Hi everyone, Tomer here :)
Back with you to share a key piece of our beliefs that informs who we partner with at Flori. Today will be about credit. As mentioned in the headline: I believe real-world credit solutions will bring the next billion people to crypto and will be a trillion-dollar opportunity.
In this article I’ll first go back to understanding credit from the economist-within-me perspective, the gaps that exist today and then I’ll share some examples of companies bringing the theory to practice: some we have funded and some I wish we had.
My hope is that this helps inspire others about a world we believe is possible — to continue building and using the great innovation and opportunity that web3 is offering to us — and put it to good use, to serve humans and the planet and enable prosperity for all.
Let’s get started by taking a step back:
What is Credit?
It’s easy to imagine that credit is new due to its digital efficiency, but credit is one of the oldest human constructs. It’s suggested that credit may have been a key factor that enabled early human societies to flourish.
It’s easy to understand credit in its social form: hunting together and sharing the catch, taking care of the elderly in your tribe, caring for one another when they are sick, etc. Credit was an agreement between people who knew each other well and had context.
But as our social structure changed, so did our source of credit. Your creditworthiness is now not based on how well you performed in the eyes of the humans in your tribe, but in the eyes of an anonymous financial system. This left an enormous gap between people monitored by the financial system and those who are outside of it, between markets and assets that your bank can collateralize, and those it can’t. For example, it’s easy to use Tesla shares, but much harder to use solar a house in a favela as collateral.
Credit is not magic, when I was a kid, I used to think that the bank was my friend; when I’m in trouble, he will just give me some money (that’s what I thought!) But no lender is a friend, and borrowing money is a two-edged sword. Play a game with friends around you and ask them what will be the compounded interest of 10% yearly for 20 years, you’ll be surprised to see the result. Credit is not for free, and there are huge disparities in interest rates in the global north and global south, those banks trust and those they don’t. See research in South Africa showing a 7.75 to 11.75 percent interest rate per month vs. the 0.03 to 0.30 percent we have seen in the US and Europe in the same time period.
DeFi has opened the door for new credit and liquidity models, so far limited to crypto-to-crypto lendings, in an attempt to arbitrage these huge interest rate gaps and level the playing field. And now there’s a new wave of DeFi supporting real-world assets and human connections, community, and trust and making them collateralizable
I like calling this field Defi 2.0.
But before we go too deep into Defi 2.0 a quick look at the origins of DeFi.
DeFi stands for Decentralized Finance and is constructed of 2 top products today:
The lending protocols are limited to one use case — lending crypto to people who want to borrow crypto to leverage/short investment in crypto.
How does it work?
I deposit $100 bitcoin, borrow $50 USDC, and buy another $50 of bitcoin.
What guarantees that I will pay back my loan? My collateral. My $100 worth of bitcoin is locked in a smart contract that triggers if my loan is not paid up on time.
These types of protocols provide credit in the value of tens of billions of dollars, closing liquidity gaps that had no other markets.
The true revolution of these protocols is not the fact that you can take a loan, but the fact that anyone can provide liquidity. Before, liquidity was something that could be supplied only by professionals: big companies and banks who have the ability to assess the asset, and provide liquidity in millions of dollars or more. The door was closed to small players.
Now when liquidity to crypto assets has become permissionless, anyone can make his assessments and decide whether to supply liquidity or not, to any asset, allowing smaller assets and smaller markets to become liquid and have greater liquidity.
So far these solutions were limited to crypto assets (as it was the lowest hanging fruit)
Can blockchain be the tool to close other credit gaps?
Yes. Or at least this is the bet I’m willing to make.
An uncommon opinion but one of the main reasons for the rise of DeFi was actually WBTC (Wrapped Bitcoin). The fact that all of a sudden you gave holders of assets worth billions of dollars access to loans.and that the use of BTC as collateral created a huge spike in usage of DeFi.
Now think about, how many other assets that can’t be used as collateral are out there in the physical world? Think of a person who has a house in a favela, owner of a forest, a pot manufacturer in Ghana, a coffee farmer in Mexico, and multiple other assets that can’t be used as collateral in the current financial system. The value of these assets far exceeds that of Bitcoin holdings!
The International Finance Corporation (2018) examines the credit constraints for MSMEs (Micro, Small & Medium Enterprises) in 128 countries, and finds that 40% of MSMEs in the sample are facing financing difficulties with a finance gap of $5.2 trillion every year which is 1.4 times of the current size of MSMEs borrowing.
What will happen on the day you allow all these assets to be used as collateral?
Which is one side of the story.
Now, not everything can be collateralized, and not every loan that a person takes is collateralized by a specific asset. Often banks are willing to lend you money based only on your credit score: your credit score is being “staked”.
This is a chart I really like, presenting the adults borrowing any money in 2021.
And specifically looking at the percentages of loans taken from family and friends in the developing economies.
These people are capable of paying back loans, but simply don’t have a credit score sufficient to take a loan formally because the bank has no history they can assess. Their family and friends do. They are underbanked.
These people would sometimes be paying loans as expensive as 15% monthly interest.
By enabling real-world credit solutions the next billion users will be onboarded to crypto — and we’ll be able to access the benefits and flexibility of financial tools that many in the world take for granted. This is not only good for all but also a trillion dollars market opportunity.
The main problem to bridge the gap is the assessment: what’s the value of the asset that is being used as collateral? And, what is the ability of the company/person to pay back its loan?
In TradiFi there’s a committee of experts with decades of experience and data to determine this. With blockchain technology, this committee will become a mathematical model or a decentralized community.
Some examples? Sure.
Goldfinch — serving business in emerging markets
Goldfinch is a decentralized, globally accessible credit protocol, with a mission to bring the world’s credit activity on-chain while expanding access to capital and fostering financial inclusion.
The protocol makes crypto loans without requiring crypto collateral — the missing piece that finally unlocks access to cryptocurrency capital for most people in the world. Goldfinch creates a way for borrowers to show creditworthiness based on the collective assessment of other participants which.
I love Goldfinch because it provides the basis for establishing an on-chain credit history — which is the foundation of any scalable lending model. They are the first I identified doing this well
Ethic Hub — serving coffee farmers in Mexico
EthicHub is a great example & use case: they back coffee farmers by providing them affordable loans that are paid back when they harvest their crops. They are backed by crowd-collateral (farmer and their network) — and with this model, they connect DeFi to the real-world economy — enabling DeFi investors to lend to real world farmers/businesses.
Solid World DAO- serving carbon markets
Solid World serves projects that will generate carbon credits — which typically function in time horizons of 5+ years. Solid World identifies and vets the projects and connects them with DeFi lenders who are buying futures on the projects. Like the examples above, they make the debt more liquid and accessible and add transparency to the system.
Centrifuge — serving SMEs
Centrifuge, like the companies above, standardises another class of typically illiquid assets (in this case invoices, real estate, and royalties) and connects them with DeFi lenders. As of September 2022, they have lent $180M.
Jia — serving savings cooperatives in Kenya
Jia serves savings cooperatives in Kenya — connecting DeFi lenders with small businesses and individuals underserved by the traditional financial system. With the loan repayments — the borrowers develop an on-chain credit score.
Masa Finance — soulbound Financial Identity to unlock on-chain lending
Masa solves a different piece of the puzzle: the identity protocol — that strengthens all the above projects by providing a key piece of infrastructure they need: a unique digital identity that is verifiable in a decentralized way, which will give access to on-chain credit products.
At Flori — we are excited to support both fast-growing examples who have figured out how to connect defi to real-world audiences that can benefit from access to healthy credit — as well as the key pieces of infrastructure that will be needed and will need to mature to make this market robust, secure, transparent and accessible to all. We believe credit done well is a key tool to enable prosperity for all, empower families and businesses, and level the playing field of opportunity.
Reach out to me.