DeFi and the Three Cs of Credit

The purely collateral-based type of lending practiced so far in decentralized finance has limitations.

Insights, news and analysis for the professional investor By Marc Hochstein, Executive Editor September 12, 2021 Sponsored by     Bitcoin (BTC) - $45,361.26 Ether (ETH) - $3,322.78 Prices as of 09/12/21 @ 8:00 a.m. UTC If you were forwarded this newsletter and would like to receive it, sign up here.  Over the summer, I read a penetrating, if sometimes borderline hagiographic, three-part profile of Sam Bankman-Fried, the founder of cryptocurrency derivatives exchange FTX. One line really stuck out to me: "Whenever he listens to someone, SBF seems to be mentally toggling between their perspective and a few dozen others." As Bankman-Fried himself explains, answering a question about his favorite thinkers, "There are bits and pieces I try to patch together from different people. In so many cases, people will have really important insights that I missed. Then they'll also have a lot of really dumb thoughts." Taking a page from his book, I tried to toggle between two perspectives in this week's column, by looking at the blooming decentralized finance (DeFi) market through the lens of traditional finance (TradFi) and vice versa. Hopefully the result is more illuminating than you would get by marinating in just one worldview.  If you like what you read, please forward Crypto Long & Short, and reply to this email with feedback and questions. You can also find me on Twitter.    Enjoy the rest of your Sunday.   – Marc Hochstein, executive editor A message from Crypto.com Buy bitcoin and 100+ cryptocurrencies with 20+ fiat currencies. New users can enjoy 0% credit/debit card fees on all crypto purchases made in their first 30 days. Download the Crypto.com App now. The Briefing Imagine thinking that not collecting sensitive data is inherently a bad thing. That canard seemed to be the subtext of two memorable lines in last Sunday's front-page New York Times story about the regulatory crackdown on cryptocurrency lending.  In a passage explaining decentralized finance (DeFi) platforms, the authors note, with a faint whiff of disapproval, that "the sites do not even collect users' personal information." The whiff gets stronger a few paragraphs later, in discussion of the Compound lending protocol, complete with air quotes. "Each of the nearly 300,000 'customers' is represented by a unique 42-character list of letters and numbers," the authors write, referring in Gray Lady style to a user's wallet address. "But Compound does not know their names or even what country they are from." Four years after the breach of the credit reporting agency Equifax, which exposed the personal information of 147 million people, would it have killed the Times to at least consider the upside of not storing such records?  "On the normal web, you can't buy a blender without giving the site owner enough data to learn your whole life history. In DeFi, you can borrow money without anyone even asking for your name," Brady Dale wrote in CoinDesk last year.  Of course, there is a catch, as he was quick to add: "DeFi applications don't worry about trusting you because they have the collateral you put up to back your debt (on Compound, for instance, a $10 debt will require around $20 in collateral)." This purely collateral-based approach to lending taken so far in DeFi has disadvantages for the borrower and lender alike. A challenge for the industry is to move past the current model's limitations without sacrificing the privacy-preserving innovation that the Times implied was some kind of outrage.  To understand those limitations, we have to take a detour to the musty, stuffy world of traditional finance. Read the full column here.   – M.H.   A message from Copper Copper provides a gateway into the cryptoasset space for institutional investors by offering custody, prime brokerage, and settlements across 250 digital assets and more than 40 exchanges. We are committed to providing flexible solutions that adapt to the changing cryptoasset space, while enabling far greater transparency, control, and security for asset managers.    To learn more visit copper.co/interest Chain Links Coinbase CEO Brian Armstrong tweeted the U.S. Securities and Exchange Commission threatened to sue the exchange over a yet-to-be-issued lending product, even demanding the names of customers on the waitlist. TAKEAWAY: This is the latest signal that Gary Gensler's SEC is taking a tough line on the crypto industry following the agency's reported investigation of the developers of Uniswap.    DeFi derivatives platform dYdX airdropped more than $50,000 worth of its governance token to certain users. TAKEAWAY: Governance distribution has again produced a windfall for DeFi users, as the fully diluted value of the newly issued token was almost $12 billion. Well, most DeFi users: U.S.-based users were barred from the airdrop because of strict securities regulations.   El Salvador's law making bitcoin legal tender took effect three months after it was passed by the country's legislature. TAKEAWAY: President Nayib Bukele has firmly stood by the decision to adopt bitcoin as a payment method and store of value, boasting that El Salvador now holds 550 bitcoin, nearly $26 million worth at recent levels.  Mastercard agreed to buy blockchain sleuthing firm CipherTrace for an undisclosed sum. TAKEAWAY: Visa and Mastercard have both made significant moves to adopt blockchain technology. The nature of blockchain may be an improvement upon legacy payment systems, with faster settlement times and immutable, transparent transactions. So one possible interpretation is that the payment giants are hedging against the greater adoption of digital ledger technology. But remember that despite being a consumer-facing brand, Mastercard's customers are banks, so the company may simply see CipherTrace as a play to offer those institutions more services – in this case, analytics for compliance.  Crypto-focused private equity fund 10T raised $389 million for a second round of later-stage crypto investments. TAKEAWAY: Institutional money is now moving into crypto through several types of vehicles. 10T takes a different approach than venture capital funds and is betting on the ability to generate cash flow through mature digital asset businesses. Its portfolio includes the likes of Kraken, Ledger and Huobi. FTX added Steph Curry to its dream team of athlete ambassadors in an equity deal. TAKEAWAY: The exchange has used around $350 million in capital from its recent funding round for marketing throughout the sporting world. The marketing approach is a bet on attracting a new user base from outside of crypto.   – Teddy Oosterbaan Introducing Crypto for Advisors, a weekly newsletter designed to inform and educate financial advisors (FAs) and registered investment advisors (RIAs) who seek to incorporate this rapidly moving asset class into their work. Subscribe today. Podcast episodes worth listening to: How the '08 Financial Crisis Is Helping Guide OCC Chief Hsu's Agenda – Acting Comptroller of the Currency Michael Hsu and Rob Blackwell, "Banking With Interest."  Why Former US Regulators Are Moving Into Crypto – Nathaniel Whittemore, "The Breakdown." Congressman Tom Emmer: 'Crypto Is Not Partisan' – Michael Casey and Sheila Warren, "Money Reimagined." Crypto Long & Short A newsletter from CoinDesk See Previous Editions Copyright © 2021 CoinDesk, All rights reserved.  250 Park Avenue South New York, NY 10003, USA You can manage your preferences here or unsubscribe from all CoinDesk email.