Benjamin, cap | Private Credit And The Evolution of Onchain Yield

Hi everyone. My name is Benjamin and I'm the founder of Cap. Today we're going to talk about verifiable credit. And this might seem like a new word and it is because we're presenting a new framework by which we can improve the current infrastructure for private credit with the goal of making it safer for investors and making it safer for lenders. The first of all, before we talk about what private credit is and um how we are tackling that problem, we have to think about why is this important for this room.

Why is private credit important for crypto markets? And the short answer is that crypto needs real yield. Right now, crypto is uh yield in crypto is a circular economy. We have not escaped the Bitcoin markets. So all the major yield platforms in crypto, and I'm talking about yield that's above a billion dollars in AUM, revolves around Bitcoin markets, whether it's Bitcoin back lending, inflationary incentives whose tokens are highly correlated with Bitcoin, or perpetual basis trading, which is also reliant on um the market for Bitcoin.

So the problem is we're focusing too much on these crypto native markets and so when the Bitcoin prices are up, we have a lot of yield. When Bitcoin prices go down, we have the current scenario in which most uh yield platforms in crypto can barely beat US Treasuries rates. So we need some way to connect our yield markets to the productive economy, an economy that is not just tied to this circular economy that we've built within crypto. And we think that private credit could be an interesting opportunity to do that. Now, why?

Well, what is private credit? Private credit largely is a large umbrella and it covers direct lending to any sort of private company. It can be to manufacturing firms, it can be to trading firms. It's a very wide range of lending to private companies. And today is one of the fastest growing ways of traditional markets to earn yield.

Obviously without with its with its problems, which we'll we'll discuss, but we think that this is a very good way for crypto to get yield. Now, if we can for the purposes of this presentation, agree on two things that crypto needs real yield and that private credit is a good opportunity to get that yield. If we can agree on that, how should we bring it to on-chain markets? Should we just tokenize it? Well, so far many players in the space have taken that approach.

Let's just tokenize existing private credit and bringing it on chain. I think this a terrible idea. Why? Because we would be exposing crypto to some very key and important drawbacks that exist in private credit. We have an opportunity to use smart contracts, to use crypto technology, to improve private credit instead of just bringing it on chain to our users.

Now, if we wanted to improve private credit in order to bring it to our users in order to improve the yield in crypto, we have to address some key drawbacks. Now, these are the drawbacks that us as a team at Cap we think are the main ones and the ones that we should solve. Obviously, we cannot fully solve all these problems. We can try to mitigate them as best as we can and so I'm going to explain what these are and how we want to mitigate them. The first one and the one that I'm personally most interested in is scalability.

So, we have to understand how credit is underwritten in these private credit funds today. So, what you will have is obviously all of the borrowed demand, the different types of companies that want to borrow from these private credit funds. And all of them are underwritten by the employees of these private credit funds. Obviously, implementations vary. Each company will have their own investment committees, their own portfolio managers, risk committees.

Depending on the jurisdictions, there might be different requirements from regulators. But what binds them all together is that no matter how many loans are being processed, let's say two loans, 10,000 loans, a million loans, they will all go through the same people. And so, obviously, people can't you you can't if you have 10 employees, you can't do 10,000 loans. Maybe you can do 50 loans a year. And so, as a result, out of all the opportunities, you will have maybe a a few that you actually enter into.

And so, two things will happen. Either you will underwrite too many loans, more loans than you can actually um due diligence on, or you will just focus on the big loans that maybe are not as competitive, but allow you to deploy. In practice, it's a bit of both. Some loans get fast-tracked when they shouldn't have. Some loans that are not that profitable uh pass through the the cracks.

So, how are we at Cap trying to improve that system using smart contracts? Well, what I want to have you guys focus on is this role of the the underwriter. We're bringing this new role that does not exist in private credit, and it's new and we're bringing it with Cap. And so, what is it? Well, these uh folks are come from different types of industries.

We can have stakers like EtherFi, like Renzo. We can have credit insurers like Travelers Insurance, Liberty Mutual. We can have credit funds like RockawayX. We can have crypto funds like Antalpha. Now, very wide range of companies.

What brings them all together? Well, what brings them all together is that they have assets that are not that productive compared to the US dollar. So, for example, a credit fund that has Swiss francs. Swiss francs is a wonderful asset, but the yield is not great compared to the dollar. For example, we stakers, Etherfi, they have ETH.

ETH is a great asset, but it's not as productive as the dollar. So, why do they come to Cap? Well, we bring them to Cap because we tell them, you can now underwrite individual loans, and you can get a premium for underwriting these loans um against your assets. And the the premium will come from dollar loans, which is way more productive than the assets that you have. And so, they come to Cap in order to get yield from these loans.

On the other side, you have the same loans that private credit has. So, anybody that's borrowing from Apollo would be borrowing from us here. The difference here is how the underwriting happens. So, any number of these underwriters will have their own set of skills, their own industries that they're comfortable with, and their own relationships that they have on the borrowers. So, for example, a restaker like Etherfi, maybe they know a lot about the business model of FalconX.

So, they will underwrite FalconX. They'll put their ETH and say, "I vouch for FalconX to borrow from Cap." So, the result is that now Etherfi gets um a credit spread for underwriting that loan that they would not be able to access otherwise. And our dollar uh lenders now get a secured rate on their dollar, which is higher than they would get otherwise in crypto. And this is a real example.

FalconX is actually uh getting liquidity from us. So, Skuid has is actually getting liquidity from us. And so, you can see here that unlike in the traditional model where you have all the loans going through the same people, here you can have an unlimited amount of underwriters, an unlimited amount of borrowers all being underwritten at the same time. So, that's how we address scalability. The second problem uh or the second issue that we uh identify with private credit is misaligned incentives.

The people that are responsible for underwriting credit at these private credit funds are not completely aligned with the lenders. And because of this, it leads to some outcomes that are not favorable for the lenders. For example, many private credit funds continually change their accounting practices in order to manufacture yield where there's no yield. And so this is bad for lenders, obviously, because you think you're getting 9 10% APR, but it's really that accountants are playing accounting games. And here's some details about why the incentives are misaligned.

Well, the lenders, they want to protect their principle, number one. Number two, they want to get some yield. Whereas the private credit funds, they want to have more AUM, they want to deploy more so that the capital is sticky cuz it's deployed. The private credit fund employees, very different. They want to advance their careers, they want to make more money.

And so you can see that these are not exactly all the same uh incentives. Similar slide to what we saw recently. How do we try to address this using smart contracts? Well, the decision maker here is the underwriter. If a crypto fund with their Bitcoin underwrites Susquehanna and Susquehanna defaults, well, who's losing money?

It's the underwriter, it's the decision maker. And because uh the underwriter doesn't want to lose their money, they're going to make a better decision because it's, you know, they're dealing with their own money. Uh the next one is opacity. Opacity is a bit complicated because there is a lot of information when it comes to loans. There is the return on these funds, there is what is being used with the money, there is the collateral.

So there's a lot to get into. I want to focus specifically on collateral. Why? Because a staple in private credit is collateralized loan obligations. Where you have the borrowers that put up collateral as recourse in case they can't pay back the money.

Um I want to tackle that, that's what we're trying to focus on a cap. And in in TradFi, traditional private credit spaces, we see that there's large-scale fraud. There's an issue where the same borrower will pledge their collateral to multiple lenders. And so, when there are issues and somebody needs to get that collateral back, they find that there's no collateral, right? Because all this collateral is either hard to price, hard to identify, maybe it's based on NAV, maybe is some sort of other very complicated collateral, or it's been pledged to multiple people.

And you would think regulators are tasked with making sure that this doesn't happen, but in reality, that's not the case. You can see First Brands and Tricolor lost a lot of money to a lot of lenders, and regulators were not able to protect these lenders. So, how do we solve it? Well, we're in the blockchain, right? If all of the assets are on the blockchain, it's impossible to double pledge.

We see MakerDAO, which is now called Sky and Aave, they've been doing over-collateralized lending for many years, and it works. If you have your ETH at Aave, we know it's at Aave, you can't also put it at Morpho. The other part is automated recourse. If we do need to liquidate, if we do need to get recourse from the collateral of these underwriters, it all happens automatically. I don't need to make a phone call, we don't need to go to court, the smart contracts will execute the logic without asking anybody.

And that keeps the lenders safe, it keeps the borrowers safe, it makes sure that there is no room for misinterpretation. The next and the final one is illiquidity, which is another complicated problem that we obviously cannot fully solve, but it is very problematic right now in private credit. Right now, a lot of retail investors are trying to leave private credit because they're scared of everything that's happening now with all these large-scale frauds. And we found out that all this capital is deployed. And so, if you're retail and you're trying to remove your liquidity, you really can't.

And maybe it will take you several years to leave because there are caps on how much you can withdraw each quarter. As a As a result, a lot of people are getting pennies on the dollar and they're incurring a lot of losses. The way we solve this, well, not solve that, but the way we try to mitigate it is two different ways. One of it is relying on code. If you want to withdraw your liquidity from CAP, we don't need to call somebody.

There's no emails. There's no human interactions. We're almost like a vending machine. And this is the way a lot of decentralized finance works. Everything's automatic.

You say, "I want to remove my capital." And everything beyond that happens based on code. The second part, which is a bit more of a complicated discussion, is how we price the capital in our protocol. Historically, if you have a mismatch of liquidity between how much you're lending, how long you're lending, and how fast your depositors want their capital, you're going to have to make some trade-offs. Are you going to favor the borrower, or are you going to favor the depositor?

Well, in traditional private credit, you favor the borrower. You just want the capital out there because you want it to be sticky, and you really don't want people to remove their capital. In tradi- In traditional decentralized finance like Aave or Morpho, we're favoring the lenders to the detriment of the borrower. And the way that works is with these very steep utilization curves. So, if people try to remove their liquidity, the utilizations will spike.

Now, the borrowers are paying so much in interest that they have to bring back the capital. CAP, we're trying to meet in the middle. So, normally, the way we lend money to these traditional institutions like Susquehanna, like FalconX, is that we have near fixed rates so that there's no um large volatility in the interest rate that they're paying, and they they can plan their capital markets based on that. However, if we get to a point where there is extreme volatile or extreme competition for the capital, everybody's trying to leave or a lot of people trying to borrow and the utilization of our of our capital reaches beyond 90%. At that point, we switch and we're no longer favoring the borrower.

Now we're favoring the lender. And so we at that point we do kick in the interest rates which either force people to repay or allow new investors to come in that are interested in that higher yield and then we can swap new lenders for for the old lenders. So as a summary, I think that private credit is a necessity in crypto in order to tie us to the real economy. We need real yield. And private credit needs blockchains.

Clearly, markets are not happy with private credit today and we need a better solution. And I think Cap addresses these needs. So if you want to learn more, you can go to cap.app and I'll be around the conference so happy to chat. Thank you guys.