The Investor’s Guide to TrueFi Capital Markets

Crypto capital markets connect yield-seeking investors to capital allocators, often representing a variety of investment strategies

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Graphic by Crystal Le

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key takeaways

  • DeFi has long struggled to find yields that aren’t correlated with crypto, and as a result, even the most robust overcollateralized protocols feel liquidity tighten in market downturns
  • The experts at TrueFi believe that the $8 trillion global credit market is ripe for blockchain disruption

What are crypto capital markets?

Like in traditional finance, crypto capital markets connect yield-seeking investors to capital allocators, often representing a variety of investment strategies. But unlike the old model, this new market place uses blockchain infrastructure to provide access to alternative digital assets, increase funding efficiency, reduce fees and most importantly, add transparency in terms of economics and real-time reporting.    

But the approach to blockchain integration and decentralization varies greatly. While some markets rely on centralized underwriters, other DeFi protocols delegate this job to portfolio managers, or even seek the wisdom of the crowd in the form of DAO participants.

Capital markets also differ in how they seek to offer a wider range of collateralization options. When lending was initially introduced to DeFi, borrowers were limited to the common over-collateralized loans on platforms such as AAVE. Addressing the capital inefficiency of over-collateralized lending will allow DeFi lenders to expand their market share; the total addressable market for global lending is $8 trillion. 

Borrowers today now have access to uncollateralized loans through a new breed of credit protocols. In this sponsored guide, TrueFi – one of the first credit protocols to innovate beyond the constraints of over-collateralized lending, will help us explain their approach. 

What is TrueFi?

TrueFi is a credit protocol designed to break down the barriers of capital inefficiency through a hybridization of on-chain governance and credit-based lending. Using on-chain governance introduces a new level of transparency, while credit-based lending allows lenders to manage risk through traditional due diligence and underwriting methods and portfolio management. Together, the two approaches allow TrueFi to offer loans without the need for over-collateralization.

While TrueFi was first launched to connect pooled lender funds with vetted crypto-native borrowers, TrueFi is now also a home for independent portfolio managers seeking to allocate capital to real world opportunities. This represents a new method for fund management, reducing the overhead of running a fund while opening the door to global DeFi liquidity.

Furthermore, TrueFi argues that offering credit on-chain gives investors more transparency into their capital decisions, possibly even preventing the centralized lender implosions recently observed in the crypto markets. Most of all, TrueFi is built on the belief that these benefits, in aggregate, will finally attract traditional institutional capital to DeFi.

Industry leaders are looking to TrueFi as a potential catalyst for DeFi’s march towards broad adoption, especially beyond crypto-native usage. While not eliminating inherent credit nor smart contract risk, this new model could potentially can change the paradigm. 

The history of TrueFi

TrueFi was introduced by Archblock as DeFi’s very first uncollateralized lending protocol in November 2020. They were the first DeFi protocol to originate an on-chain unsecured loan to Alameda Research. While Archblock managed most off-chain responsibilities (like know-your-customer and credit checks), TRU token holders were active in approving both new borrowers and individual loans. 

Since then, TrueFi has evolved to make lending decisions guided by a credit model, while taking differences between borrowers into account through traditional underwriting. This has dramatically increased the rate of borrowing while adding improvements to staking, governance and lender liquidity.

After growing over $1.7 billion in originations through its lending protocol, TrueFi officially launched its on-chain capital markets, opening TrueFi to serve as financial infrastructure for nearly any kind of credit financing opportunity. The credit markets allow fund owners or portfolio managers to bring their portfolios on-chain, with deep controls over nearly every element of their portfolio including lender selection, fee structure, strategy and duration. This quarter, TrueFi will add further institutional upgrades such as tranching and a dedicated capital allocation period, pulling the protocol toward feature parity with the lending products available in traditional finance.

In June 2022, TrueFi announced a second significant milestone in its roadmap toward progressive decentralization. They formed the TrueFi Foundation, a legal entity that represents the interests of a newly formed TrueFi DAO. This update followed the launch of binding on-chain voting and a transfer of key TrueFi smart contracts to the DAO’s control, formally putting the future of the protocol in the hands of its token holders and users. Launching the TrueFi DAO allows TrueFi to operate entirely independently from Archblock. In turn, Archblock will remain a key contributor to TrueFi, but focus its efforts on being the institutional bridge between traditional finance and TrueFi infrastructure.

TrueFi’s mission has evolved throughout its history. Though TrueFi started with the intent to become DeFi’s leading uncollateralized lending protocol, TrueFi’s recent steps toward decentralization and the growth of real-world lending on the protocol have pushed TrueFi toward a much bigger mission. Today, TrueFi states it is to become a ‘publicly owned & operated financial utility,‘ emphasizing credit-based lending for the entire global lending market. 

What impact can TrueFi Capital Markets have on TradFi and DeFi?

DeFi has long struggled to find yields that aren’t correlated with crypto. As a result, even the most robust overcollateralized protocols feel liquidity tighten in market downturns. The team at TrueFi argues that if DeFi’s lending ecosystem had more real-world exposure and greater transparency, fewer individual actors could threaten liquidity failure with a single market downturn.

Routing DeFi liquidity to real-world lending 

Opening DeFi liquidity providers to portfolio managers captures that real-world utility, as TrueFi can provide credit-based lending where DeFi can’t. For example, TrueFi recently added USDC.homes, a portfolio dedicated to providing loans to Texas-based homebuyers. This type of exposure generates yield uncorrelated with the crypto ecosystem, making direct real-world impact while also diversifying a crypto lender’s portfolio. It is not only a stabilizing force but also a DeFi adoption driver. As a result, TrueFi sees it as the bridge to the remaining $8 trillion in the traditional global credit market.

Capital efficiency for on-chain lending

For this “TradFi-to-DeFi” bridge to work, lending protocols need to attract traditional portfolio managers and lenders. TrueFi’s on-chain portfolio management has become a major attraction because it provides more capital efficiency to borrowers and gives managers greater liquidity at lower costs without sacrificing control over their portfolio.

TrueFi also argues that moving the operations on-chain removes traditional bottlenecks and makes the approval process more efficient. Automated smart contracts, broad portfolio access from launch, and transparent lending histories replace much of the human capital needed for traditional fundraising, reporting, and management purposes.   

Increasing lender access

The best lending opportunities are rarely presented to investors who aren’t high net worth individuals or institutions. This happens for a variety of reasons: lender eligibility requirements (such as accreditation or being outside US jurisdiction), minimum commitment requirements, or simply the fact that seeking out retail investors for premiere deals has low return on time for the portfolio manager. 

TrueFi built its capital market to help portfolio managers extend these opportunities to a broader pool of investors.  And like traditional capital markets, portfolio managers (PMs) retain control over investor eligibility. By bringing alternative investments on-chain, TrueFi mitigates several disadvantages that smaller investors face in traditional finance markets in terms of implementing strategic asset allocation with alternatives, diversifying cross-sectionally and managing investments. 

Ultimately, this model derives its value from its efficiency and transparency. And as it attracts more portfolio managers into the DeFi lending ecosystem, TrueFi believes it will offer investment opportunities to investors they wouldn’t be able access anywhere else.

How does TrueFi Capital Markets work?

Onboarding with TrueFi

To launch a portfolio on TrueFi, managers must first be approved by TrueFi governance. Managers typically make a public post to introduce themselves and gain community support for their onboarding.

To publicly launch their portfolio to TrueFi’s thousands of lenders, managers must enter a legal agreement to access services required to design and launch a compliant portfolio. In the past, this process was run through Archblock. A small but growing list of vendors are offering TrueFi managers solutions like know-your-customer checks or co-marketing support. 

PMs pay a protocol fee on all outstanding loans in their portfolio to the TrueFi DAO treasury, which is how the DAO generates income. TrueFi covers the next steps to launching a portfolio on their website.

Portfolio Managers

Once the service agreement is signed, portfolio managers are responsible for underwriting loans they originate. This form of “delegated underwriting” allows the DAO to focus on supporting TrueFi infrastructure while placing the role of managing the risks and returns of a lending book in the hands of relevant industry experts, namely the portfolio managers.

In addition to screening for anti-money laundering (AML) and combating the financing of terrorism (CFT), PMs execute lending contracts with each borrower. This agreement provides legal recourse in case of a default. Ultimately, the protocol relies on PM expertise and grades them by reporting on-chain the loan performance. PMs with better performance are more likely to attract lenders to their portfolios. 

Investors

Investors on Archblock’s Institutional Platform generate sustainable yields and have a diverse list of alternative assets and portfolios to select from. Lenders on TrueFi earn yield on both loaned stablecoins and staked TRU.

Investors interact with portfolio managers similarly to how they do with liquidity pools. They either provide or withdraw liquidity from the fund. Some portfolios are permissioned, meaning that investors need approval from the PM. Regardless, all investors must complete KYC requirements before any business is conducted. Investors receive portfolio tokens representing their investment after depositing. Once a portfolio is closed, liquidity providers redeem their portfolio tokens to withdraw funds plus accrued interest.

Borrowers

Borrowers use TrueFi’s application form to get connected with a manager. Because it’s the PM’s responsibility to underwrite the loan, approval requirements will vary from manager to manager. Some could choose to lend with 100% LTV or others could lend with no required collateral. Some might require tokenized collateral like USDT, or they could accept physical property. 

All of this depends on the mission of the portfolio. Some managers might want to target higher yields by offering unsecured loans to high-net-worth institutions. And some managers might wish to have a diversified portfolio with a mixture of high and low-APY loans. 

Inherent risks

Regardless of strategies, it is essential to remember that even with expert underwriting, credit checks and legal recourse, risks of defaults still exist. TrueFi outlined the additional safeguards they take to mitigate those risks in a blog post. Additionally, any protocol with a layer of off-chain governance does require a higher degree of trust than total on-chain governance. Like any unsecured lending protocol, TrueFi’s objective is to develop innovative solutions that offer as much transparency as possible while acknowledging the inherent risk. In terms of technical risks, TrueFi has undergone five smart contract audits and remains hack-free.

Closing Thoughts

The experts at TrueFi believe that the $8 trillion global credit market is ripe for blockchain disruption. There are too many inefficiencies and bottlenecks preventing capital flow to solid investments, while both access constraints and rent-seeking intermediaries keep retail investors from accessing alternative investments. By solving for these inefficiencies and opening up access, TrueFi is in a race to become the first trillion-dollar protocol. 

Blockworks’ recent Twitter Space with TrueFi, Maple Finance and Goldfinch demonstrated how much that competition is heating up. 

TrueFi sees itself as the first credit protocol, and maintains the largest book of loan originations. Their latest developments in real-world lending, decentralization and on-chain portfolio management could set them up for success. For now, investors and sideline spectators alike will need to wait and see if this traction is enough to attract institutional interest and add a few more zeroes to TrueFi’s total value locked.


Disclaimer: Nothing in this sponsored guide is intended to provide investment, legal or tax advice and nothing in this article should be construed as a recommendation to buy, sell, or hold any investment or to engage in any investment strategy or transaction.

This content is sponsored by TrueFi.


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