DeFi lending for business: the $5tn opportunity no one is talking about
Decentralised finance or “DeFi” is on track to become the financial phenomenon of 2019. Even before the announcement of its most famous example to date — Facebook’s Libra project on 18 June — the trend was already on the lips of everyone from government ministers to crypto investors.
10 days prior to the “Zuck Buck’s” big reveal, G20 Finance Ministers and Central Bank Governors met in Japan. On the agenda was a seminar involving leading cryptographers and academics discussing the findings of a Financial Stability Board (FSB) report entitled “Decentralised Financial Technologies”.
Whether or not attendees had anticipated Facebook’s move, clearly DeFi had already succeeded in securing its place on the G20 agenda.
In this article, we’ll explore why — despite these successes — the current state of DeFi is embryonic and limited in both achievement and ambition, with the most important use cases yet to emerge.
We’ll also position our own project — Clear Factor — within it: as a radical new DeFi solution to tackle an oft-overlooked $5tn global financial access problem.
What is Decentralised Finance?
DeFi involves using decentralised technology to dis-intermediate middlemen, eliminate centralised processes and breakdown geographical boundaries (that have historically hindered access to financial services). Examples include the decentralisation of information recording (such as distributed ledgers), consensus mechanisms, and decentralised risk-taking and decision-making (such as P2P lending). In doing so, DeFi promises to improve efficiency, reduce costs and make financial services more accessible to all.
The technology community behind DeFi
DeFi is made possible by the ability to program the rules and outcomes of financial interactions through protocols such as Ethereum, with its smart-contract functionality. DeFi already receives much debate and attention within the global crypto start-up community and, according to Defiprime.com, there are already 182 such projects in progress across 15 categories including:
· Assets management tools
· Decentralised Exchanges
· KYC & Identity
· Margin Trading
· Prediction Markets
· Tokenisation of Assets
The Block’s recent infographic, reproduced here, shows the current players in more detail:
So what DeFi products are live already?
Of the DeFi products with live financial throughput, half of the top ten are currently focused on niche crypto lending use-cases. These apps comprise almost 90% of all USD value flowing in to the 17 leading projects tracked (source: defipulse.com). Volumes are small but growing, with USD value locked within lending projects up more than 300% over the last 12 months from $163m to $664m.
Top live products include Maker (which at the time of writing holds almost three-quarters of all of value locked), Compound and Dharma:
· Maker offers decentralized censorship-resistant issuance of what are essentially crypto loans, although you must “overcollateralise” your loan with existing crypto holdings to a minimum of 150% the value of the loan.
· Compound delivers investors interest of up to 8.10% on their crypto holdings by making them available for (overcollateralised) short-term loans.
· Dharma also offers interest on crypto with users earning up to 10% on crypto deposits locked up for 90 days.
Kudos must go to these projects for launching products already and beginning to, at least technically, deliver on DeFi’s promise to remove middlemen (in this case quickly and automatically facilitating loans without a bank in sight). However, they remain niche and so far, the stated potential of DeFi is a long way away from being realised. This is understandable, given it often takes time with new technology for the major use-cases to be fulfilled.
Banking the unbanked
It has been suggested that DeFi could help bank the world’s unbanked:
· 31% of the world’s adults do not have a bank account or mobile money provider.
· Of these 1.7bn adults, two thirds of them (1.1bn) do however have a mobile phone.
Therefore, so the thinking goes, there is a significant opportunity to help improve access to retail financial services through DeFi’s potential to be used with only an internet-connected device such as a smartphone as a minimum requirement.
Libra tips a nod towards exactly these ambitions with its grand mission to “enable a simple global currency and financial infrastructure that empowers billions of people.”
Its white paper states that the world’s unbanked struggle due to “[in]sufficient funds, high and unpredictable fees, banks being too far away, and lacking the necessary documentation”. However, it remains less clear just how it will achieve these goals in practice (should it reach fruition in the face of impending major legal, regulatory and political battles — in what will be a significant test-case for DeFi).
Redefining the scope of DeFi
It’s clear that as of today, DeFi only has niche achievements to show for its lofty aims. Once again, this is no criticism — it is early days. However, by focusing its end-vision on retail users but its initial execution predominantly on esoteric crypto-leverage products, many important use cases have fallen between these two stools. This is where our project, Clear Factor, fits in.
As most debate is limited to the retail challenge — i.e. unbanked individuals — the problem of unbanked organisations is often overlooked. And yet the picture is similarly vast and unpalatable. The World Bank estimates that 70% of all micro, small and medium-sized enterprises (MSMEs) in emerging markets lack access to credit. This credit “gap” is as high as $2.6tn.
In fact, it could be far higher however as a 2018 IFC/SME Finance Forum study found that 65 million enterprises, or 40 percent of formal micro, small and medium enterprises (MSME) in developing countries, have an unmet finance need totalling $5.2 trillion a year
This is clearly important, given that 90%+ of the world’s businesses are MSMEs, and they contribute 50% of the world’s gross value added. In Europe, SMEs employ between 60–70% of the workforce.
Clear Factor: funding the unfunded
How could DeFi’s promise to be permissionless, decentralised, trustless, transparent, censorship resistant, and programmable help solve such a problem?
We believe that small companies with up to ten employees could benefit the most from a new kind of business-lending model.
These MSMEs consistently say that access to working capital is their number one challenge. Since the 2008 financial crisis, the big banks have continually failed them, considering them to be high-risk and high-cost to acquire, underwrite and serve.
Often an MSME’s sole short-term funding option is invoice finance, whereby they provide their ledger book as collateral for credit. Yet a lack of choice and competition means there are many challenges for this solution too: inflexible “lock-ins” of an entire ledger book for long time-periods, exorbitant and opaque fee structures, complicated application procedures and documentation requirements and so on.
At Clear Factor, we believe that an unfulfilled, unrecognised but eminently achievable promise of DeFi is its potential to open-up business lending across borders and to fund unfunded SMEs.
We are clear on wanting to achieve this vision and, unlike some projects, we are also clear on how we will achieve it.
We believe every viable SME business should have access to fair-interest rate working capital in the form of invoice finance via a democratised and decentralised ecosystem.
To achieve this, we are already building a global ecosystem of SMEs, debtors, investors and underwriters, in which every member benefits materially from using the Clear Factor ecosystem whilst also being empowered to govern it.
What’s different about our solution?
In our model, an SME can auction off each invoice in their ledger book one at time to raise debt. There are no lock-ins, fees are transparent and the process is streamlined. Fraud (such as duplicates invoices being auctioned) is prevented through the use of an immutable distributed ledger.
Each debtor invoice is assessed twice — one by algorithmic means and once by a new breed of freelance local underwriter within the ecosystem, who is rewarded for doing so. Investors (both individuals and organisations) are encouraged into the ecosystem to provide debt to viable businesses in this way. To open up access and lending across borders, we will use the Stellar network to facilitate currency conversions and cross-border transactions.
These are all improvements on the current system that should mean better access to working capital for many more MSMEs. While there are a handful of companies in the space working on some parts of this model, no-one else is building a complete and comprehensive ecosystem in this way and has the right kind of team to achieve it.
What of delivering on DeFi’s promise to cut out the middle men? Well, up until now, invoice finance has predominantly been offered by large financial institutions. In our model, individual investors can buy invoice debt and freelance underwriters can underwrite individual invoices — these are new roles that do not exist in the marketplace today, which we hope will also help with new kinds of flexible job creation in a financial employment market that is already changing apace.
Despite the recent hype, decentralised finance remains nascent, misunderstood and narrowly defined. These challenges must not limit its progress or ambition. It’s time for DeFi to spread its wings beyond current limitations and start to deliver on its wider potential. With Clear Factor, we have a plan to do just that — and help solve the $5tn business credit challenge that hinders future global growth.
You can read more about our project, goals and timeline at our website. Please follow us on Medium to receive our latest updates.
Visit Clearfactor.io today to join the Fair Finance revolution today and help the world’s SME’s finally get the treatment they deserve.