Startup Adapts Credit Default Swap Model to Unsecured Crypto Loans

Credit default swaps are the stuff of financial lore. These complex instruments played a role in the subprime mortgage crash of 2008 and featured in the celebrated account of that cataclysm, “The Big Short.”

Now a variation on credit default swaps have come to crypto.

$2.5M Round

A new protocol called Carapace is offering protection against default risk on undercollateralized loans in crypto. And while this mashup of Wall Street alchemy and blockchain finance may raise eyebrows it is backed by a prestigious venture capital firm in digital assets: NFX.

NFX, which concentrates on seed and pre-seed stage venture, led a $2.5M funding round in Carapace, the firm announced today. NFX has invested in crypto and non-crypto ventures, including Ribbon and Lyft.

Carapace works much like an insurance company, but it insures debt, not property or automobiles. Selling default protection against unsecured assets is a high risk proposition.

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The Defiant

It’s working closely with Goldfinch, a credit protocol with $99M in active loans. Carapace will sell lenders on Goldfinch protection on their loans. If a Goldfinch borrower defaults, Carapace will reimburse for the loan’s principal.

The funding comes from a pool, and contributors may earn a yield on their investments.

Default Risk

“What we are essentially doing is a protection service where we are matching these lenders who are providing liquidity into these undercollateralized lending protocols with other investors who are willing to take on some of that default risk,” Rohit Sabnis, co-founder of Carapace, told The Defiant.

Most crypto loans are overcollateralized largely because users of blockchains are pseudonymous — no one necessarily knows anything about each other except what’s visible on-chain, and how much wealth a person commands is much easier to establish than a person’s overall creditworthiness.

This has made the unsecured lending space somewhat of a holy grail in crypto. There are few options for lenders to get protection on unsecured loans.

“I saw that undercollateralized protocols like Goldfinch, Maple Finance, and TrueFi were growing, but the problem was that there was no reliable way to hedge against default risk,” Taisuke Mino, Carapace’s other co-founder, told The Defiant.