Token sales and ICOs have transformed the process of raising equity. The next step for blockchain in financial markets is debt. And just as blockchain and the token economy have resulted in a new asset class, blockchain also has the potential to create new forms of debt.
In recent months, there has been movement into this area by traditional financial systems. In August 2018, the World Bank issued a global blockchain bond, bond-i, “the world’s first bond to be created, allocated, transferred and managed through its life cycle using distributed ledger technology.” Also in August, BMO worked with the Ontario Teachers’ Pension Plan to test blockchain technology by offering a fixed income issuance that was mirrored on blockchain.
Of course, these are traditional forms of debt, and they are innovative only in that they are new on the blockchain. But are there other forms of debt that might be offered on the blockchain? Nadav Hollander, founder of Dharma, believes that there are.
What is the Dharma protocol?
The Dharma protocol is an infrastructure layer that sits on top of the Ethereum blockchain. It is a protocol, not an end-user application, so its primary users are developers. Dharma was created to solve two specific problems. The first of these, creating a way to administer debt agreements, is relatively straightforward. Dharma uses smart contracts that execute when specific actions are completed.
The second problem, finding sources of credit for borrowers, and matching borrowers with lenders, has been solved by creating a group called “relayers” – centralized actors who host an online order book, rather like a bulletin board, and match borrowers’ orders with available lenders. When needed, Dharma also relies on a group of underwriters, centralized actors who vouch for their belief in the likelihood that a borrower will default on a loan. An underwriter’s success is visible on the blockchain, and successful underwriters will generate more business.
Why is decentralized lending significant?
It’s important to remember that although the internet is globally accessible, and largely borderless, not everyone has access to financial services online. Banking systems have borders, and these borders do restrict access. In addition, while early hype about blockchain promoted its chances of extending opportunities for banking the unbanked, and building financial services that are globally accessible, Hollander points out that many fundamental financial building blocks must be created before this possibility becomes reality, including stable cryptocurrencies that are pegged to fiat currencies, good markets for derivatives, and a robust decentralized credit market. It is this last building block that Hollander sees as a legitimate first step towards the utopian goal of extending banking services to the entire global population.
New forms of debt
By creating a way to match borrowers to lenders, Dharma’s decentralized credit market fills a very real existing gap. But Dharma also offers opportunities for classes of debt that currently don’t exist. As an example, there is an emerging class of crypto-collectibles, most famously represented by CryptoKitties. These non-fungible assets can become extremely valuable. Dharma lets owners take out lines of credit against the value of their digital collectibles, and Hollander envisions that a class of underwriters may emerge who specialize in appraising the value of these digital assets.
Hollander also points out that the most compelling use cases for these new debt classes will likely be generated by crypto natives. These are likely to be individuals currently working in crypto, who need to access a line of credit, or who want to borrow or lend for speculative purposes. In addition, however, these services will be of interest to businesses such as marijuana dispensaries that are currently on the margins of the current financial system.
Other possible use cases for debt on the blockchain
The recent ICO boom was almost entirely based on selling tokens that functioned largely like equity. Hollander envisions a future where this ICO model is applied to debt fundraising, and where businesses could benefit from selling tokens as debt assets, allowing them to raise debt at very low fixed costs. Dharma could be leveraged for trustless savings accounts, where specific investment actions would be undertaken based on smart contracts set up between depositors and account holders. Finally, municipalities, particularly in developing nations, could use tokenized municipal bonds to raise debt and access needed funds for infrastructure needs.
The security and transparency of smart contracts executed on the blockchain is already well understood. As investors become more comfortable with the concept of tokens representing value and equity, the natural next step is to link tokens with loans, bonds and debt instruments. As the blockchain economy gains maturity and becomes more robust, additional use cases will certainly emerge.