Key Takeaways

Goldfinch is an on-chain private credit protocol that allows entities, mostly lending businesses and credit funds in emerging markets, to borrow from a variety of KYC’d lenders.
To date, it has originated ~$113M in loans, generating ~$12M in interest income with an expected ~$22M in interest income if all open loans go to term.
The protocol utilizes a tranche system where liquidity providers can deposit junior or senior debt, with increased returns for junior debt providers given their additional risk upon default.
Goldfinch is actively improving lender risk-adjusted returns through mechanisms such as an automated leverage model and increasing liquidity for both backers and liquidity providers.

Goldfinch is an on-chain credit protocol that allows off-chain entities to access credit without crypto collateral. By utilizing different credit tranches and the collective due diligence of the community, the protocol allows individuals to define their credit risk based on individual risk appetites and desired exposure. Goldfinch currently provides loans to companies in over 28 countries through loan originators that are often credit funds. As of today, it has around $100M in active loans with significant growth in 2022, as shown by the chart below.

Supplying Credit

There are two methods by which one can provide liquidity to potential borrowers. The first is by being a backer that supplies capital to individual borrower pools. The second is by being a liquidity provider and depositing into the senior pool, where capital is automatically allocated across all borrower pools. Backers and liquidity providers have different seniorities on the debt hierarchy. Liquidity providers own the senior tranche of the debt, while backers own the junior tranche of the debt that is first to take on any losses.

Backers

Backers provide liquidity to individual credit pools. They act as secondary credit underwriters, conducting their own due diligence on individual pools, and are the first to lose if a pool defaults. To help with their due diligence, each investment pool has a data room. Each data room includes documents that traditional investors are likely used to, including PPMs, subscription docs, and other legal agreements.

In return for providing liquidity, a backer receives an NFT. The NFT tracks the total amount supplied and how much capital has been redeemed. Backers may withdraw interest payments as they are paid by the borrower, but the ability to withdraw principal is dependent on the pool term as proposed by the borrower. External parties such as AlloyX and the Goldfinch community have launched marketplaces for secondary NFT sales, allowing backers to exit their position before the pool term deadline.

The protocol provides additional GFI rewards to backers that conduct due diligence and deposit early into pools. Without these GFI rewards, backers would likely wait till other backers deposit or liquidity pools add additional leverage to the pool, so that they decrease their risk and let other individuals go through the vetting process for them. Given that backers are likely to conduct due diligence by themselves, they often deposit in significant size as shown by the graph below.

Liquidity Providers

Liquidity providers supply capital to a senior pool that deposits across all pools in the Goldfinch protocol that have backer liquidity, earning a diversified source of yield. Liquidity provider capital ranks higher in debt seniority than backers, and given the lower risk, 20% of their interest earned is reallocated to backers.

The mechanism by which liquidity provider capital is allocated across pools is called the leverage model. In simple terms, when backers evaluate a pool and decide to deposit capital into it, the senior pool automatically allocates more capital to it. Right now, the senior pool will allocate 4x the amount of backer capital to each pool.

In the future, the pool will allocate based on a more sophisticated leverage model. The senior pool will deposit a multiple of the backer capital into a specific pool.This multiple is called the leverage amount (A) and is determined by the formula A = S * D * L where:

S is the total capital supplied by backers
D is the distribution adjustment on a scale of 0 to 1, which increases if the backers are more distributed in terms of % supplied.
L is the leverage ratio from 0 to a maximum of 4, which scales with the number of backers, and has a minimum number of backers and a maximum number of backers required to achieve the maximum leverage.

Goldfinch refers to this model as trust through consensus, as the protocol does not trust any individual backer or auditor. Instead, the protocol trusts the consensus by allocating more capital into pools that more people trust with larger amounts.

When liquidity providers supply capital to the senior pool, they receive an equivalent amount of FIDU. If they would like to withdraw, they submit a withdrawal request which is fulfilled every two weeks with a 0.5% withdrawal fee. The two week distribution period means that capital is returned every two weeks, but the distribution amount varies depending on the total amount of available capital in the senior pool and the total amount currently requested to withdraw.

In order to bypass the withdrawal request system, liquidity providers may choose to swap their FIDU tokens to USDC through a Curve pool, albeit at a sizeable discount most of the time.

Given that the senior pool has a shorter lock-up and that individuals depositing do not have to do their own due diligence, the distribution of senior pool depositors skews towards the smaller sizes.

Protocol revenue comes from the 0.5% withdrawal fee when liquidity providers unwrap the FIDU token and the 10% of interest payments directed to the protocol reserve allocation. 30 day protocol revenue has reached a relatively steady state of $100K, while cumulative protocol revenue has grown to ~$1.7M since inception.

Unique Identity (UID)

Goldfinch is not a permissionless credit protocol. Investors and borrowers have to go through strict KYC procedures to verify their status and identities on-chain so as to comply with US security laws. Goldfinch has partnered with Persona to manage the KYC process and data; and with Parallel Markets to manage the KYB/accreditation processes and data. Having said that, no personally identifiable data is stored on-chain.

There are currently 5 types of UIDs:

Non-U.S. Individual: can vote and supply capital across the protocol
U.S. Accredited Individual: can vote and supply capital to the Senior Pool, and to Borrower Pools on a case-by-case basis (depending on Borrowers’ requirements)
U.S. Non-Accredited Individual: can vote, but cannot supply capital
U.S. Accredited Entity: can vote and supply capital to the Senior Pool, and to Borrower Pools on a case-by-case basis (depending on Borrowers’ requirements)
Non-U.S. Entity: can vote and supply capital across the protocol

The Unique Identity mechanism of Goldfinch opens up an important gateway for on-chain individuals or businesses to start building their on-chain credit history, something that is key to unlock the growth of on-chain credit markets. Importantly, any other developer can use the UID as a standard ERC-1155 contract and integrate it into their protocol. This could potentially be attractive to Verite, a set of decentralized identity standards developed with support from Block, Circle, Coinbase, and Center that will likely be adopted on Coinbase’s L2, Base, to support protocols that want KYC/KYB requirements.

Borrowers

As of today, the Governance Council approves each borrower on Goldfinch after a community discussion on the governance forum. From there, borrowers can create a pool with various terms such as interest rate, limit, payment frequency, term, and late fees, along with a comprehensive data room that includes any legal documentation.

Borrowers can draw capital through their pool at any time so long as there is capital available, they have not hit the upper limit of the total capital in the pool, and they have not hit the borrower pool limit. When repaying interest, borrowers can also make early repayments on the principal by repaying more than the interest owed.

Borrowers are not necessarily individual companies looking for a line of credit. Often they are investment firms that have credit funds and seek to use funding from Goldfinch to deliver capital to businesses in the form of debt financing. They would profit from the interest rate delta between the rate at which they borrow from Goldfinch and the rate at which they lend to companies. As shown by the graph below, there is a strong demand for credit financing through the Goldfinch protocol at what are likely attractive rates to credit funds or organizations in developing countries.

Goldfinch differs from undercollateralized borrowing protocols such as Maple Finance and Clearpool, which primarily lend to crypto market makers, in that their loans are fully collateralized by off-chain assets. Additionally, Goldfinch has a more sustainable and diversified customer base. 90% of Goldfinch loans are under fintech credit funds all around the world. This is not to say that Goldfinch isn’t susceptible to events such as global macroeconomic shocks. As seen from the graph below, the active loans by region has been relatively distributed since day 1, likely as a result of the diversification of geographical interest from credit funds.

Like any borrowing protocol, the question still stands: What incentives do borrowers have to repay their loans? For Goldfinch, the incentive is very large as all loans are over-collateralized. Don't feel like paying back your loan? You can say goodbye to your collateral. Of course, like any other lending/borrowing default, the collateral recovery will have to go through traditional off-chain legal means. Borrowers are also linked to an on-chain credit history through their UID and once borrowers miss any payment, they are prohibited from any further borrowing.

Most of Goldfinch’s loan documents with funds require a loan-to-value of at most 90% for any deal and are secured by off-chain collateral. In addition, most credit funds also have an equity buffer as a cushion if necessary. For example, the largest pool on Goldfinch, Secured U.S. Fintech Yield via Stratos with $20M in total capital, invests in corporate loans, asset-backed loans, and real estate loans. Corporate loans have a maximum debt / adjusted EBITDA of 6x, asset-backed loans have a maximum advance rate of 98%, and real-estate loans have a maximum loan-to-value ratio of 80%.

To show how seriously the community takes such off-chain covenants, a recent governance proposal seeked to resolve a covenant breach by a Goldfinch borrower, Tugende. Tugende is an asset-backed fintech lender that finances small businesses in Uganda and Kenya. Initial loan conditions by Tugende included a maximum loan-to-value of 80%, with value defined by cash on hand, inventory on hand, and loan receivables; the other covenant being a tangible net worth (tangible assets minus liabilities) that is at least 20% of their total assets.

As of December 2022, Tugende did not meet these levels due to deteriorating economic conditions in Uganda and global high inflation resulting in repossessions and lease cancellations. Importantly, this is not a default. Tugende is able to meet its interest obligations for now. Warbler Labs, the product owner of Goldfinch protocol, has proposed to come in and work with Tugende to get its covenants back above the required level. As of February 25, 2023, the snapshot vote has officially passed and Warbler Labs has been appointed to act on behalf of the Goldfinch community to resolve the breach and bring Tugende back into compliance.

Callable Loans

Through GIP-42, Warbler Labs has proposed bringing a new loan structure to the Goldfinch protocol, a callable loan. A callable loan would give backers the right to “call back” their invested capital. Borrowers would then be required to return 100% of this “called capital” at the end of a “call period”. The initial proposal sets the call period to be three months and call requests must be submitted at minimum 60 days before the end of the call period. As of March 2nd, the snapshot vote to enable callable loans has officially passed.

The motivation behind this proposal was to provide liquidity providers with more liquidity. They could do so if they wanted to by redeeming their investments early, rather than having to wait for the long multi-year periods for the loan to reach expire. Callable loans may not be a suitable option for all borrowers but could be an ideal product for borrowers with short-term loan cycles. For example, for a fintech company that provides buy-now-pay-layer loans to customers with a maximum tenor of 30 days, callable loans would be an appropriate product as Goldfinch would always give the borrower at least 60 days to get repaid on their loans.

Final Thoughts

Goldfinch currently has ~$100M out of the ~$450M active loans of private credit on DeFi rails. Goldfinch is developing various mechanisms such as the Goldfinch Membership, a way for members to receive a share of protocol fees, a GFI staking mechanism for auditors that will allow a decentralized borrower approval process, and a GFI staking mechanism for borrowers. These mechanisms will allow Goldfinch to grow and become more open and permissionless, and subsequently should see increased adoption from different types of lenders and borrowers.

Goldfinch is focused on enabling private credit expansion and liquidity for both borrowers and lenders, while increasing the trust assumptions of the protocol through mechanisms such as backer reputation systems, backer secondary markets, auditors, and origination fees. Goldfinch is poised to capture a sizable portion of the $1.6T market of private credit in traditional finance given their focus on regulatory compliance, strong incentive mechanisms, and thorough credit underwriting/maintenance processes.

Goldfinch: A Strong Contender in On-Chain Private Credit Markets

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