Centrifuge 101 Questions

[davidbentzon]

Thanks for the write-up!

A few reflections/qs:

@sirj

With a fund like Percent investors know what is shown to them, with our end goal of transparency, we are working towards a future where investors can be more involved and educated regarding their investments thus leading to a scalable source of capital as more investors join in for Issuers.

What is it, specifically, that you want to make more transparent that is expected to drive more investors to provide liquidity?

@sirj

I would not suggest an Issuer rely on a single source as this can prevent growth.

Fully agree. But I feel like that is somewhat unrelated to the question regarding the need for a blockchain-based solution.

@sirj

So to answer why blockchain- blockchain benefits the investor by providing clarity and a trust-less system for investments.

How? Would be great with an example

[davidbentzon]

Thanks a ton for providing these insights. Super helpful.

Some of my clarifying questions are of more technical nature and maybe the Centrifuge team is better positioned to answer them.

Here goes:

@Harbor

Centrifuge’s infrastructure allows an issuer to launch a securitization at minimal cost

What is it about the technology (web3) that allows Centrifuge to provide securitization at minimal cost?

@Harbor

• Issuers have access to a new set of investors: Crypto native retail investors, institutions, DAO treasuries as well as integrations with other DeFi protocols

Why is it relevant for you guys to get access to a new set of investors? I’m sure you would be equally happy to access liquidity from fiat investors provided that liquidity is coming from different sources/entities.

@Harbor

• Investors gain access to asset classes historical reserved for large institutional players with the ability to diversify across different pools with a very low minimum investment ($5,000). Think of how ETF’s shook up the wealth management business.

It’s amazing. Big fan of this! However, I’m still left wondering why web3 is needed to solve this problem.

@Harbor

• Investing and Redeeming in pools is “self service” for investors with daily automated reporting on NAV calculations

Why is this a benefit for you?

[davidbentzon]

Why would you want to have decentralized underwriting? Do you think it would lead to a lower cost of capital for the Issuers?

[davidbentzon]

Incredible. Thanks for going on the record as well.

After reading your response and Bryan’s, my key takeaway is that Centrifuge allows Issuers to access liquidity cheaper.

As mentioned in a few other replies, I am still left wondering how specifically web3 is enabling this compared to a web 2.0-powered solution. Would be great to hear from the technical part of the Centrifuge team how they approached it and ultimately landed on a blockchain-based solution rather than web 2.0.

[Sherman]

Hey David!

Thanks for your interesting questions, I’m enjoying reading this thread…

I’m not a Team Member but an Investor so my 2 cent on this.

I feel like sometime Blockchain is a very convenient tool for some applications.

I’ve came across Bitcoin in 2014 and I got attracted to the Blockchain Tech because of Grid Computing (You can include in this Decentralized web hosting/Storage, etc.).

In Grid computing, the logic behind Payment (In for the requestor and multiples Out for the “Computors/Workers”) and Trust would be very hard to create via Web.2 and as Blockchain is and was an available tool that allow you to create complex Payment/Trust scheme, why trying to create a new Web 2 Tech pipeline that would allow you to do stuff that was never done before and would have been really hard to setup?Just use a tool that is already available, Blockchain.

I Feel like the same could apply to Centrifuge. Financial Market are made possible through very complex and expensive piping (Clearing House) and I think that Blockchain via its accountability, openness and it’s low-maintenance coast and the fact that it can support complex financial operation is the way to go to create an Open Private Debt Market (Centrifuge).

So is it impossible to do it on Web 2? Probably! But it’s doubtful it would achieve the same result.

Was Blockchain the tech to adopt to try this? I Believe so ! Hey, even the French Bank Société Générale want to give it a try!

PS: Most of actual Grid Computing project haven’t received the traction that they should had have, but, it’s mostly because of Bad Execution, Poor Token Design mostly due to the ICO (there is no need for a Token except a stable coin for them to work.) not because of the use of Blockchain.

PS 2 : I unfortunate can not give you a highly detailed view on specific technicalities that Blockchain allow you to do more simply than the Traditional Finance, I do not have the capacity to compare how the very very complex world of clearing house compete to the more open and “simple” but still highly technical world of Blockchain Tech, so it’s just an essay/overview on my thesis behind Centrifuge and the Blockchain plus value in general. Hope it was still somewhat interesting for you!

Cheers

[Tjure07]

It’s supposed to be cheaper and faster because you don’t need to rely on a single entity (=bank).

Here is a great thread on the topic

Token design proposal for underwriters to minimize trust in real-world assets

How to Reassemble the Existing Financial Infrastructure A token model for underwriters to minimize trust in real-world assets Centrifuge is a protocol for decentralized asset financing which lets businesses finance their real-world assets on-chain. We’re developing a new system of credit, one that is open, resilient to single points of failure, and with equal opportunities for borrowers and investors. Centrifuge creates the first alternative to banks and the existing credit system. [Screen S…

[davidbentzon]

Love it. I’m almost sold now. I’ll do a write-up on my thinking soon with a focus on comparing a web 2.0 solution with a web3 approach. Thanks!

[Tjure07]

That would be awesome. Do you mind to share it here?

I am very interested (and others for sure too) to see the comparison and the “winner”

[davidbentzon]

The question that’s been nagging me is: “Why do we need the blockchain to solve this problem?”

Here’s my current thinking about this. I’m going to keep it high level and focus on the logic.

To determine the justification for using web3 to connect Issuers in search of liquidity and investors looking for great risk-adjusted returns, we need to compare a web3 approach with a web 2.0 solution.

First, let’s take a look at the web 2.0 approach. I’ll use percent.com as a case study. Note, the information on their website is relatively sparse in terms of how things work under the hood, and so there are probably details I’m missing.

Web 2.0 approach

1. Underwrite/perform due diligence on the Issuer
2. Spin up an SPV for the portfolio of assets that the Issuer wants to borrow against
3. Create a bank account for the SPV
4. Market the opportunity to investors (typically HNWIs and Family Offices)
5. Perform KYC/AML on prospective investors
6. Create a bank account for each investor who qualifies
7. If the funding goal of the portfolio is reached, transfer the money from the bank account from (3) to the Issuer’s bank account so they can deploy the capital
8. Once the investment matures, the principal and yield will be manually transferred to the investors’ Percent accounts

Web3 approach

1. Underwrite/perform due diligence on the Issuer
2. Spin up an SPV for the portfolio of assets that the Issuer wants to borrow against
3. Create a pool On-Chain for the deal
4. Market the opportunity to investors (typically HNWIs, Family Offices, and DeFi protocols)
5. Perform KYC/AML on prospective investors
6. If the funding goal of the pool is reached a smart contract will automatically draw down the DAI to the Issuer
7. Once the investment matures, the principal and yield will be transferred to the investors’ wallets automatically by a smart contract

I have deliberately left out the case of underperforming investments and defaults from the process because the approaches in both cases are similar.

What approach can provide the lowest cost of capital to borrowers?

It’s clear that both approaches are fairly similar today. However, there are key differences.

Based on these differences, my current thinking is that web3 will be able to provide the lowest cost of capital because …

• Sending money to the right parties happens automatically via smart contracts → programmable money
• The bank is removed as a trusted intermediary
• Access to liquidity to the pools will be greater through composability (plugging into other DeFi protocols) → In a Discord conversation, one Goldfinch team member highlighted that a $10m deal got funded in < 2 hours. I’m sure Centrifuge has similar stories.
• [VERY LONG-TERM BUT EXTREMELY POWERFUL] Perfect competition for underwriters as underwriting becomes decentralized via network effects → faster and cheaper cost of capital
  • This could potentially be done in web 2.0 - and percent.com is working on it - but as an underwriter, I’d much rather participate in a network where I own part of the network as well

Additional benefits

• Full transparency of transactions → more trust
• DeFi runs 24/7
• Greater transparency through daily NAV updates

So, why do we need blockchain?

The technology is uniquely capable of removing several steps of the credit process which leads to a lower cost of capital for borrowers.

There are still many kinks that need to be worked out but as far as I see, blockchain has the potential to disrupt global credit markets in a meaningful way.

I would LOVE to hear other people’s thoughts so we can get smarter collectively.

[mayoe]

I would add secondary liquidity for smaller scale transactions and access to a global investment audience. @Harbor mentioned the size to but together and SPV in traditional markets was around 100 million. SPVs for small transactions is not as easy as people think. The non-standardization of the SPVs also creates barriers to easy secondary market transactions. Also, if you want to get out of a transaction early with Web3 there’s the possibility of trading your interest with another user, that is much less cumbersome then it would be using existing web2 solutions.

[davidbentzon]

Secondary market transactions and trading interests are massive benefits.

Btw, I’m curious. Do you know how trading interest work in practice in web3? Really curious here.

[JeremyKim]

Under Web2.0/Percent:
Firstly, I would start by saying that Percent’s process is probably a more streamlined version of the TradFi/Web2.0 approach (larger deals will involve additional steps and more third parties). Under Percent, the AO/borrower would have to create an SPV (not Percent), and Percent creates a separate entity that lends to that SPV, then Percent investors participate in the Percent entity that lends to the borrower’s SPV.

I would also add to the investor list for both, institutional credit investors.

For Web3 #7 - I believe the principal and yield are not actually transferred to the investors’ wallets, but are held in the pool as liquidity for the investor to claim (or can be kept in the pool for the pool manager to reinvest). For Web2 #8, I believe Percent deals distribute monthly interest (no option for reinvestment).

@davidbentzon

The bank is removed as a trusted intermediary

This may be an oversimplification. Typically in structured credit transactions, there are oftentimes several banks involved (i.e. depository account bank, trustee bank, lender, etc); so it’s not just “THE bank”, but rather “banks”. I would caveat this by saying that a lot of AOs will still need to convert the DAI (and eventually USDC) to fiat, so a depository bank would still exist in the Web3 solution today (though eventually this may also open the doors to fiat-native lenders lending out in stablecoins).

@davidbentzon

The technology is uniquely capable of removing several steps of the credit process which leads to a lower cost of capital for borrowers.

Instead of saying “removing several steps of the credit process”, I would say “removing several steps of the credit transaction process” - this is a key factor because we will still do the necessary credit underwriting work, but the execution of the funding transactions involve significantly fewer third parties.

[Rhano]

@davidbentzon I just came across this interesting article today on Cointelegraph where this is a report from BCG (Boston Consulting Group) which adds very relevant context to the conversation in this thread (on-chain tokenization vs. traditional asset fractionalization).

I figured it would be interesting for you to read it too, so I will share the link to the article on Cointelegraph below.

Tokenization of illiquid assets to reach $16T by 2030: Report