Tokenized Private Credit: How On-Chain Lending to Companies Works

Private credit in one paragraph

When a company borrows from a specialist fund instead of a bank or the bond market, the loan is private credit. The market grew strongly after the 2008 financial crisis, as banks pulled back from riskier lending and institutional investors looked for higher returns than bonds offered. Loans are negotiated one by one, rarely traded, and valued by the lender rather than by a market price.

What tokenization adds

• Access. Investors can hold a token representing a share of a loan pool, sometimes with lower minimums than a traditional fund.
• Settlement. Funding and repayments move in stablecoins, across borders and at any hour.
• Visibility. Deposits, drawdowns and repayments can be checked on-chain instead of only in quarterly reports.
• Composability, in theory. Credit tokens could be used elsewhere in DeFi, for example as collateral. In practice transfer restrictions and regulation limit this.

Anatomy of a typical pool

1. Credit manager (pool delegate). A firm that finds borrowers, performs due diligence and sets loan terms.
2. Borrowers. Trading firms, fintech lenders, small and mid-sized companies, or funds holding real-world assets such as receivables.
3. Lenders. Investors who deposit stablecoins and receive pool tokens in return.
4. Tranches. Many pools split capital into a senior part, paid first, and a junior or first-loss part, which takes losses first and earns more for it.
5. Legal wrapper. An off-chain company or fund that holds the actual claim against borrowers. A token is only as strong as this agreement.

Two models: reputation or assets

In undercollateralized lending, a borrower such as a market maker borrows more than it posts as collateral, based on its reputation and financial reporting. In asset-backed lending, the loan is secured by real-world assets such as invoices or consumer loans, held by a legal entity. The second model gives lenders more to recover when things go wrong, but it depends on the quality and custody of those assets. Either way, lenders increasingly rely on on-chain credit scoring and off-chain reporting to judge borrowers.

Where it has gone wrong

The model was tested hard in 2022. After the FTX collapse, several trading firms that had borrowed from on-chain credit pools could not repay. On Maple Finance, a default by the trading firm Orthogonal Trading caused heavy losses for lenders in the affected pools. Other platforms have recorded defaults by fintech borrowers in emerging markets. These cases showed that on-chain transparency reveals a default quickly. It does not prevent one.

Questions to ask before investing

• Who underwrites the borrowers, and how did they perform through a downturn?
• Is there first-loss capital below you, and how large is it?
• What exactly does your token give you a claim on, and under which jurisdiction’s law?
• How are the loans valued, and how often?
• What happens to your money if the platform itself shuts down?
• How long is your capital locked, and can you exit early?

How we cover this topic

Articles in this section explain mechanisms and risks. We do not rate individual pools or recommend investments; see our editorial policy. For the businesses on the other side of these loans, read on-chain credit use cases.