Crypto-enabled credit: the next wave of the crypto financial stack

The relationship between crypto and traditional financial players (yes that now includes you too fintechs) has swung from disdain (remember those days when crypto was written off as a casino) to the recognition that crypto will usher the next wave of financial innovation (initially through tokenization and stablecoins). A key component of any financial stack is lending - so the question is what does the next iteration of crypto-enabled credit look like?

Here's how I believe the crypto enabled credit stack is going to evolve:

✅ Stablecoins being used for payments:

It's 2023, I'm busy scaling the crypto-enabled payments product that I had built, and suddenly I notice an increased inbound of requests for conversations from my crypto friends and strangers building in the US. The West had finally woken up to something that those who had been building in emerging markets, like myself, had known for a while - Stablecoins have real utility even during a bear market.

Now many take it for granted, of course stablecoins make sense, in fact the champagne has been popping around crypto ecosystems as finally we have something that has achieved Product-Market-Fit, stablecoins. Fast forward to today every other bank or fintech has or is developing a robust stablecoin and blockchain strategy, everyone and their sister is launching or issuing a stablecoin and there are numerous guides, market maps and thought leaders emerging focused on helping you navigate the world of stablecoins. In fact by the end of 2024 not only had Stripe announced its acquisition of Bridge (an API that enables businesses to easily accept stablecoins) for an eye-watering $1.1billion, but there was a hot debate as to whether stablecoin transaction volumes had toppled Visa and Mastercards combined.

✅ Crypto as a source of liquidity:Outside of the crypto-native lending protocols (where you can lend and borrow cryptocurrencies), there is a growing real world asset (RWA) lending market where loan books, private credit funds and assets such as US treasuries, corporate loans and business invoices are tokenised and brought onchain.

Yet many of these projects focus on loan issuance, loan funding and loan maintenance as well as credit securitisation and bringing these onchain, and mainly provide loans to institutions. In and of itself this does represent a huge step forward. Apart from improving manual and labourious processes that existed within traditional lending (for example Kevin Miao beautifully articulates how credit securitisation, which is fundamental within credit, has benefited from being brought onchain), crypto-enabled lending also ushers in greater transparency and liquidity by enabling more individuals to easily and cheaply invest in private credit fixed income funds.

However, this is not the only way in which credit could benefit from embedded and leveraging crypto.

So remember this gorgeous image from earlier in the article? So far we have discussed Stablecoins being used for payments and Crypto as a source of liquidity, now onto the rest.

🟧 Yield bearing stablecoins being used for treasury management and to hold funds: The proliferation of yield bearing stablecoins (cryptocurrencies that are pegged to fiat and enable holders to earn yield without having to actively manage investments and regardless of what wallet they’re held in) is still, relatively speaking, new. In fact I remember sitting with a partner at one of the biggest crypto VCs and raving about how yield bearing stablecoins were going to be the next big thing, and spoiler alert he's right. With their creation, using stablecoins for more than payments starts to make financial sense for businesses, with the opportunity to earn higher yields than from fiat equivalents (eg short term reserves in t-bill etc). For example, at the time of writing:

With more businesses adopting stablecoins when it comes to the movement of money and blockchain technology more broadly, this is likely to be the next logical step - especially for businesses centred around cross-border payments or for multinational businesses. I share more thoughts on how yield-bearing stablecoins can be used to fuel and innovate within crypto-enabled lending.

🟧 Crypto enabled lending platforms using crypto as a source of liquidity, managing origination & investing in underserved markets:

Whilst we are starting to see how crypto can be used as a source of liquidity to finance RWA lending at scale, many of these protocols invest in institutional funds or large private credit funds usually focused on Western markets and only a few manage loan origination and underwriting themselves. Whilst some of these protocols such as Goldfinch started with the ambition of aiding the provision of credit to underserved credit markets (eg SMEs in emerging markets), many have since pivoted from this. Many of the key crypto-enabled lending platforms have played a significant role in enabling more people to invest in credit and fixed income vehicles, with less. However, the opportunity remains the same, there are still numerous underserved credit markets (whether in emerging markets, new sectors or even some markets in the developed world such as credit for immigrants) and these represent a huge opportunity.

This step will be key to unlocking the next step, bringing creditworthiness and underwriting completely onchain, Because ultimately if we target underserved markets it is possible to create native standardised onchain credit scores enabling creating automation, transparency and efficiency in the credit markets.

❌Underwriting and creditworthiness is brought onchain:

We aren't at this point yet because there is not enough onchain data tied to individuals identity. KYC is still a relatively new (and by some crypto purists, hated) feature in crypto. As more payments, transactions and savings for brought onchain for verified individuals and businesses it will be possible to use this data, alongside existing real world data to determine creditworthiness. This will come first before creditworthiness is determined using onchain data alone.

As I mentioned I'm not a crypto purist, by any stretch of the imagination. I simply recognise that this could offer huge benefits to the credit market, increasing capital efficiency, the types of credit you can invest in and enabling creditworthiness to be global, so that (somewhat selfishly) if I were to relocate my credit history wouldn't have to start from 0.

So the skeptics at this point (and by the way whilst it may not seem like it, I am far from a crypto purist) are probably thinking: “Ok nice jargon, but what does that actually mean and look like in practice?” 

Let’s keep it simple and focus on a credit card that leverages yield bearing stablecoins.

Yield bearing stablecoins could be used by credit card providers to for example reduce the end users APR - remember APR attached to credit consists of more than just pricing the risk of default, it also takes into account other fees and costs. Credit card issuers (and sometimes providers) earn merchant fees (fees businesses pay for accepting a credit card payment).  Imagine if the credit card issuer held a percentage of these merchant fees in yield bearing stablecoins, creating a new passive source of income whilst maintaining liquidity. This new income could be used to finance some of the fees and costs typically covered by APR, enabling APRs to be reduced whilst ensuring that the credit card provider maintains similar revenue levels and attracting more users.

Once again the more crypto-versed of you will say, "but aren't stablecoin yields underpinned by the (US) stablecoin issuers holding T-bills and many financial service providers use T-bills or money-market funds as part of their short term reserve process to cover daily transactions, credit settlements, and unexpected withdrawals, so what's the real benefit of yield bearing stablecoins in this case." Firstly, stablecoins offer instant liquidity with 24/7 markets. Secondly, there are stablecoins that offer yield that aren’t tied to T-bills take the third biggest stablecoin (by market cap), USDe by Ethena as an example.

While early RWA lending protocols focused on emerging markets credit access, many pivoted due to weak local underwriting. Having worked in emerging market lending, I've seen effective risk assessment models succeed - from Grameen Bank to Tala and Branch in East Africa.

Ultimately when reaching these new markets, to begin with crypto should largely be used to access additional liquidity and reduce the cost of credit, many of the other approaches that exist in traditional finance (cough cough robust underwriting processes) should be localised rather ‘cryptotized’ or brought onchain.

Equally let’s use Klarna’s CEO’s recent teaser tweet to explore other ways credit players could use crypto to reach new markets

Leveraging a robust and localised underwriting process, Klarna could accept payments in stablecoins. Many emerging market currencies can be volatile (devaluing rapidly at times) against Western currencies, making it harder and more expensive for the likes of Klarna to serve these markets (as they now have to worry about managing FX risks amongst everything else). At the same time, in some markets in can be difficult or expensive to access USD. Enter, you guessed it, stablecoins. Especially in markets where crypto adoption is rapidly increasing, Klarna could simply accept and leverage stablecoins, bypassing traditional payment rails.

Interestingly during the bear market we have started to see projects emerge that use crypto as a source of liquidity to finance underserved markets. Enter Arf by Huma Finance and Mansa Finance. Both of these protocols tokenise credit, using crypto as a source of liquidity to finance cross border payment companies removing the need of holding funds in multiple pre-funding accounts in different countries in multiple countries to offer real time (or at least quick) remittance options. In fact it is estimated that $4trillion is trapped in pre-funding accounts around the world. For example, here is how Mansa initially went about addressing this:

Crypto is the next wave of financial innovation but as Ben Bernanke (former Fed Chair) said:

So for crypto to truly usher financial innovation it needs a robust credit offering and stack. There is a whole separate discussion of some of the underlying infrastructure that need to exist in order for there to be a robust crypto-enabled credit stack but that's a discussion for another day. Remember it is only day 1.