Decentralized finance, the multi-billion dollar industry built largely around instantly accessible crypto loans, may have bitten off more than it can chew. The way decentralized lending protocols determine credit risk means that peer-to-peer loans demand hefty wads of up-front cash or charge high interest rates.
Teller, a lending protocol created by a team fresh out of Andreessen Horowitz’s crypto school, thinks that DeFi should take a step back and make amends with its centralized roots. Teller wants the best from both worlds: from DeFi, instantly accessible loans for everyone; from traditional finance, the credit scores that keep loans cheap.
Teller lets its users connect their credit scores with its protocol. A high credit score means that a customer would be able to take out a DeFi loan, from a lending protocol like Aave, Compound or Maker, with less collateral (less money up front) or with a lower interest rate. “It actually goes all the way down to zero collateral, which is really exciting because it’s fully unsecured,” Ryan Berkun, Teller’s founder and CEO, told Decrypt.
— Teller Finance (@useteller) July 16, 2020
And these DeFi loans also feed back into the credit score: default on a loan, and Teller will send the debt collectors after you and your credit score will lower—meaning it’ll be harder to get a loan at a regular, traditional bank. Berkun said that Teller’s partner, an undisclosed credit ratings agency, works with around 150 banks worldwide. Berkun didn’t provide details.
Teller announced yesterday that it raised $1 million in a seed round led by Framework Ventures, a San Francisco venture capital fund that invests in DeFi. Framework did not disclose its exact investment.
Michael Anderson, co-founder of Framework, told Decrypt that he saw in Teller an “opportunity for people who want undercollateralized [DeFi loans].” While some people appreciate the anonymity of DeFi loans—they offer the opportunity to bank entirely off-the-grid—anonymity comes at a price.
“People who are willing to tie their identities to things means that they will potentially have a lower [Annual Percentage Rate] in terms of what they’re going to pay,” said Anderson. “There’s a reason why a credit score exists.”
What was wrong with DeFi?
Berkun’s pitch for Teller relies on the premise that the methods DeFi uses for lowering collateral won’t work at scale. He’s aimed his sights at “credit delegation,” a new feature of DeFi lending protocol Aave that lets lenders earn extra interest on the money they’ve plugged into its smart contracts.
Credit delegation works like this: Put $100 into Aave’s smart contracts and you’re eligible for, say, a $50 loan. If you don’t want to take out a loan—you’d prefer to just be a lender—you can delegate this loan to a friend, earn interest from that loan, and secure it with an Ethereum-based legal contract. If your dear friend betrays you, you could take them to court and wave the legal contract at the judge.
“In reality, that doesn’t scale,” said Berkun, since it requires the two parties to know each other. “And it just doesn’t really work for the traditional lending markets,” he said. Algorithmically determining interest rates using credit scores means that Teller can operate at scale, just like a regular bank, he said.
Stani Kulechov, founder and CEO of Aave, disagrees. He thinks that his new DeFi system works just fine, could help loop traditional investors into DeFi, and provide an additional source of revenue for its customers. “Aave credit delegation is simply a technical tool to source liquidity into crypto OTC [over-the-counter] lending desks and traditional finance,” he said.
Kulechov thinks Teller and Aave could work in tandem. “I could imagine that Tellor could source their liquidity from Aave via credit delegation and use their credit scoring for underwriting loans to reduce credit risk,” he said.
“Both Aave’s credit delegation and Teller are fascinating tools for expanding DeFi into undercollateralized lending,” he said.
Defi and CeFi are back together again—a marriage perhaps encouraged by Framework, which has invested in them both. “We will most likely work together quite soon,” said Kulechov.