Imagine this: I would like to earn 15% a year fixed return generated by lending money out for short term working capital needs where the lending is secured by receivables.
Does such an opportunity exist? Yes and No.
No for most people who are not deep in the credit space.
Yes for a few who know where to look and how to access these opportunities.
While tokenization projects are busy working with issuers to figure out the legal and operational setup to bring assets onchain, little has been done to make the discovery and risk assessment steps accessible and digestible for onchain users.
In this week’s newsletter, we will look at pain points of the current discovery and decision process of a potential capital allocator.
The Journey
There are three crucial stages to achieving an investment objective.
You have to know which assets offer the target return
You have to be able to assess the risks associated with that return
You have to be able to access these opportunities
Let’s walk through an example.
Step 1
In order to arrive at “I would like to target 15% fixed a year”, one probably needs a general level of financial literacy that can benchmark US equity indices’ risk premia, US 2yr TBills, US 10yr TBonds, US Investment Grade spreads and US High Yield spreads with their respective return numbers.
While not everyone can do this, a large number of people working in investment management, banking and adjacent fields probably should have the basic framework for this.
Once you can calibrate the return target, then the real work begins.
Step 2
Let’s say you do indeed want to target a 15% fixed return, how would you go about achieving that?
Since 15% is almost twice the return that a US HY ETF is achieving YTD, we are probably left with private markets. And because we want to target a fixed return, private equity or VC is out of the question. That leaves private credit.
Step 3
Although the space has grown from a few hundred billion to $1.4 trillion in the last decade, the biggest players in the market, such as KKR, Blue Owl, Carlye and Blackstone, are only available for institutional investors or Ultra-High-Networth-Individuals. For most people, there is no route of access.
So where do you go?
Assuming you know that tokenization has brought various private credit opportunities onchain, where would you go to find out what actual opportunities are there?
Well first you need to know what tokenization projects are there and what sort of credits they offer:
Centrifuge (US private credit)
Maple (private credit, structured credit, tokenized TBills)
Goldfinch (EM private credit)
Ondo (tokenized TBills)
Matrixport (tokenized TBills)
Now I have spent the past 3 years deep in the trenches of onchain credit with interviews, 20 articles and a 30 pages research report published on the sector. I can pinpoint available deals and track records of these platforms but if you are new to the industry, discovering and gathering information on what projects are there and what each offers is a non-trivial task that requires hours of digging through websites, online forums and data tracking.
Step 4
Now assuming after hours of work, you have successfully navigated the discovery part of the process and arrive at the point where you find out the following opportunity.
This is currently the only available credit opportunity that comes close to 15% a year. Of course this speaks to the deal sourcing challenges I highlighted in my deep dive report.
Unless you are one of a few thousand people working in government tax credit receivables, I am willing to bet that most of us have never heard of tax receivable financing. What follows from this point is hours of research to understand the context of the product.
In traditional finance parlance, you need to do credit research. This involves understanding not only the counterparty credit risk of the ultimate payer but also various operational and legal processes and incentives involved in the flow of money.
Most of us do not possess the time or experience to unearth these details. After all people who carry out this function professionally are the credit analysts In the tradfi world. They are paid very well by buyside funds or sellside banks for their work and expertise.
Of course there are also independent credit rating agencies such as Moody’s, S&P and Fitch, who would step in with credit reports for the broader market.
Currently no such players exist in the onchain credit world. The closest attempt has been Centrifuge’s Credit Group, a network of tradifi credit professionals who pen short reviews for deals that asset issuers want to bring to the Centrifuge tokenization platform. Full disclosure: I am currently the Strategic Lead for the Credit Group.
Step 6
If there are multiple opportunities, then each needs to undergo such a credit analysis step. I highly doubt many have the necessary skillset and time to assess them adequately. We would probably need detailed research reports as a starting point to guide our thinking on various assets.
Are the returns offered adequately compensate for the risks associated with the asset?
How does one set of risks compare to another?
How does the best offer here compare to other opportunities that may offer a lower return but also have a much easier to mitigate risk profile?
Step 7
If after all those steps you decide an onchain private credit meet your requirements, you will have to onboard through a KYC process.
If we take stock at this stage, there are at least 7 layers of barrier to access for a potential capital allocator:
Understand the broad spectrum of risk curve and returns
Understand the broad asset class that can offer double figure fixed return
Discover and understand access channels
Discover specific asset opportunities
Understand each opportunities’ risk profiles
Compare each opportunity to find the optimal choice
Becoming qualified for that opportunity
Now we haven’t even talked about the massive barrier of having to be immensely knowledgeable about the crypto onboarding process: how to use a wallet, how to onboard fiat to crypto etc
Improvement
While 1-2 have more to do with general financial literacy, 3-7 should be collapsed into a single discovery and research front end point. Here are some ideas for improvement:
An aggregation layer for all onchain credit opportunities will probably exist. Currently there is AlloyX. The first aim here is to ensure there is an easy access point.
Issuer level as well as deal level data should be made searchable so that they can be sliced and diced according to asset class, yield, issuer track record (both onchain and offchain), maturity, redemption period.
Due diligence reports should be made optional upon commission by potential investors or issuers as a starting point for deeper discussion.
Tradfi market commentary and educational content on assets should be a must to provide up-to-date contextual framework.
Conclusion
While much attention has been focused on what assets are being tokenized onchain, much more focus needs to be expended to improve the actual onboarding process for potential allocators.
This lack of basic infrastructural pieces shows how early we are in the market. Many barriers to entry exist in the current process that can be collapsed to streamline the discovery, due diligence and onboarding process.
Whilst hard to scale, various educational efforts on research and content fronts must be made in order for the market to mature.
Disclaimer: This content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.
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