Bringing DeFi returns to institutional investors has long been a goal of the crypto industry. Connecting off-chain capital to deploying crypto assets presents legal and technical challenges every step of the way.
Institutional credit infrastructure provider Credora and Polkadot DeFi hub Acala believe they have found a way to bridge the gap, starting with a product that offers yield opportunities to bitcoin holders.
In partnership with Swiss-based market-making firm Portofino Technologies, the initial offering – announced Thursday – targets family offices, credit companies and hedge funds, and expects returns of 7% to 10% per year.
Previous attempts to offer returns to Bitcoin (BTC) lenders have not always gone well, with companies like Celsius proving to be opaque, vulnerable and ultimately dangerous places for customers to store BTC.
Credora has devised a legal and technical structure that offers lenders much more certainty and transparency, according to co-founder Darshan Vaidya.
“On the Acala side, it’s about transparency around core revenue generation and so on [Credora’s] On the other hand, it is about transparency around where exactly the money is at any given time, and transparency around the legal structure associated with the loan,” Vaidya told Blockworks.
Their first product is a Special Purpose Vehicle (SPV) that generates revenue from staking Polkadot’s native currency, DOT.
It works like this: Portofino, starting with borrowed bitcoin, exchanges a portion for DOT staked at Acala, while hedging the price risk using derivatives markets on Bitmex, Bybit or Deribit. Returns on Polkadot stakes are falling in the 15%-21% range, Acala’s co-founder Bette Chen told Blockworks.
“For a liquid staking protocol like Acala, we aim for a sweet spot – you aim for an optimized return, but at the same time [to be] safe for the strikers there,” she said. Acala uses a variety of specialty validators, including Coinbase Cloud, which offers slashing protection (think insurance) for its service.
Portofino is required to put its own capital into the SPV as a junior tranche, while bitcoin lenders have a higher priority to do so, ensuring their assets are secured by the full cache of funds.
“What we have created are secured lending vehicles that, by design, cannot go bankrupt, so each SPV can legally only engage in a specific activity,” Vaidya explains.
The ‘first loss’ capital provided by the market maker means ‘their incentives’ [are] aligned so that the trading firm is always incentivized to ensure that the senior tranches are repaid first,” he said.
In other words, the quarterback has “skin in the game,” to use the Southern Derby racing phrase popularized by Warren Buffet. If they don’t meet their monthly return forecasts, they miss out on their own profits.
Credora provides real-time monitoring for lenders, allowing them to track capital movements – both within and outside the chain – in real time, according to Vaidya.
He calls it the ‘anti-principal-lender approach’ – referring to the lending platforms that ran into trouble in 2022, where ‘there is no transparency in terms of what the principal lender is doing’.
“Their incentive is to offer higher and higher returns, to try to capture as much AUM or TVL as possible, and to continually meet that demand – and still make a profit – you have to move further and further out of the risk curve,” says Vaidya. said.
That is a flawed model and the antithesis of DeFi ideals.
The current product offering can be seen as a proof-of-concept, but similar SPVs could be set up in the future with different strategies or input capital – such as stablecoins.
Once the model is proven, and perhaps with more regulatory clarity, Acala’s Chen said: “The next step now is for institutions, which may include fintechs, [to] actually package and localize these products for their retail customers.”