Maple Finance — The suits are coming! And why that might be sweeter than it sounds
Launched in 2021 Maple Finance serves three different market participants within the cryptosphere: those willing to lend their funds out in return for a yield, institutional borrowers wanting to borrow those funds for a price and thirdly those qualified to manage this relationship for a fee.
Combining the use of smart contracts with a well thought out method, Maple has created a credit marketplace where vetted institutions can borrow against their reputation in the form of an under-collateralized loan.
In terms of challenges, this is a world apart from the current methods within decentralized finance where over-collateralized lending has previously been the only option available.
Over Vs. Under Collateralized Lending
Decentralized lending and borrowing started with ETHlend in 2017 but after an extended bear market where liquidity dried up the project failed until it was reborn as AAVE which went live in early 2020.
The smart contracts developed by AAVE allow investors to deposit their crypto holdings as collateral into a given pool to then receive another cryptocurrency in the form of an over-collateralized loan.
An example and use case of an over-collateralized loan would be someone holding $100,000 worth of $ETH that has a need for dollars but does not want to sell their $ETH position. They would lock up the $100,000 worth of $ETH within AAVE and receive $80,000 worth of the $USDC stablecoin. When they want their $ETH back they would repay the $USDC loan plus any interest.
As the value of the $ETH deposited in the AAVE pool is above the value of the $USDC borrowed from the pool the loan is considered over-collateralized. If market forces push down the value of the $ETH position into pre-defined parameters it would be automatically sold on the market to pay back the outstanding loan. This method removes almost all the risk for the loan provider from a default and works with a completely trustless methodology.
Over-collateralized loans have proved incredibly popular with crypto investors wanting to borrow against their portfolios and equally well for platforms willing to provide this lending facility. No credit checks are needed from the borrower and in the event of a default no third party needs to be hired to recover the loan. AAVE alone had over $19B in value locked as collateral with dozens more providers offering this type of service. In tradfi this would look similar to a lombard loan with a non-recourse provision.
Outside of the cryptosphere a borrower, whether an individual or company, would go through the lenders process of due diligence and have their credit-worthiness determined based off the Five C’s (character, capacity, capital, collateral and conditions). Once the supporting documentation for all the C’s is ready it can then be submitted to the chain of risk analysts to gather enough plausible deniability to qualify for the coveted rubber stamp of approval.
Under-collateralized lending however opens up a lot more risk to the lender. Funds are lent out based on the evaluation made on the borrowers ability to pay back the loan, which involves an element of predicting the future. If things don’t go to plan and repayments aren’t made to schedule then a process to recover the funds begins and at the lenders expense.
Defining credit worthiness based on reputation can be very subjective which contributes to the reason why there hasn’t been any major developments to automate the 5 C’s even within centralised tradfi. The anonymous nature of crypto makes a credit reference agency difficult to implement and debt recovery in the event of a default nearly impossible to enforce. These components may be developed in the future but for the moment a meeting in the middle is where Maple is operating. Decentralized in some aspects but lacking the external infrastructure to go all the way.
Let’s take a look at the problems solved for each stakeholder interacting with the protocol and how it works for each of them.
The Lender. With real world interest rates hovering on or just above zero for the last few years and not-so-transitory inflation rising above 7% has meant idle cash has been losing its purchasing power at a rate not seen since the 1980’s. Therefore the risk free rate of return offered by savings accounts is actually guaranteeing a loss.
A few paces down the risk curve we’ll see that even AAA-rated corporate bonds with yields of under 4% hardly make a dent.
It’s not hard to understand then the temptation investors felt when Anchor, a decentralised savings protocol, was offering 20% APR on stablecoin deposits. A stablecoin being a digitalised version of the US Dollar with a value of 1:1.
Anchor was quite transparent that this fixed rate of 20% was unsustainable long term and would decrease once it changed to a variable rate, so the rush began to get it while you can.
After 10 years of referral programs from the likes of Airbnb, ride hailing apps, food delivery services and even razor blade subscriptions a whole swath of consumers and investors have become very accustomed to well funded tech companies employing high growth tactics at huge expense to get user numbers to critical mass. This may have been a factor that led opportunistic investors in Anchor to be blinded from other risks.
Touted as a safe way to enter the cryptocurrency space the Anchor protocol attracted over $15B within its first year with many of the depositors being first timers to the crypto space.
To cut a long story short, the stablecoin being used depegged from the US Dollar, bringing down the whole Terra Luna ecosystem that Anchor was built upon with it. It became evident after mercenary capital left that heavily subsidised growth tactics aren’t as effective within DeFi for creating a sticky user base and everyone lost their shirt.
If there was one benefit to be found in the aftermath of the UST collapse it has to be that it has investors asking more of the right questions.
Begs the question then — how do the pools found on Maple offer 6.8% — 11.4% APY? and what makes it any different?
- Sustainable yield derived from lending to real companies. The return a lender receives comes from the interest rate the borrower is paying (minus any fees). As the borrower is a real company paying for a lending service it is vastly different from Anchor where yields were coming mostly from a marketing budget. That said…
- Maple does need to be attractive. While the bulk of the yield a lender receives is coming from real world businesses paying back their loans plus interest, the $MPL token is given as an added bonus to lenders. The value of the $MPL token contributes to the APY percentage displayed on the pools. A simplified example would be a pool showing a 9% APY would loan funds to borrowers at an interest rate of 5%. The lender then receives this plus $MPL tokens equating to another 4% of the deposit. So, $100,000 USDC deposited would be withdrawn as $105,000 in USDC and $MPL tokens valued at $4000 = $109,000. More on the $MPL token in Tokenomics.
- Current borrowers within Maple pools tend to be crypto focussed trading firms that employ non-directional and delta neutral trading strategies or businesses sitting cash-flow positive. The make up of the borrowers is of huge interest to the lenders as it determines the risk profile of their whole investment.
- In the event where a borrower misses a repayment there is a layer of protection to soften the financial impact on a lenders yield. This is defined as Pool Cover. Every pool offers two different layers of protection and is the first money at risk that goes to “make the lender whole” — one is from the $MPL token which we will cover in the Tokenomics section and the second is detailed below under Pool Delegates.
- All borrowers have been fully KYC’d and have signed a Master Loan Agreement. In the event of inability to repay, impropriety or misconduct where a loan is taken but not repaid by the borrower there are real world consequences which can be enforced through the courts.
The Borrower. Businesses of all sizes and circumstances have a need to borrow money — whether it’s to open a first barber shop, set up new offices in territories you’re expanding into or facilitate larger trade volumes within a market making operation.
Within tradfi there are a number of different sources of funding that could be considered to finance these growth plans but a crypto native project would face a number of additional challenges in persuading a traditional lender of its merits.
Due to a lack of traditional options then, a crypto native firm wanting to finance growth plans would likely be limited to seek out VC money or other forms of direct investment which carry a very high cost of capital. Borrowing at a single digit interest rate versus giving up equity in the business is more efficient — especially if the funds will de directed towards CapEx or OpEx.
This is where Maple steps in. Having created a marketplace where the underserved Borrower can present their funding requirements directly to those with deep sector knowledge provides an option previously unavailable to these businesses. In fact, while crypto native firms appear to be the focus at the moment there is also future where Maple’s solution could be applied to businesses outside of crypto that face similar hurdles.
To qualify as a borrower and receive a loan from a Maple pool the process isn’t dissimilar to what you would find in tradfi. It involves completing an application form, detailing how the funds will be used, completing KYC requirements and other information the Pool Delegate requests in order to build a risk profile. Once submitted, the approval decision will ultimately be made by the Pool Delegate and terms including loan duration, interest rate, penalties, required collateral etc. will be agreed upon before the borrower pays the 0.99% origination fee and receives the loan.
Pool Delegate. Perhaps even more than Maple itself the responsibility for safeguarding lenders funds falls on the shoulders of the Pool Delegate. But while the terminology of Lender and Borrower may be familiar the term Pool Delegate will be new to the vocabulary.
In tradfi the duty for understanding the risk profile and credit worthiness of the borrower is determined by an underwriter. Their evaluation process will be a combination of the Five C’s, a deep analysis into the business financials and how the macroeconomic environment may affect said business. From this process a judgement will be made into how likely it will be for the loan and its interest to get paid back.
An important skill set of a Pool Delegate is to be a good underwriter. However running a Maple pool and being an underwriter for a bank do have some key differences. This is because the pool is a syndicate of investors capital that gets lent out and a bank lends out its own money — this separation of church and state provides massive scalability for Maple but leaves some areas that need to be filled back in for incentives to re-align.
- Management. Running a pool and managing a hedge fund aren’t worlds apart. Both need to define a strategy on how to deploy investor capital — a hedge fund could choose large blue chip investments or decide to focus on smaller high growth potential companies. In the same essence a pool delegate may decide to lend sizeable sums to a handful of established institutions or choose to have their pool more fragmented in dozens of smaller borrowers. There’s no wrong answer here but again it’s a question of risk and making a decision.
- Redemptions. The most optimal use of the capital would be to have 100% of the pool deployed and earning interest. However that would leave nothing left for Lenders wanting to remove their capital from the pool. It becomes the job of the Pool Delegate to get as close to 100% deployed as possible whilst also being able to facilitate the redemption requests from Lenders wanting to remove their capital.
- Reputation. If Maple continues it’s current growth trajectory and meets it’s very public goals of attracting $5–$10B over the next 12 months it will be one of the leading destinations for Lenders to make deposits. This flood of capital will inevitably lead to competition within the marketplace between Pool Delegates vying to attract investors who will be evaluating their past performance.
- Pool Cover. A reputation for good management and track record of solid underwriting skills should offer some reassurance to investors but if we’ve learnt anything from our friend Nassim Nicholas Taleb there needs to be skin in the game. Once a Pool Delegate has been approved by Maple and a pool is created they will need to establish pool cover before taking on any Lenders funds. Built into the smart contract is a protection layer consisting of $100,000 of the Pool Delegates own funds. This deposit of sorts act as the first at risk money in the event of a default from the Borrower, it functions so the Pool Delegate loses first protecting the impact on a Lenders capital. This is in place to keep interests aligned and forcing the Pool Delegate to put their money where their mouth is when it comes to choosing credit worthy borrowers.
- Fees. To serve these core functions and take on the associated risks the Pool Delegate receives a fee of 0.33% of the loans originated and a cut of the interest charged. While it doesn’t sound like a lot compared to a hedge funds “two and twenty” fee structure but with pool sizes of $100 — $300M this quickly becomes a worthwhile endeavour especially when it is usually outside of the core business.
- Investors and Funding
- Tokenomics and Revenue
- Growth Case Study
- Links and Resources