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Crypto for Advisors: Private Credit Meets the Blockchain
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Sarah Morton, Kelly Chambers
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What happens when traditional private credit meets the Web3 on-chain investment opportunity of real-world assets? As decentralized finance, smart contracts and crypto evolve, more products are built on-chain, reflecting products prevalent in traditional finance while taking advantage of blockchain functionalities. Kelly Chambers from KellytheWriter explains the evolution of real-world asset private on-chain credit.
Bryan Courchesne from DAIM answers what is on-chain De-Fi and why it matters in Ask an Expert.
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Real-world asset on-chain private credit is a corner of crypto that you may not hear about often. But it’s a corner worth knowing about as it may start to offer mainstream investing opportunities.
You may have heard of private credit but have you heard of real-world asset (RWA) on-chain private credit? Here’s the difference between the two.
In traditional finance, private credit loans are a form of non-bank lending where financing is provided by non-bank institutions typically to small and medium-sized businesses.
In the world of digital assets, RWA on-chain private credit brings the process of lending and borrowing against real-world assets onto a blockchain. The real-world collateral of these on-chain loans may be in the form of a business’s inventory, receivables, real estate, revenue-based financing.
There are a handful of DeFi protocols offering RWA on-chain private credit. These protocols offer businesses, many SMEs from around the world, access to debt capital from non-bank lenders. In most cases, lenders interacting with RWA on-chain private credit are required to complete KYC/AML, accreditation checks and other requirements.
The benefits of bringing private credit on-chain are reduced transaction costs and increased transparency compared to the traditional financial system. The risks include borrower default risk along with the unknowns of a still-maturing crypto industry.
The three largest on-chain private credit firms based on current active loans according to analytics firm rwa.xyz are:
Centrifuge: A credit marketplace allowing borrowers to finance real-world assets by accessing DeFi capital without banks or other intermediaries. They also serve large decentralized organizations through Centrifuge Prime where DeFi native organizations can take advantage of real yields from real economic activity.
Maple: An on-chain marketplace focused exclusively on serving institutional and individual accredited investors with lending opportunities suited to their liquidity, risk, and return requirements. Maple offers various secured lending including vehicles backed by U.S. Treasury bills, investment-grade debt, and loans overcollateralized by digital assets.
Goldfinch: Founded by Warbler Labs, Goldfinch is a decentralized credit protocol that allows for crypto borrowing without crypto collateral – with loans instead fully collateralized off-chain. Warbler Labs founders also recently launched Heron Finance, an on-chain private credit RIA.
Other smaller firms like Credix and Clearpool have continued building in the space throughout 2023:
In 2023 CoinDesk highlighted Credix in a story, describing how lenders on the platform can capture nearly 11% annual yield by investing in insurance-protected private credit to Colombian farmers backed by receivables.
In December of 2023, Clearpool launched its institutional-grade KYC & AML-compliant private credit marketplace called Clearpool Prime.
It’s important to note that the largest on-chain private credit firms today may not be the largest tomorrow. You can see in the graph courtesy of rwa.xyz that market share has ebbed and flowed among firms, with all firms struggling to survive crypto’s downfall in 2022. Throughout 2023, on-chain private credit firms have slowly made a comeback.
Historically, on-chain private credit has been driven by a small number of native crypto users. One trend to monitor is the potential to make blockchain-based RWA private credit more accessible to mainstream non-crypto-native consumers.
Maple Finance’s CEO is on the record stating, “We want to abstract away as much of the complexity of crypto as possible. My vision for the future is we could pitch a family office and say we have a credit and lending product that has lower fees than your average Ares or Apollo credit fund.”
In addition to making on-chain private credit mainstream, there are also efforts to bring it to a wider audience. Much of private credit has been used by institutional lenders, but some see more room for accredited investors to put their capital to use.
For example, Heron Finance, the offshoot of the Goldfinch protocol, recently launched a blockchain-based RIA registered with the SEC that is designed for US-accredited investors who don’t have crypto-native knowledge.
If the experience of on-chain private credit becomes more mainstream, with onramps via wire transfer or ACH, it may open investment opportunities for financial advisors serving high-net-worth clients looking for additional yield but not willing to transact in various cryptocurrencies and multiple wallets. For forward-thinking financial advisors, it’s an area to watch.
Q. What is on-chain DeFi?
A: On-chain DeFi refers to decentralized finance (DeFi) protocols and applications that operate directly on a blockchain. This is done through self-executing smart contracts.
Q. Why is it important?
A: On-chain DeFi is important because leveraging smart contracts creates a trustless system that does not rely on intermediaries to function. By having self-executing agreements written directly into the code and stored on an immutable blockchain, participants can use services such as lending, borrowing, trading and asset management in a verifiable, transparent and seamless manner.
Let’s look at trading for a simplified illustration. A decentralized exchange (DEX) will settle trades on-chain whereas a centralized exchange will use an internal centralized system. This is important because if you, for example, use a DEX to swap Solana (SOL) for Helium (HNT) your HNT that you receive to your wallet will be verifiable on a transparent ledger. Contrast that to people in 2022 who were trading Solana for Helium on FTX. The tokens they received were kept on a centralized ledger, verifiable (or not) only by FTX internally. And when FTX went under, it turned out that those tokens did not actually exist. It’s difficult to know who to trust. That’s why on-chain smart contracts are so important. Creating a self-enforcing, self governing system is the best way to mitigate bad actors and make a safer environment for all participants.
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