Liquidity in unsecured lending takes a long position on tomorrow’s whales
A short tour through some of the new DeFi projects that aim to get capital to the folks who don't already have it
Rich people don’t produce much.
This hit me when I read a historic Twitter thread. Just before the giant crypto exchange, FTX, fell apart, a young crypto trader, Ishan Bhaidani, wrote a viral thread about why he was taking all of his assets out of the venue and shorting its token, FTT. The thread pointed to a variety of strategic mistakes that he believed the exchange had made.
His diagnosis, the executives were, in his words, “post-economic.” What he meant by that was that they had made so much money that they didn’t have the drive to compete that they might have had earlier on and that caused them to miss opportunities.1
His hot take aged very well. It went into the books for good about a month later.
His point about being “post-economic” is obvious, but it was the first time I really thought about how an entrepreneur’s drive might drop as they started to win.
Said another way, for every person, there must be an amount of liquid cash that starts to distract him. At what point does his mind start thinking about ways that he could spend the money in his bank rather than entirely focusing on earning money in order to put more of it in the bank?
Wealth must become distracting at some point. This is not a bridge I have had to cross, but it makes sense once it occurs to you to consider it.
And yet, up to this point, decentralized finance has primarily been a great way to leverage already being wealthy. The lion’s share of DeFi so far has been about eking out yield on your existing crypto wealth.
At least, so far.
Jacob Chudnovsky, founder of 3Jane, is one of the creators of an uncollateralized lending protocol. He said the same thing as Bhaidani another way recently on a recent DeFi Dad podcast appearance when he said:
“A lot commercial credit is unsecured, what that typically means is you are super productive, but you might not be asset rich. Which is the flip side of what everyone else in crypto is catering to, which is you are very asset rich, but you might not be productive.”
🤯
He continued, “You need to be able to extend credit against their future revenues and future cash flows. Right now, in DeFi, it’s not quite that. You are extending credit to asset-rich individuals but they are not necessarily productive.”
Most lending in DeFi right now is overcollateralized. In other words, you already have a lot of money, but you want to take a leveraged position on all that money you already have. This is fine, yet it’s a service for the wealthy. That’s only going to grow so much.
A bunch of DeFi founders have gotten rich off this kind of service, but it can only go so far. It’s not great for getting new ventures off the ground.
Lending without or with less collateral
You are probably an avid user of unsecured lending, in the form of your Visa, MasterCard or American Express account.
Humanity has access to lots of other forms of unsecured lending, such as commercial paper. That’s how companies cover the gaps between their cash flows and their immediate obligations. Like they might have $50 million worth of checks in the mail, but they have to provide $20 million worth of payroll tomorrow, and they don’t have the cash. That’s commercial paper.
There’s also term loans, with fixed amounts and fixed schedules for companies with good credit lines.
And there’s trade finance, where credit is extended against revenue on deliveries of goods as they travel the high seas (or whatever).
That’s just a few examples. The point is that history has run on a lot of trust so far. In crypto, there’s been a big emphasis on trustlessness, but it seems like founders are starting to realize that trustlessness doesn’t need to be a universal virtue.
Like, yes, it’s nice that I don’t have to trust Bitcoin proper to know that I will have the assets in my wallet until I decide to send them to someone else. But there might be some other ways in which trust really does help grow the globe’s wealth.
However, founders are not idle! The DeFi world is going pretty hard right now (again, to be fair) to solve the problem of uncollateralized and under-collateralized lending, to bring on-chain one of the main forms we see lending take everywhere else.
I’m going to go through three different companies out there that have stepped into this market and talk about what each of them are doing.
These endeavors are small. They are new.
It feels like a kind of round II, and it’s just beginning.
Each of these companies are using crypto technology in interesting ways to extend credit in slightly new ways, with just the right amount of trust in the game.
Divine Research
In 2006, Grameen Bank won the Nobel Peace Prize for pioneering micro-credit. Basically, it gave small loans to the poorest-of-the-poor, largely women, and found that by and large they paid it back.
Since then, the micro-finance model has evolved. A common form it takes is that it staggers up the amount it will lend to people. It starts off very small. If someone pays that back, then the lender will offer more money. Up to some limit.
The terms for the loans vary wildly and sometimes the percentage rate asked for is fairly high, because these are high risk loans. However, they tend to get paid back.
Progressive writers in the West like to wring their hands and clutch their pearls about micro-finance — they are much more comfortable with just giving money away — but the evidence that people want credit is easy to find.
Loan sharks are everywhere. At least we should all agree that micro-finance is a better way.
Divine Research is bringing it to the blockchains through its app built onto the World blockchain (formerly known as “Worldcoin,” Sam Altman’s eyeball scanning side hustle.)
Divine Credit has been able to bring micro-finance to the crypto world thanks to the World ID. The reason World scans eyeballs is because they use that scan to make sure you only ever get one identity on its blockchain.
So Divine is extending small loans to anyone with a World ID. That’s all it takes to get your first loan. If you pay it back, you can get a larger loan. Pay that back? Get an even larger one, and so on.
The project has a pretty high default rate on those first loans, but on the 11 AM YouTube show, Diego Estevez, the young creator of Divine, explains that once people repay a loan, they are way more likely to repay the next one. The likelihood increases dramatically then from loan to loan.
Just before Christmas, the firm tweeted that it had issued over 1,000,000 loans. That’s all the more I can really tell you about it. There’s no dashboard for it on DeFiLlama and I don’t have the World App.
I’m leading with this one because it’s loans to regular people, the project that looks the most like a credit card. It’s the most relatable.
But other companies are looking more at commercial and institutional applications.
Wildcat Protocol
One of those companies looking to get funds into more institutional hands is Wildcat. It’s name is meant to reference the wildcat banking era, back in the early days of the U.S., when people could just throw up banks willy-nilly.
What’s interesting about the Wildcat model is that it puts borrowers in the driver’s seat. Once they are onboarded through the know-your-borrower process (they get checked for sketchiness), they can basically write terms for their loans.
Of course, if they write terms more generous than anyone will accept, they can’t find a lender, so it’s a negotiation that happens in public.
Laurence Day, one of the cofounders, described it as “either the Tinder or Craigslist of private credit” on the Defi Dad podcast.
The primary client so far has been market makers, but the company setting this marketplace up is looking to grow the kinds of customers it serves.
Wildcat is much more complicated than Divine. It has a lot more buttons to push and levers to pull, but the basic ideas are these:
Publicly disclosed loan terms that everyone can see, helping to set a public baseline for expectations from both sides of the market.
A company in the middle that is only helping the two sides of the market find each other, but is not itself party to the loans (though the founder has said he ends up backing a lot of the loans on the platform out of his own pocket).
A system that gives the lenders enough information that they could take legal recourse if that’s what they needed to do, enabling that fallback that a trust-based system uses out in the analog world.
The flipside, of 3: No liquidations.
The big takeaway for me looking at this was a system that put these loan agreements on chain and made them all public. That sort of transparency is very crypto.
According to DefiLlama, it’s brought in $15 million in fees and currently has $23.6 million in total value locked. I can’t find a dashboard to show how much loans it has originated, though (it must be considerably more).
3Jane
3Jane seems like it has set out to look the most like commercial paper, doing it on chain.
This is the company whose founder I cited at the top.
He explains that he’s been able to get into unsecured lending because ZK TLS enables it to access just enough personal information, without violating privacy.
Plaid gives them some recourse for users who default.
Credit Karma allows them to check people’s credit without actually needing to hold information in house.
Chudnovsky makes a compelling case that until unsecured credit comes on chain, it’s going to remain a game of slowly growing the gains of folks who are already wealthy.
“If you can’t extend credit to those nascent businesses, Chudnovsky says, “then you’re sort of throttling the potential innovation.”
DefiLlama currently shows it with $38 million in total value locked and $88,000 in fees accumulated so far, though its entire life as a product just runs through the end of last year.
For some crypto-native fun, liquidity providers in 3Jane can opt to get USD3 or sUSD3. Both of these are yield-bearing tokens. The first is the senior tranche. Lower yield, less risk.
The second one is the junior tranche. For folks that really want sweet returns, but might not get paid if a wave of defaults hit.
Aww, takes me back to 2008.2
Watch this space
This stuff is all pretty new.
I feel like I can see the hints of potential exploits out in the wild there.
If the industry has matured, they will have hedged that risk so that when exploits happen they can bounce back and improve, rather than fall apart, like so many credit products did in the wacky yield farming days of DeFi Summer.
This idea has been kicking around for a while. The first time I thought about unsecured lending in crypto was when I wrote about Aave’s credit delegation program.
As far as I can tell, nothing much came of that. The argument by present founders is that the infrastructure just hasn’t been there till recently to do it right.
And there was a lot of hopium clouding people’s eyes. I remember people talking about deriving a credit score from your on-chain activity, but, real talk, if the only loans you take out on chain are overcollateralized, you aren’t going to learn much about a borrower’s responsibility.
The ability to turn to products like Credit Karma as needed is clutch, at least if a founder wants to be realistic.
And it seems like an era has also arrived when founders are ready to admit that code might not be 100% adequate as law. There could still be cases when blockchain projects need to turn to the courts.
In my opinion, that doesn’t mean that crypto is abandoning its values, though. In each case, these projects will provide a level of transparency into these markets that we’ve never seen before.
That’s real.
It may take a few more minor inventions till the planet can get to a perfect post-state state.
That said, you know that unsecured lending must be onto something because the FT wrote about it this past summer as if these were a sure sign that the Trump administration’s approach to managing blockchains will surely throw us all back into the stone age.
No doubt. Any day.3
“There’s a whole graveyard of attempts at unsecured credit over the years,” Chudnovsky pointed out on the podcast. And he reminded me of one of the earliest operators in this space, Iron Bank.
Iron Bank existed in the CREAM universe of DeFi protocols, but one of its counterparties got exploited and the dream of unsecured protocol lending fell apart.
If at first you don’t succeed, someone else should try again.
Crypto was founded on “don’t trust, verify.” But okay we’ve verified that “don’t trust, verify” works great, so I guess we’ve reached the era when we’re ready for: “OK, trust a little, but with caveats and maybe call the cops.”
It turns out that this was not actually the problem at FTX. They hadn’t made unbelievable amounts of money. The company had stolen it. But that’s another story and if you want to read more about it, you should snag a copy of my book.
I kid. Mostly.
Never change, FT.