Dharma Protocol: An Overview

A Protocol for Tokenized Debt Assets

German Espitia
Apr 27, 2018 · 7 min read

2017 was the year of the ICO. More than $2B were invested into tokens. This points to a very real and unmet demand from retail investors for assets with equity-like risk profiles. In the real-world, equity is a much smaller asset class than debt. Naturally, it makes sense to port the world of debt to the blockchain.

What is Dharma?

Dharma is a protocol for tokenized debt. It creates a common standard that all stakeholders can use to administer tokenized debt assets throughout their life cycle.

Debt is a massively varied asset class, and, in theory, virtually any type of debt agreement could be issued and underwritten via Dharma protocol. Examples include bonds, retail and margin lending.

By unbundling the process of debt, Dharma brings a transparent and open-market model for issuing and pricing of debt and thus lowers the barriers to entry for all debtors, creditors, underwriters and relayers.

Debt goes digital

Why build an open protocol for debt?

Any alternative worth pursuing must bring significant improvements to the current status quo. In the case of debt, an open protocol makes sense for several reasons:

  • Barriers to entry: allowing anyone to build applications for a fundamental building block of economic life fosters innovation.
  • Interoperability: different entities will be able to communicate with each other and allow new players to be instantly compatible — an end to walled gardens.
  • Comparability: in the case of financial assets, being able to compare value across assets makes the network more efficient.

“The collective value created by a network of networks is greater than any single individual network”.

Joel Monegro

Why move debt onto the blockchain?

As with any other primitive, it is not so much that these systems can’t be built in a centralized manner but that once the central data broker is taken out of the picture, it makes these systems much more socially scalable. From that starting point, we are left with two good reasons to move debt onto the blockchain: opportunity and improvement.


ICOs hit a nerve in the masses that allowed companies like Coinbase to gain more customers than stock brokers like Charles Schwab. If the ERC20 standard enabled ICOs, Dharma could enable Initial Debt Offerings or IDOs. An IDO would allow projects to raise funds through debt and pay back investors on pre-defined terms.

And why not? Equity markets pale in comparison to debt markets. As Nadav from Dharma pointed out: “the total value of global equity hovers at around $73T, a relatively modest sum in comparison to the $213T in global debt assets.” If the world’s value is going to be tokenized, it only makes sense that debt does too.


The entire planet felt the shock from the 2008 financial crisis. One reason for the crisis was because of the lack of transparency behind debt instruments such as Collateralized Debt Obligations or CDOs. Dharma aims to build a future where anyone can look at publicly traded debt instruments such as CDOs and write a blog calling them out for being subpar.

Debt markets are notorious for lack of transparency and inefficiencies. Sitting behind proprietary silos, it is not easy for the public to evaluate the integrity or value of debt instruments. This gives way to abuse and corruption, a stigma that the financial industry now holds with the general public.

Furthermore, debt is not easily transferable, let alone programmable. Tokenized debt is primed to benefit off of the intrinsic properties of blockchain based assets:

  • Transparency
  • Open-market pricing
  • Transferability
  • Programability

How does it work?

Before describing the high level functions of the ecosystem, we go over some definitions to better understand the interactions within the system:

  • Debt orders: data packet used between agents and keepers (defined below) that contain the necessary data for the Debt Kernel to trigger the issuance of a debt token and atomically swap the principal amount from creditor to debtor.
  • Debt Kernel: smart contract that holds all the business logic to administer the debt.
  • Terms Contract: smart contract that holds the terms which debtors and creditors agree upon.
  • Repayment Router: smart contract to route repayment from debtor to creditor while reporting to the Terms Contract of the repayment.

Agents and Keepers:

Dharma’s ecosystem is made up of two sets of players: agents and keepers. Agents are the end-users of the system — debtors and creditors. Keepers provide services to the network in return for compensatory fees.

  • Debtor: “a party in a debt transaction who is borrowing an asset and owes a creditor some agreed upon value”
  • Creditor: “a party in a debt transaction who is lending an asset is owed some agreed upon value by a debtor.”
  • Underwriters: The originators of debt. They negotiate the terms of the loan with the debtor and attest to the likelihood that the debtor will default. They are also in charge of forwarding the signed debt order to relayers, servicing debt by using all reasonable measures to ensure repayment and handling collections in the case of defaults.
  • Relayers: They aggregate debt orders from trusted underwriters and provide investors with meta-data necessary to make informed investments decisions.

How it all comes together:

An example of of the cycle of a debt asset would be as follows:

A model of how the debt issuance process flows, beginning with the debtor.

A debtor approaches an underwriter looking to borrow funds. The underwriter evaluates the debtors credit worthiness and presents the debtor with the terms of the loan. If the debtor accepts, the debtor will sign the debt order while the underwriter will cryptographically attest to the likelihood of the debtor defaulting. Now we have a debt order with signatures from the debtor, underwriter and an agreed upon terms contract.

The debt order is now forwarded to any numbers of relayer(s) who will host the debt order for investors to evaluate given the meta-data associated with the debt order (e.g. underwriter history, terms, etc).

When a creditor decides to fund the loan, they would sign the debt order and forward it to the Debt Kernel.

The Debt Kernel now mints a unique non-fungible debt token to the creditor, transfers the principal to the debtor and disburses the corresponding fees to the underwriter and relayer.

When the debtor makes a repayment, they would send their payment to the Repayment Router who will transfer the payment to the current owner of the debt token and register the payment with the corresponding Terms Contract. In practice, the underwriter will facilitate the repayment mechanism.

Please note that important details that pertain to implementing Dharma in the real world were left out. This includes underwriters and relayers obtaining necessary licenses, underwriters using legal means to collect collateral and ensure timely payments as well as the regulatory environment at the time of writing. Also, the model shown above is one of many, you can view others in the whitepaper.

What can be built with Dharma?

In the short-term, the more interesting use cases will be those uniquely enabled by the advent of digital assets.

  • Non-fungible tokens (ERC721) as collateral. You could take out a loan using digital goods as collateral. The Dharma team created a tutorial on how to take a loan using your Cryptokittie as collateral. Although just an example, it paints the picture as to how this could look like the in the future.
  • Borrowing and lending: You could also lend out or borrow digital assets against your ERC20 tokens. Dharma recently published Dharma Plex to showcase this functionality (open-source and free to use). Why HODL when you can LEDN?
  • Initial Debt Offerings: Along the same lines, with the rise of ICOs, we can see the emergence of Initial Debt Offerings or IDOs where the issuer is raising capital via debt. An example, uniquely enabled by NFTs and Dharma, might be a gaming company raising debt from fans and committing to repaying in special game characters, tokens or special items.

Over the long term Dharma, being a generic and un-opinionated protocol, could be used to issue and underwrite any type of debt instrument. We can imagine retail loans, municipal bonds, micro-financing, credit derivatives, etc.

End game:

Like all other financial primitives being built out today, it’s about giving the entire planet access to financial services. To understand how Dharma could do just that, consider the following:

  • No capital markets operations for underwriting (i.e. getting institutional investors to invest in their debts) lowers the barriers to entry and enables new markets to have access to funding. Anyone who has an interesting idea on how to originate and underwrite debt for X market can easily build an online lending business with out having to worry about how they are going to fund those loans.
  • Similarly, relayers don’t have to hold a balance sheet of investor’s cash as investments happen atomically between creditors and debtors, which again, brings down the barriers to entry and enables new markets to join.
  • Because underwriters’ history of making predictions is on-chain and transparent, the market should gravitate towards underwriters based on merit and not deep pockets or proprietary access to data.
  • Tokenized debt allows for instant secondary markets that should bring efficiency and more liquidity to credit markets. If the system were to gain traction, on average, people would obtain better rates than are currently available.

Unbundling the process with an open and transparent system allows new market players to enter the space to provide services for previously underserved individuals.

As Nadav stated, the end-game is making financial services as ubiquitous and accessible as Facebook is today. To commoditize financial services in the way Facebook did to content.

Resources to learn more about Dharma Protocol:

Thank you to Brendan Forster and William Pangas for the invaluable feedback.

Thanks to Brendan Forster

German Espitia

Written by

helping devs @coinbase. previously iOS / ecommerce magician.

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