Outlier Ventures: Comprehensive interpretation of the current situation of unsecured lending

Author: Achim Struve

Compilation of the original text: Deep Tide TechFlow

introduce

This article will focus on a specific area with great potential. In the US alone, the unsecured personal loan market will reach $210 billion in Q1 2023, surpassing the $61 billion in total value locked in decentralized finance (DeFi). This means that the DeFi space in general and the decentralized lending industry has huge potential for growth. This significant growth potential was the motivation for creating the current major unsecured lending protocol. This article provides a clear picture of these protocols in terms of funding adoption, token valuation, incentive impact, and market dominance.

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Lending assets is the cornerstone of any financial system. Lenders can earn benefits on idle cash, and borrowers can get quick access to working capital.

Lending markets in the DeFi space are often over-collateralized, meaning borrowers must deposit more collateral than the loan is worth.

For example, a borrower wants to provide $10,000 in ETH as collateral for a $5,000 USDC loan. While over-collateralized lending is the norm in DeFi, unsecured loans in traditional finance are sometimes partially or completely uncollateralized. This overcollateralization ensures that when a borrower defaults, the collateral can be sold to repay the lender.

While overcollateralized lending is safer for lenders, it is inefficient, limiting market expansion. It requires unsecured lending protocols that can access trusted credit data to estimate a borrower’s risk profile without disclosing sensitive information on the blockchain, thereby overcoming this limitation in DeFi. Oracles combined with zero-knowledge proofs are already being developed to alleviate the need for borrowers to disclose their identities to unsecured lending platforms.

However, unsecured lending is an important industry in DeFi, and its higher risk is reflected in its higher loan annualized percentage yield (APY) than over-collateralized lending platforms (such as Aave and Compound). Unsecured or unsecured loans increase the likelihood of default. Loan liquidation and repayment of off-chain assets and contracts may take a long time.

With regard to the security of the lending pool, lenders must rely on the due diligence (DD) of the pool managers. Lenders may not be able to obtain liquidity when needed because the amount of liquidity that can be drawn from the loan pool depends on the amount of liquidity present in the pool.

Figure 1 shows a representative ecosystem of unsecured lending protocols. In the case of TrueFi, lenders contribute capital to a lending pool that borrowers will use to obtain loans. $TRU holders can vote on the loan, which must also be approved by the portfolio manager.

Unsecured Lending Market Overview

Table 1 presents a snapshot overview of some agreements that provide unsecured loans to institutional borrowers. These protocols are sorted by their Total Value Locked (TVL).

The total FDV of all unsecured lending protocols native tokens in Table 1 is $341 million, equivalent to 6.6;% of the crypto lending and borrowing industry, 0.7;% of DeFi and 0.03;% of the total cryptocurrency market cap.

In addition, the total TVL is $384 million, which is equivalent to 0.6% of the TVL of DeFi. These figures demonstrate the very small market share of the unsecured lending protocols in Table 1 in the overall DeFi and crypto space. On the other hand, they illustrate the growth potential given the size of the traditional off-chain unsecured lending market.

Growth potential is even more evident from the competition's average loan APY (including native token rewards across all protocols) value of 8.6;%

It is important to note that lending to an unsecured lending protocol involves higher risk, so a higher lender compensation (APY) is justified compared to lending to an over-collateralized lending protocol such as Aave.

Token Performance Comparison

A comparison of the historical valuation developments of the relevant tokens in Table 1 can provide insights into potential future trajectories. However, token valuation as measured by FDV depends on many factors, such as general market conditions, individual protocol adoption, and the token design itself. Tokens with low value capture attributes may underperform while products (lending platforms) may outperform in terms of TVL and loss ratio.

Therefore, multiple levels of comparison will be made. An overview of token design and value capture features provides the first insight into the expected relevance of overall protocol adoption.

For example, tokens with strong value capture may be more representative of general protocol performance, while tokens with limited value capture mechanisms may be less representative of overall protocol performance. Afterwards, important token metrics relationships for the current time snapshot will be compared. The last coin performance analysis focuses on historical development.

Token value capture

Table 2 gives an overview of value capture properties and utilities from the top 6 protocols in Table 1. All tokens provide governance power to holders and stakers.

Additionally, Maple, Centrifuge, and TrueFi leverage staking in exchange for secondary tokens. Secondary tokens are sometimes designed as a vote-locked (ve) model and can also be used as a vehicle for distributing fee shares to loyal supporters. In the case of Centrifuge, Maple, TrueFi, Clearpool, and dAMM, fee shares are conferred via direct distribution or via distributed buybacks.

Goldfinch and Clearpool do not have ancillary tokens, instead using their primary tokens directly as protocol incentives. All native protocol tokens accrue value directly from product usage, whether through the already mentioned fee shares, governance, or by providing user advantages when staking tokens. This means that a correlation between all tokens and protocol adoption can be expected.

Token Index Relationship

Figure 2 shows the relationship between protocol deposits (TVL) and different metrics such as FDV MC, average APY of lenders, number of holders, and Twitter followers. These ratios are given as a percentage of the highest value in the same category.

• The Deposit/FDV MC ratio provides the protocol's capital adoption within the current market valuation range. It should be noted that these indicators only consider unsecured loans and pledged deposits.
• The deposit/average APY ratio is an indicator between capital adoption and capital incentives.
• The Deposit/Holder Ratio provides the average deposit value per native token holder and is a benchmark for actual user quality by capital size.
• Deposits/Followers ratio provides an indicator of capital adoption per unit of marketing effort. It is important to note that the number of Twitter followers does not necessarily correlate with the actual user adoption of the product.
• Fan/Holder Ratio is an indicator of actual user adoption of the native token versus marketing effort.

Data collection was completed in February, but due to drastic changes in the market, all data points needed to be updated. In previous data collections, the rankings of individual protocols in different categories were quite diverse. But now, we see that Centrifuge is the clear leader in all categories, a direct result of its high TVL.

The success may be due to their innovative use of RWA tokens compared to other players.

Standardized Token Market Value Historical Comparison

The previous comparison is about the most recent value. Figure 3 shows the historical development of FDV MC for different unsecured lending protocol tokens. These values are standardized against Ether FDV MC to achieve a benchmark against the cryptocurrency market. The ordinate is given on a logarithmic scale, which mitigates the appearance of high volatility. Considering that the time period starts from January 1, 2022 to May 19, 2023, all native unsecured tokens have declined relative to $ETH.

Reasons for their poor performance may be as follows:

• **Cryptocurrency market crashes. **The overall cryptocurrency market has been in a downtrend since November 2021, and unsecured lending protocols are not immune. As the price of cryptocurrencies falls, the value of the native tokens of these protocols also decreases.
• **Concerns about the sustainability of unsecured lending. ** Unsecured lending protocols are a relatively new and untested concept, and there are concerns about their long-term sustainability. Some critics see these agreements as inherently dangerous, arguing that it is only a matter of time before they collapse. Some protocols have experienced partial accidents, such as Centrifuge, Maple, and TrueFi. Other lending protocols and investment platforms are even facing complete collapse, such as Celsius, Voyager Digital, and 3 Arrows Capital, which may heighten fears.
• ** A safer alternative to mortgage lending. **Collateralized lending agreements are more popular because they offer a low-risk alternative to unsecured lending. As more people turn to collateralized lending, there is less demand for unsecured lending, which puts downward pressure on the value of these protocols’ native tokens.

Summary and Insights

Token designs for unsecured lending protocols exhibit different approaches and value growth mechanisms, with all providing governance capabilities through their tokens, but not all providing direct revenue sharing through staking. Nonetheless, all token designs gain some form of value growth from product adoption.

Centrifuge is currently the most successful unsecured lending protocol in terms of FDV valuation and TVL. Although they also suffer from some overdue loan issues, their strength lies in their innovative approach to RWA.

The overall valuation of all native unsecured lending tokens underperformed and failed to outperform the cryptocurrency market. The 2022 bear market has had too many partial crashes or even full crashes, leading to less trust in the space.

In terms of combined FDV MC, the unsecured lending space is small relative to the entire DeFi space (0.7%;) and the entire cryptocurrency market (0.03%;).

Considering the huge influence of unsecured lending in the traditional financial field and the trend of the market to optimize capital efficiency, decentralized unsecured lending still shows a huge potential for growth and innovation. It just takes more time to rebuild trust and innovate to make this happen.