible for setting interest rates for their pool of loans, which can be dynamic or have fixed default levels. Examples of fixed-rate agreements include Maple Finance and TrueFi, as the loan terms of their lending pools are usually determined down the chain by the borrower and the party running the pool. Dynamic interest rates typically use algorithms that take into account pool utilization to determine the appropriate interest rate. This method is used for imagesdAMMIn such an agreement.

borrower

How to borrow?

The borrower's process is relatively standardized in most credit agreements, they must complete KYC and anti-money laundering (AML) procedures under the agreement and conduct an analysis of the loan pool's financial condition before opening it.After completing the necessary procedures, borrowers can open a borrowing pool, often similar to a revolving line of credit, in which they can borrow up to a certain amount and borrow whenever they want. Because there is enough money available. These processes work for most agreements that allow institutions to set up their own pools of capital and borrow directly from them, such as dAMM and Clearpool.

However, for agreements using a business model that allows an institution to set up a credit facility, the borrower generally must go through additional third parties during the setting up process. This extra party acts as the pool manager, interacting directly with borrowers and negotiating credit terms with them. These pool managers must usually pass KYC checks by protocol when the pool is set up by them. Becoming a pool manager is similar to running a credit business, and borrowers must interact with them to get a loan. Once the loans are approved by regulators, borrowers can also start borrowing from the pools. Agreements that follow this structure include Maple Finance and TrueFi's capital markets, where each pool is run by a single agency that pools funds and self-approves each borrower.

Interest payment

With most agreements, interest compounds automatically each period, giving borrowers the flexibility to choose to repay the loan when they see fit. However, there are some agreements, such as TrueFi, that only require the interest to be repaid at the end of the loan term, leaving the borrower under no obligation to pay interest until the repayment date is reached.

credit

How to lend?

Currently, most credit agreements run unlicensed pools, which means lenders can choose to deposit funds into any pool they choose. As long as users have a compatible Web3 wallet and a pool of assets to deposit, they can provide funds to a lender of their choice to start earning interest. However, for some agreement and license pools, lenders need to complete the KYC/AML process before they can deposit funds into these pools. At present, the three agreements that require lenders to complete KYC before they can deposit funds are Goldfinch, Centrifuge and Credix.

Vanilla lending pool

Most current agreements use a model in which lenders simply choose the institution to which they wish to lend their money and deposit it in the appropriate pool. This is similar to offering funds on AAVE, except the borrower is an institution that goes through the KYC process and joins via a credit agreement.

Tiered loan pool

Several agreements divide their loan pools into different parts, allowing lenders to choose the amount of risk they are willing to take in order to earn interest. Centrifuge is an example of an agreement which provides a segmented loan in the form of different tokens representing a junior or senior loan. Lenders who choose to lend money to the junior tranche typically earn higher yields because they provide the first loss capital in the event of any default. Senior tranche lenders, on the other hand, receive lower yields but are protected from default because of the liquidity of the junior tranche.

Interest payment

With most agreements, once the lender deposits the money, he cannot withdraw it until the loan term ends or there is enough money in the pool. This may mean that the funds provided are illiquid over the life of the loan. If a lender deposits funds in the pool at a time when its funds are fully used, the lender will not be able to withdraw the funds until the next interest payment or the loan is fully repaid.

DeFi as an equalizer for credit access?

DeFi credit agreements appear to be mere iterations on the chain of traditional banks or lenders due to their centralized nature compared to their over-collateralized counterparts. However, DeFi credit agreements have advantages throughout the entire process and life cycle of the loan that TradFi cannot replicate.

The evolution of credit processes

In TradFi, the amount of credit a person can obtain depends on a framework commonly referred to as "5C credit." The framework plays an important role in determining how much credit is available to a party wishing to obtain it. This is also called the creditworthiness of the party requesting credit.

These 5C's are often evaluated at the same time to get an accurate picture of the potential borrower's current financial position. For example, smes will be assessed by 5C if they want a loan from a bank to fund the purchase of machinery. However, the process of obtaining a loan is not as simple as approving a wallet transaction in MetaMask as obtaining a loan on AAVE. Instead, it requires the participation of multiple parties and individuals to complete each step of the process.

As a result, obtaining a TradFi loan is not only expensive, but also time-consuming. According to the data, only about 7% of TradFi loans are processed in an average week, with multiple parties involved leading to a spike in loan costs. In addition, applications for new lines of credit at financial institutions with which the borrower has an existing relationship may still need to go through the full 5C review cycle again. The operating costs of all these processes are likely to be borne by the borrower in the final pricing of the loan, as TradFi loans, at least legal ones, are highly monopolised by established financial institutions. As a result, the total cost is likely to be borne by the borrower in the pricing of the total loan.

The inefficiencies of Tradfi's antiquated process are simplified by the current DeFi credit model, which provides borrowers with operational flexibility to borrow and repay 24/7 after the initial borrower's application is approved.

One example is Clearpool's loan origination process. With Clearpool, the borrower goes through only two intermediaries -- the protocol itself and Credora. In addition, the number of steps and processes required to approve and initiate a loan request is significantly reduced compared to TradFi agencies. Middlemen are eliminated, so borrowers can get competitive rates from DeFi mortgage deals. The cumbersome technical details involved in TradFi borrowing, such as waiting for loan withdrawals to be credited to borrower accounts or transferring borrowed liquidity to destination accounts, can be effectively replaced by blockchain technology.

Greater credit availability for underserved borrowers

DeFi credit agreements, while not perfect, make loans more accessible to borrowers who were previously considered "underserved" and/or priced by legitimate TradFi/CeFi lenders (loan sharks, of course, are outside the context of this article). After the 3AC fiasco, for example, aspiring cryptocurrency market makers may find it difficult to increase leverage by borrowing from CeFi lenders, and they certainly have no hope of expanding their balance sheets through repo transactions with TradFi investment banks. Similar barriers exist for many crypto financial institutions, and DeFi credit offers a cheap and non-dilutive alternative to bringing in new venture capitalist (VC) capital. In the non-financial sector, DeFi credit is also filling a void for companies in emerging markets (Latin America, Africa and emerging Asia).

Companies in emerging markets face a significant financing gap because many are underserved and lack investment of about $500m a year. Several credit agreements have tried to fill this gap, one of which is Goldfinch, which specialises in connecting lender capital with borrowers in developing countries, where TradFi credit is expensive and inconvenient to access. While 5C credit due diligence is still performed on borrowers at Goldfinch, credit risk assessment is at least done by decentralized consensus (among stakeholders) rather than a corporate monopoly.

Although DeFi credit agreements currently only serve a niche market, there are several ways to achieve larger adoption. One understandable trajectory is the mutual recognition of credit scores/ratings between users and entities in DeFi and TradFi, which would allow borrowers with a credit history on one hand to obtain credit on the other. This will benefit not only institutional borrowers but also retail borrowers, and potentially make on-chain credit cards a reality. However, mutual recognition of credit scores may require borrowers to reveal their true identities for KYC and compliance purposes. This can undermine decentralization maximization.

Transparency, anti-fraud and risk management

The development of DeFi credit agreements offers promising treatments for several problems in the TradFi and CeFi credit markets.

Most importantly, DeFi lending is on-chain and open to review, balancing access to information between lenders. In contrast to TradFi, lenders with private credit exposure to borrowers in some cases learned of an impending default before lenders with only public debt exposure. Private credit lenders have an unfair advantage in faster access to information and may reduce their exposure at the expense of public credit lenders. Despite insider-trading laws, such cases are difficult to prove in court, so lenders without an information advantage stand to lose. If an institution conducts all lending through DeFi, transparency will prevent the above information gap and bring about fair and true equality for all lenders.

Protocols such as Clearpool provide real-time credit scores through the use of Credora, where information about borrowers and their respective loan pools is readily available. They also provide users with information about loan size and repayment history, as well as transaction hash values if the lender wants to track the flow of money for each borrower. Although credit terms such as the size of the collateral are not visible to the user, there is still a higher level of access to information than lending to a CeFi institution.

Admittedly, at this stage, many of the whitelisted DeFi borrowers are not just borrowing on the chain, leaving a potential information advantage for CeFi lenders. However, as we observed during the CeFi credit crisis from May 2022 to July 2022, publicly reviewed chain lending is usually repaid first (partly to free up asset collateral, but also due to regulatory pressure).

DeFi's consensus mechanism in credit due diligence also helps reduce fraud. Traditional loan approval processes at financial institutions often rely on a small number of decision makers, which carries concentration and key personnel risks in preventing fraud. Netflix fans may remember Anna Delvey or Anna Sorokin from the true-story TV series Invent Anna, who forged her identity and managed to trick banks into extending credit lines for false impressions and forged documents. It is hard to imagine her achieving this in the context of DeFi lending, where KYC is conducted by a group of agreement stakeholders (e.g., token stakeholders).

Existing credit agreement

In the table below, we compare current and well-known credit agreements in DeFi using a variety of qualitative and quantitative metrics.

DeFi Current limitations of credit agreements

Despite its achievements, the popular DeFi credit protocol still faces a number of restrictions that, to varying degrees, hinder further adoption.

Lack of term structure

This shortcoming is by no means limited to DeFi credit agreements. Most DeFi money markets operate on a zero-maturity basis because ofSmart contractRisk, investors are still largely sticking to liquid investments. Depending on the agreement, the DeFi credit pool can be structured as a revolving credit facility, where borrowers can draw and repay on a flexible schedule, or as a short-term fixed term line of credit with a maturity of less than six months. The only exception is Goldfinch, which allows companies to take out three-year borrowing arrangements.

Currently, as most DeFi credit borrowers are financial institutions such as trading companies, the lack of duration is less of a concern as these borrowers are usually content with short-term financing. This gives them the flexibility to shrink their balance sheets when market opportunities do not warrant aggressive borrowing. As for credit investors, however, some are increasingly happy to take on the risk of smart contracts and seek longer-term fixed-rate returns. The needs of these investors may be better served by differentiated, long-term offerings.

Concentrated industrial risk

As noted above, most DeFi credit borrowers operate in the same sector, which exposes lenders to higher correlations between their loan portfolios, also known as higher joint default probabilities. Goldfinch's model of introducing non-financial borrowers helps bridge this gap through diversified on-chain lending.

Lack of a consensus credit rating framework

With the emergence of on-chain credit rating providers such as Credora, the current lack of a standardised DeFi credit rating framework may soon be resolved. Investors currently have no easy way to assess the creditworthiness of borrowers: they either have to establish bilateral relationships and collect financial statements, or rely on rating providers.

Legal and compliance implications

There are many unclear legal implications when it comes to DeFi credit. First, DeFi credit launches do not necessarily provide prospectuses as TradFi credit bond issues do. The lack of a prospectus and legal documents may lead to problems including, but not limited to, illegal solicitation and unclear priority of debt. How can lenders determine whether their loans are equal to a borrower's other unsecured off-chain liabilities? In the event of default, are underchain creditors entitled to accelerate DeFi obligations even if the DeFi credit pool is paid on time? Is on-chain proof of loan to borrower legally binding in court? All of these delicate procedural imperatives must be addressed before the DeFi credit market can gain greater adoption.

Capital illiquidity

Although most DeFi credit pools currently do not have clear lock-in periods for funds, lenders must not treat their invested principal as liquidity. The amount available is determined by utilization, which means that if most of the available pool money is borrowed, lenders need to wait for repayment or for new money to flow in before they can withdraw the money.

Although some agreements provide a "liquidity exit" by allowing lenders to sell their tokenized loan tokens on the open market, lenders will still be in trouble if they pull out of the pool in large numbers, for obvious reasons. This may be better addressed by distinguishing between a term loan and a revolving credit facility, so lenders can determine how long their funds are locked up and can proceed to plan accordingly.

Another way to increase the liquidity of DeFi credit borrowings is to bring market makers into tokenized loans - similar to the way TradFi market makers use the principal balance sheet to provide secondary liquidity. The obvious obstacle to this route is the lack of credit instruments (credit default swaps, short tokenized loans, etc.), which reduces market depth by reducing the ability of market makers to hedge risk.

Future development

In this section, we outline several directions in which we foresee the DeFi credit space eventually going one day to make universal DeFi credit a reality.

Retail credit

In TradFi, the retail industry makes heavy use of credit to finance the purchase of big-ticket items such as cars or mortgages and more general use cases such as paying for a college education. The availability of retail credit in DeFi will be a major value proposition.

Gearbox ProtocolIs an example of an attempt to address the retail DeFi credit market. It provides retail credit by using credit accounts, which are isolated smart contracts with set parameters that only allow access to whitelist tokens and protocols to implement income or trading strategies using credit loans. This model allows credit to be created without the need for KYC because the borrowed funds are not held directly by the user, which eliminates the risk of them defaulting and the borrowed funds running away.

Currently, retail DeFi credit remains limited to financial use cases, while consumer use cases remain very limited due to the difficulty of determining on-chain identity. We believe that one possible solution to the "incentive to default" problem is to use soul bound tokens (SBT). These non-fungible and non-transferable tokens will ensure that if a user defaults, he will not be able to obtain future loans because his credit history will be linked to his on-chain identity. As the technology stack continues to evolve, we foresee SBT playing a central role in ensuring retail consumer credit compliance becomes a reality.

Zero knowledge KYC (zkKYC)

Current credit agreements require all borrowers and certain lenders to accept KYC/AML procedures, which are still centralized and have no industry-wide standards.

zkKYC will allow users to prove their identity without fully disclosing all personal data, while still complying with all necessary KYC obligations. This also helps to provide standardized KYC procedures across different credit agreements, potentially increasing the composability of decentralized identification across different agreements while protecting user privacy.

Final thoughts

Despite the many obstacles ahead, the DeFi credit market has demonstrated its growth momentum and ability to foster innovation.As the most frequently traded risk premium in TradFiOne is that credit risk could become the next big thing in the "real yield" narrative.

Perhaps the most interesting observation about DeFi credit is that the growth of this market directly opposes the decentralization of "DeFi". Lenders and borrowers voluntarily accept KYC and whitelisting to participate in these agreements, placing a low priority on anonymity. This licensed on-chain market may be a lasting trend that will lead toDegree of institutionalization of on-chain financing and investment activitiesAs regulators delve deeper into trades and returns that were previously beyond their reach. The long-term impact of this development is difficult to measure, as DeFi's initial concerns about the erosion of privacy and distributed governance may be addressed by allowing future innovations in permission-free and algorithmic credit assessment.

All things aside, we at Treehouse are optimistic and excited to be a part of the DeFi credit market growth as our engineers work to integrateCredit risk management tools. We believe the next star project in DeFi credit could involve instruments and markets that can trade credit more efficiently and on more diversified borrower entities, or with index packages with various term structures.

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