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“[Dharma] helps achieve our mission of creating a borderless, permissionless, and generic credit market by bringing liquidity to our ecosystem projects.” Brendan Foster
Crypto lending has become sought after by holders who want access to liquidity without having to sell their coins at depressed prices, by holders looking to offset dilution from protocol inflation, and by traders and investors who want to take on leverage or borrow coins for short selling. Borrowers can deposit their crypto as collateral to take out loans in dollars or dollar-pegged assets, and lenders can loan out their assets to earn a rate of return.
The majority of borrowing and lending is facilitated through exchanges like BitMEX and Bitfinex or custodial lending platforms like Genesis Capital in crypto markets today. The criticisms against centralized lending platforms include that they are custodial (users are not in control of their funds), not globally accessible, and often limited to institutional traders and investors. In response, non-custodial crypto lending platforms have emerged to democratize access to credit markets, including key player, Dharma.
Dharma launched its decentralized, non-custodial peer-to-peer credit market publicly this week. Since launching on April 8, 2019, the platform has originated over $900K in loans. Prior, it ran an alpha version of the product, known as Dharma Lever, that has been in pilot mode since ETHDenver. Originally, Dharma was created with the intention to be an open protocol that provided third party developers with the tools and platform to build several types of lending applications on a standard protocol. Dharma Lever was going to be the first of multiple applications on the protocol. With the application’s public launch, the company has shifted its focus from developers to users. Coindesk reported, “Dharma will pivot with this news, from a protocol to a company that’s facilitating the marketplace it created.”
With Dharma, anyone anywhere with an internet connection can create an account and instantly access the Dharma credit market. Unlike traditional credit markets, users are not required to have bank accounts or undergo credit checks to access the services offered by the platform. Dharma leverages smart contracts to automate key functions such as collateral management. Moreover, the protocol is open-source and transaction data is publicly trackable, which provides transparency to stakeholders in the system and could provide borrowers with a new way to build credit history. This could be especially appealing to individuals who don’t have access to basic financial services (though onboarding this demographic will likely take more time and education). Third party data platforms such as Dharmalytics and LoanScan make it even easier to track network activity. Further, because Dharma is an open protocol, it is openly auditable and globally accessible, which could improve price discovery and result in more competitive rates.
Dharma offers borrowers and lenders a fixed interest rate for a fixed period of time. Borrowers currently pay 0.1% to borrow ETH and 2.5% to borrow DAI. In order to take out a loan, borrowers are required to deposit collateral that is 150% the value of the loan. The system notifies users if the value of the collateral falls below this threshold, but the smart contract will automatically liquidate borrower collateral if it falls below 125% of the value of the loan. Lenders receive 2.5% on ETH loans and 4% on DAI loans, though their deposits only start earning interest when the funds are deployed, i.e. matched with a borrower.
Initially, borrowers can take out loans for a period of 90-days, but the team said it plans to add more optionality around loan terms. Starting off, Dharma is also subsidizing users — borrowers are paying a lower rate than lenders are receiving. This could change down the line. Further, Dharma plans to eventually charge origination fees as it matures and becomes a “very standard revenue-generating business. A normal company, making revenue off of good software.” Users currently have the ability to borrow and lend ETH and DAI, though the platform could roll out support for additional assets down the line.
FOCUS ON USABILITY
A key differentiator of Dharma versus many decentralized applications is its focus on simplifying the user experience and abstracting away the usual complexities of dealing with cryptoassets. What stands out is that users can send funds to Dharma’s smart contracts from any mobile, desktop, or hardware wallet — they are not limited to using Metamask. Additionally, Dharma has created Dharma Key, a four digit pin that users set up to access and control their funds, which is intended to address the burdensome task of managing private keys and signing transactions. A key advantage of Dharma over custodial lending platforms is that, once matched, capital is deployed from the borrower to the lender within a matter of minutes or seconds.
One uncertainty lies in how Dharma plans to transition from subsidizing users to generating revenue. For the time being, the company is covering the spread between lending and borrowing rates and is also abstracting gas costs away from users. While this incentivizes participation and improves usability, it is likely not sustainable. Recognizing this, the company intends to eventually establish an origination fee to mitigate these initial costs. Moreover, Dharma raised $7 million earlier this year from Green Visor Capital, Polychain Capital, Coinbase Ventures, and others to support its new direction.
Additional risks such as fiscal uncertainty and sourcing borrow demand apply to crypto lending platforms as a whole. As it stands, “borrowing money against [a] crypto investment is not a taxable event.” ETH holders can, for instance, realize potential profits in the more price stable DAI through Dharma while avoiding capital gains taxes. However, the IRS has yet to address crypto-collateralized loans and future decisions on the matter could impact user demand or even the legality of crypto lending service.
Another issue is that the ratio of lenders to borrowers is unbalanced. According to Hollander, “there is much more interest in lending cryptocurrencies than there is in borrowing them.” This might be a key reason crypto lending platforms are offering borrowers lower interest rates than lenders receive at the potential expense of profitability. To address this concern, Dharma has been ramping up efforts to source borrow demand by partnering with hedge funds.
That being said, it is still early days in the world of open finance and crypto in general. While it’s important to continue monitoring progress on challenges that can be addressed, it’s encouraging to see a team building a borderless credit market that offers a similar (dare I say, better?!) user experience relative to traditional fintech products and services.
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