What Happens in an Asset Default on Tinlake?

[Tjure07]

Jeannice explores a common question about Tinlake and Real World Asset (RWA) financing: what happens when a borrower defaults on a loan?

https://medium.com/centrifuge/what-happens-in-an-asset-default-on-tinlake-b50be2e5a363

[edwardwu11]

This is great Jeannice, thank you for posting! I think what would really be helpful for all readers would be a theoretical mathematic example of the on-chain calculations for each of: 1. a default of a short duration asset (eg invoice financing) of [x, 1?, 5? 10?]% of the TIN and how the calcs flow into NFT valuation, etc, 2. a default of a longer duration asset (eg mortgage).

[Tjure07]

Thanks for your question.

@roollie could you please reply to his post?

[roollie]

Sure, what is represented onchain is really a discounted cash flow model. In the model below, I kept it simple and assumed a 10% discount rate (the blended DROP yield and expected TIN return) and a 20% TIN buffer. Also, in Tinlake, you should not see a future-dated asset but I’m going for the spirit of your question. If the cash flows and the time period the default occurred are exactly the same, you see from the model below that the impact on the pool is the same.

In all likelihood however, for short duration assets, you should be able to manage the likelihood of defaults better: i.e. if it’s an invoice and the company doesn’t pay it on time, you can choose not to provide services to the company anymore. I’ve linked this quick model in Google sheets if you want to play around with the numbers further. Please let me know if you have further questions!

[edwardwu11]

Thank you Roollie! Just to play devil’s advocate (not trying to be obstinate, but want to make sure i fully understand), a couple further questions:

1. Why discount rate of 10%, what would be the financial/mathematic justification for applying the same discount rate to all assets–this implies all assets have the same risk in the future, doesnt it?
2. I’m not sure the short duration model is calculating correctly, with only asset 1 default, shouldn’t the pool value be higher than the long duration comparison? Asset 1 in the short duration example is much smaller impact than the asset 1 default in the long duration example. I may be missing something here

[roollie]

Oh no worries, I welcome the questions!

1. You are correct: I oversimplified to answer your earlier question directly. Each asset can have a different risk class: therefore different interest rate and potential default rate. The discount rate is a weight average of the expected portfolio mix. 10% was just a number I pulled out of thin air.
2. For the short duration model, I made 3 assets default per the screenshot. If it’s just asset 1, you are correct! If you play around with the numbers on the Googlesheet, there are many scenarios that you can come up with. I was more trying to prove the point in your original question that if the amounts and timeframes are similar, it doesn’t matter if it’s short duration or long duration.

[Ste]

Hey @roollie Roollie and others,

Not sure where to post these questions but they are similar to the one asked above.

Hoping you can help me out.

1.) What happens when loans for real assets default? How does the asset get repossessed and then liquidated?

2.) If I make late payments or choose to default, what are the ramifications to me as a borrower? Does it impact a credit score or anything else that “sticks” with the borrower?

3.) How are the underwriters any better than the current banking system? Are they not just a centralized group of people making decisions?

4.) How does Centrifuge know an asset isn’t double-levered? E.g. I have a loan on my inventory to my commercial bank and a loan on the same inventory via Centrifuge?

5.) What’s the pricing on these Centrifuge loans?
a. If they are like other DeFi spaces, they will be very high. Since people can borrow against real world assets much cheaper, is it fair to say anyone using this platform will be someone that can’t get a loan in the current world? Therefore, Centrifuge’s pool of loans is very risky, is it not?

b. If there are mass defaults, underwrites will close up shop, correct? With no real world underwriter to take the risks, then Centrifuge fails, correct?

Apologies if these questions have been answered elsewhere. If so, it would be great if you could direct me to the answers.

Thank you

[roollie]

Hey @Ste nice to e-meet you. Great questions! Please find my answers below, and I welcome other community members with relevant experiences to also chime in.

1. Per the article, this varies widely for different asset classes and it’s more about managing the process. For example, it can go to collections, or be sent to a service provider for repossessed and liquidation (or the issuer can do it themselves!). It depends on the asset class and the agreements in place; unfortunately there is no one size fits all answer here.

2. To clarify: do you mean as an end-borrower or as an issuer on Tinlake, which typically aggregates the assets across end-borrowers? As an end-borrower, your personal credit score could be impacted or if you are an institution, then you might find it harder to get funding. As an issuer on Tinlake, the beauty is that your repayment history is all on-chain, and available for all to see. Ideally that should be a good incentive to keep up performing loans, especially if you want to fund more in the future.

3. Not better or worse than TradFi, but a decentralized group of underwriters (like the Credit Group) should have less single points of failure.

4. The issuer SPV should own the collateral, but in the case of bad actors, double-levering could, in theory, happen. In the new legal structure, for any issuer with a trustee, the trustee will file a UCC 9-310 to perfect the security interest and priority so it would not matter if the SPV re-pledged the asset.

5a) You can look at the pricing on Tinlake. Without the CFG rewards, the pricing is actually comparable to TradFi. And no, I don’t think it’s fair to say that. Many of our issuers have external funding sources (banks, family offices, private investors, etc.), and Tinlake is just one of them.

5b) Yes, with a black swan event. That is also why having diversification and decentralization is important.