Those that have been around and have read recent editions of The Flip Notes know that I'm bullish on crypto. But not merely cryptocurrencies - and the act of speculating and trading - but on the crypto economy, the applications being built on top of Web3 infrastructure, and the opportunities thereof.

A few weeks back I asked, and wrote, "(How) Does Crypto Win in Africa?" There are going to be many answers to this question, and today, I'd like to write about one of them: Goldfinch.

While I don't normally write about one individual company at length like this, Goldfinch is bringing DeFi to the real world, starting with markets in the Global South. And after speaking with the company's Chief Investment Officer, Sam Eyob, for an upcoming episode of the podcast, I'm bullish.

The startup was co-founded Blake West and Michael Sall, both ex-Coinbase, and thereafter brought on Sam, formerly of the lending platform Lendable. And they boast a stellar roster of investors across both traditional and crypto VC, as well as emerging markets: a16z, Kindred Ventures, IDEO CoLab, Variant Fund, Slow Ventures, as well as Balaji Srinivasan, Carbon's Ngozi Dozie, and the IFC's Global Head of Venture Capital, Wale Ayeni.

There are several challenges in DeFi today, all of which Goldfinch is attempting to address:

• DeFi is currently complex and unapproachable for your average individual, on both the lending and borrowing sides of the marketplace.
• While there is an abundant crypto capital in the ecosystem, how do *we* make it more productive in the real world?
• Most DeFi platforms offer over-collateralized loans, making loans available only to those with available capital for collateral.

Let's start at the top.

What is DeFi...

With apologies to those who need no introduction.

DeFi stands for decentralized finance. DeFi protocols build financial marketplaces, adjudicated by smart contracts.

In a traditional lending and borrowing scenario, I would deposit my cash in a savings account at a bank (earning me a pretty low yield), and then the bank would lending that money on to borrowers, based on their own criteria to determine the likelihood of repayment. Traditional finance is centralized, and the lending decisioning is made centrally by the institutions.

DeFi, on the other hand, is open and permissionless. Anyone can put up their crytpocurrencies to lend, and anyone can borrow provided they put up adequate collateral in the form of other tokens. Most DeFi platforms today offer over-collateralized loans to ensure repayment, meaning as a borrower I would need to put up as collateral at least 1.5x the amount I am looking to borrow.

And these markets are coordinated by smart contracts, which programmatically perform a given set of predefined actions on the blockchain. Whereas in a TradFi scenario you're trusting your money to a person in a bank, in DeFi, the trust lies with the smart contract. (The code having bugs or being hacked is indeed the biggest risk in DeFi.)

An over-simplified borrowing and lending scenario looks like this: I lend my ETH through a decentralized application, and the protocol lends to another user after verifying that they have adequate collateral. I receive interest on that loan and the borrower has a predefined amount of time in which they must repay their loan, with interest. If the user doesn't pay back their loan by a certain time, or if the value of their collateral drops below a certain amount, the smart contract can programmatically liquidate the borrower's collateral, giving it to me as repayment.

DeFi applications are doing this at scale, over millions of users and billions of dollars. The global, borderless nature of the crypto economy means that when I lend, it might be borrowed by someone in Peru or Canada or Uganda or India. Lending protocols aren't discriminatory and, indeed, Maker - one of the earliest DeFi platforms - calls itself "an unbiased global financial system".

...and why does it matter for emerging markets?

The MSME financing gap is $2.2 trillion, according to Lendable, with over 200 million MSMEs having no or insufficient access to credit. This is a huge constraint on growth, both of the individual businesses and the markets at large.

From a startup perspective, while the amount of equity financing raised is reaching new heights this year, most companies in emerging markets need to raise debt on the back of the equity. The fastest-growing companies in emerging markets today aren't pure SaaS companies - they need working capital for asset financing, small business lending, etc.

Emerging market fintechs or MSMEs alike may not be viewed as attractive or viable funding options by traditional debt financiers, due to a lack of collateral, or the funders lack of understanding of the markets in question and/or prejudiced lending decisioning. It can be cumbersome and slow to raise debt capital in emerging markets, if not impossible altogether.

And for those who can access debt capital, it might be expensive too. Most global debt funds will lend in their preferred currency, say USD. However - and particularly in a market like Nigeria, which has strict foreign exchange rules and capital controls - these borrowers get crushed on FX when moving this money into say Naira, and then back out into Dollars again when it comes time for repayment.

Crypto solves the problem of illiquid forex markets, because these markets have liquidity, making it easier and more affordable to move a stablecoin like USDC into Naira and then back again.

Now, on the liquidity piece - there is also a lot of money tied up in DeFi. Over $178.76 billion, at the time of writing, according to DeFi Llama.

Aave, launched in September 2018 and the largest protocol in the DeFi ecosystem, has over $25 billion locked in its platform. For context, the total assets of Nigeria's largest bank, Zenith Bank, are roughly $20 billion.

So why have DeFi applications attracted so much attention and money? While there may be lots of different reasons, the primary answer has to be yields.

My business banking account offers me 0.001% per year on my savings. Bond yields are the lowest they've ever been, and negative in some places. Capital is looking for yields.

Meanwhile, I can currently lend USDT, a stablecoin, on Aave for 13.46% APY.

Yields are so high for a variety of reasons (and there are multiple types of yields across different DeFi use cases beyond lending). It's a complex game of juggling incentives on both sides of the marketplace, but in any instance in which the middlemen are cut out, rates are going to improve accordingly. (It's worth mentioning, Aave has just 55 employees, according to LinkedIn.)

But on the other side of the market, who are the borrowers?

Sure, some people are borrowing to buy fridges or other purchases in real life, I suspect most borrowers are doing so for the purposes of leveraged trading. So, surely we can make crypto capital more productive, right?

Enter Goldfinch.

Bringing crypto loans to the real world

When I think about the biggest opportunities in crypto, I generally think about the need to make decentralized apps more approachable and user-friendly. While that's still true, my conversation with Sam revealed another opportunity I had currently overlooked: compelling crypto-native individuals - from which $178 billion is currently locked up in DeFi - to lend their money more productively.

There are always going to be those chasing huge yields, but for those looking for a nice return on stablecoins (that is, coins in which the value is pegged to the USD), Goldfinch is not only a great option - offering yields from 10 to 18.75% on USDC to Backers - but one in which lenders can currently see exactly where their money is going.

Here's how it works...

Much like a typical DeFi platform, there are lenders and there are borrowers. On Goldfinch, there are two types of lenders: the Backers supply first-loss capital to given borrower pools (for which current yields are 10-plus percent). Liquidity Providers lend to the senior tranche, in which capital is automatically allocated across the individual borrower pools, earning LPs a passive yield of 6.16%, at the time of writing.

Borrowers can propose a "term sheet" to Backers, consisting of proposed interest rate, payment period, term, and so on. Borrowing is democratized in that, theoretically, any prospective borrower can access capital provided there are backers willing to put it up.

At present, those borrowing through Goldfinch's protocol are fintechs and debt funds which, when funded, draw down lines of credit to lend on to their customers. They include Almavest, a debt financing platform focused on financing fintechs with a positive social impact; Aspire, a SME lending platform in Southeast Asia; PayJoy, a fintech offering smartphone financing in Mexico; and QuickCheck, which offers consumer loans in Nigeria. (You can see all of the borrower pools here.)

In the case of Almavest, they approached the protocol looking to raise $2 million. After holding an AMA session with prospective Backers and providing a data room, Almavest's borrower pool was fully subscribed, upon launch, in just 30 minutes!

This "simplified crowdfunding model" - coordinated by smart contracts - avails cheaper and quicker debt capital to those who, at present, are then supplying that capital on to either other SMEs or individuals who may otherwise not have access to finance. And the goal, ultimately, is for the protocol to open up to individuals and SMEs seeking financing across the Global South.

As an investor, lending your capital to a pool on Goldfinch is without question more productive and brings greater utility than other DeFi protocols. And additionally, for traditional debt investors, lending in this way enables greater liquidity than the status quo in the traditional financial ecosystem, as a Backer's investment is represented as a non-fungible token (yes, NFTs are more than just JPEGs) which can be bought and sold on the secondary market.

We can imagine a future where, for this reason alone, Goldfinch then brings more traditional debt investors into the crypto fold, attracting even more (institutional) capital into the crypto ecosystem.

Now, there's one final piece to the puzzle: collateral.

At present, if I want to take out a loan on a DeFi protocol, I need to put up 1.5x collateral. That defeats the purpose of lending, as those who need a loan won't have the collateral to put up to receive a loan. So Goldfinch has built a protocol for crypto loans without collateral.

The beauty of the crypto economy, which is adjudicated by smart contracts on a blockchain, is that all transactions are transparent and "on-chain", and that chain is immutable. And this impacts borrower incentives to repay, in a world of uncollateralized loans. Per the whitepaper,

Borrowers need to publicize their address when proposing pools to Backers, their on-chain history becomes public to future creditors, even those off-chain.

Presumably, borrowers are going to want to continue borrowing, whether from the protocol or outside of it. But the protocol turns off the taps the moment Borrowers are late on a payment, and presumably, Backers will be unlikely to supply more capital to Borrowers who are late on their repayments.

Borrowers also need approval by Auditors in order to borrow, who are incentivized with Goldfinch's governance token, GFI. This provides further human-level checks to help secure the protocol against fraud.

This underpins Goldfinch's "trust through consensus" model (which also determines how funds are allocated into individual borrower pools from the senior pool). The trust through consensus principle means that "while the protocol doesn't trust any individual Backer or Auditor, it does trust the collective actions of many of them."

It's going to be an incremental approach, and the role of Sam and his credit team, at present, is to source credit-worthy funds and fintechs to bring to the protocol as borrowers. The protocol has launched in stages through a closed beta and then will progressively decentralize.

One last thing - smart contracts built on blockchains like Ethereum are composable. An individual can interact with a smart contract, and smart contracts can interact with each other. Smart contracts can act as Legos, with other developers building on top of one (or multiple) protocol(s).

A good example is the DeFi platform Yearn Finance, a lending aggregator built on top of several protocols. I can, for example, lend a stablecoin through Yearn's app, which will then determine for me which of the protocols it's running on will garner me the highest yield.

Goldfinch is not just a lending product, but a protocol that anyone can build on top of. We can imagine a future where developers use Goldfinch's protocol to build a lending-as-a-service platform, by combining it with other protocols that do credit underwriting or surface live analytics on the borrower. Or where developers built something entirely different and yet-to-be imagined.

So, if you're an individual or investor looking for a productive home for your capital, a fund or fintech raising debt, or a developer looking for something to build - do your own research, and - consider getting involved.¹ This is the future of borrowing and lending in emerging markets.

--

✌️ Justin

‍