New Breed of DeFi Credit Protocols Raises Millions at Rapid Clip
Masa Finance, Goldfinch and Others Pioneer Unsecured Credit Scoring On-ChainDive
DeFi is dead — or maybe it just needs another dose of innovation to rejuvenate liquidity.
Enter credit protocols, projects that are using new methods to set credit ratings to would-be borrowers in the crypto space and release lending.
They aren’t as splashy as NFTs or GameFi, but these projects have quietly received a slew of funding in 2022 despite the abysmal performance in the crypto markets.
And in tackling credit, the cornerstone of traditional finance, these startups are trying to lay the foundation for a more robust DeFi marketplace when the cycle turns again. The key: enabling more borrowers to receive loans from investors without having to post collateral. According to TrueFi, one of the OGs in the space, global unsecured lending is a $11T market.
“It is the first sign of maturity in decentralized finance,” Kanyi Maqubela, managing partner at Kindred Ventures, told The Defiant. “The industry has, thus far, been insular: investment, lending, borrowing, deposit tools from crypto FOR crypto activities. This is powerful and has yielded some scale for a handful of protocols, but is still a minuscule fraction of the real opportunity.” Kindred invested in Goldfinch, one of the credit protocols.
“It is the first sign of maturity in decentralized finance.”
Charlotte Dodds, marketing manager at Maple Finance, also sees credit-based loans as unlocking higher levels of potential for crypto. “Undercollateralized lending is good because it’s the most efficient way to get capital,” she told The Defiant. “You don’t need to post collateral, which means you don’t need to lock up any funds to get that capital. So all of your money in the bank is yours.”
The list of projects toiling away in this business is a long one. There’s Masa Finance, which raised $3.5M in pre-seed funding to develop what they call a “decentralized credit score” in May. RociFi, which offers credit scores and under-collateralized lending, raised $2.7M in a seed round in April.
Porter Finance, which facilitates bond issuance (and hence needs to evaluate risk in order to ensure the bonds are paid out), raised $5M in May. Solv Protocol, which operates in a similar space, did its own round in November. The list goes on.
There’s still others — Maple Finance, Goldfinch, Cred Protocol, TrueFi, DebtDAO, and more are all noodling on ways to establish credit in crypto.
Goldfinch’s approach involves evaluation of off-chain factors. Its borrowers include non-blockchain companies such as mobile phone-lender PayJoy. Cred Protocol is considering using wallets with overcollateralized lending platforms like Aave, to establish credit.
TrueFi, an elder in the space considering its Nov. 2020 launch, has a somewhat similar approach to Goldfinch. Anyone can lend stablecoins to one of the pools available on the platform. Borrowers must undergo an onboarding process which includes a know-your-customer check and a legally-binding agreement to fulfill the terms of loan.
Borrowers then submit a request for capital with an interest rate, which holders of TrueFi’s TRU token then vote on to either approve or deny the specific terms.
The only off-chain processes in TrueFi’s flow is the borrower onboarding. Without collateral, a borrower needs to face legal recourse in case of default. A would-be borrower also needs to go through a credit review — as they are typically not completely blockchain-based companies, this too is an off-chain process.
Diagram of TrueFi’s Mechanics. Source: https://truefi.io/
Driving all the activity is the rush to develop credit scores, a building block in traditional finance. These scores turn the risk of lending to a borrower into a number, and are crucial when there’s no collateral involved to secure a loan. Its absence is arguably holding back DeFi.
Maple Finance bills itself as a “decentralized corporate credit market.” It pursues a hybrid approach to credit in crypto by evaluating creditworthiness off-chain. Some of its credit pools are public, meaning anyone can lend to them and earn a yield. Some are private, so only specific lenders can fund them.
So far, Maple facilitates loans to crypto market makers like Alameda Research, where Sam Bankman-Fried used to be CEO. But it’s exploring facilitating loans to DAOs, Dodds said.
While collateralization is a reliable way to ascertain whether a user will pay a loan back — MakerDAO, which facilitates such loans, is arguably DeFi’s most successful protocol — it’s not capital efficient. The locked up money just sits there.
Collateralization is also limited in scope — people usually borrow money because they don’t have it, not to lever up against the assets they already have.
“DeFi is dominated by collateralized finances,” Ryan Chow, co-founder of the Solv Protocol, which aims to serve as a marketplace for what the protocol calls NFTs which represent financial rights, told The Defiant. These NFTs, called” vouchers,” include a bond instantiation, which is essentially a loan based on credit.
Chow sees collateralized lending as inherently limited. “The capital efficiency is too low,” the Solv co-founder said. “In conventional finance most people can leverage their credit.”
Chow emphasized that some DAOs have strong revenue, but struggle to get a loan in their current environment because their token isn’t accepted as collateral. Projects like DebtDAO are working on allowing DAOs to borrow based on revenue rather than their treasury.
While no project has yet truly scaled, it’s clear the race is on to build a credit market and release more capital efficiency and lending in DeFi. That this push is inspired by TradFi may be ironic but was probably inevitable. The trick for these ventures will be improving on the status quo on-chain.
Updated on June 10 with additional reporting on market sale and credit scoring details.