Next-Gen Lenders Get More Interesting
Maple ($MPL), TrueFi ($TRU) & GoldFinch ($GFI) & the O2O Battle
This week, we explore the investment thesis for Maple Finance ($MPL), TrueFi ($TRU), and GoldFinch ($GFI) - leaders in the on-chain to off-chain (O2O) lending revolution.
The credit cycle, the Minsky moment, and selling a commodity vs. the 3Ds of sustainable competitive advantage in lending
Maple Finance, TrueFi, GoldFinch and the O2O revolution bringing crypto rails to real world lending
Comparing $MPL, $TRU, and $GFI across FDV, Loans Outstanding, Revenues, P/S, P/E and competitive positioning
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Disclosure: Reflection Digital does own a small amount of $MPL tokens from mining rewards in 2022
Disclaimer: this is not investment advice. Crypto is highly risky. Please do your own research.
The Credit Cycle
Like death, taxes, and Kanye’s confidence, the credit cycle is one of those universal constants. Unpredictable in its timing, but as inevitable as the endless reservoir on which it’s nourished: human nature.
The credit cycle is nothing more than a series of human judgements and expectations of the future. Human judgements and expectations which are subjective, fallible, and reflexive.
Lending is tricky because there is a natural tension between growth and underwriting. Anyone can give away money. The trick is getting it back… with a return… while not losing market share… against competitors also giving away money… at often times unsustainable rates. During good times, irresponsible actors benefit, but the inevitable “Minsky moment” always comes due in the end.
In short, selling a commodity is a race to the bottom. Lending is no exception.
Developing a Sustainable Competitive Advantage
As I elaborated on a few years back in Blitzscaling Credit, there broadly appear three ways of building moats in lending:
Distribution - do you own the customer relationship? Is it sticky & high frequency?
Data - do you have differentiated data sets and strong underwriting capabilities to better price risk?
Deposits - do you have access to a sustainable, low-cost source of funds? (i.e. are you a bank?)
Without differentiation in either of these buckets, I’m skeptical of a company’s long-term position. You are simply a commodity at the mercy of the credit cycle. In traditional finance, most dominant lending operations appear to take the below forms:
Consumer internet giants (often tied to eCommerce platforms or other payment flows like eWallets etc) with superior distribution and propriety data for pricing risk
Banks - benefitting from regulatory moats and superior cost of capital
While there are many alternative models, most will get squeezed by the two, all-powerful book-ends: distribution and deposits.
In my mind, the CeFi crypto lenders ultimately failed to achieve moats in either category. Thus, they were selling a commodity (capital) and forced to thread the precarious needle between growth and under-writing discipline.
Judging by the fantastic blow ups or sizable devaluations of BlockFi, Celsius, Genesis, Voyager, CoinFlex, Babel Finance, Hodlnaut and more, the majority erred too far on the side of growth.
As is typical, the regulators are now circling in the aftermath, trumpeting new frameworks to ensure the worst of these financial excesses do not recur. Once again, the vanguard of financial services has proven its inability to self-regulate; falling prey to the siren song of the incalcitrant credit cycle propelled by human fallibility.
Regulation, Enhanced Infrastructure or… Both
Increased regulation is one (almost certain) option. However, heavy-handed regulation often has the unintended effect of kneecapping competition and gift-wrapping oligopoly status to the already too-big-to-fail megabanks to the detriment of consumers.
An alternative (admittedly imperfect) path would be a future of financial services built on more transparent, automated infrastructure. Where lenders would not all make large, undercollateralized loans to the same, over-levered hedge fund without having knowledge of the other loans outstanding.
This is why I’m bullish on DeFi protocols longer-term: the increased transparency, automated nature of execution, and ease of cross-border flows. I’m equally bullish on their Frankenstein counterparts - the “onchain-to-offchain” (O2O) lenders who aim to bridge crypto’s new infrastructure to real-world loans.
In contrast to the CeFi implosion, many O2O leaders - like Maple Finance, TrueFi, and GoldFinch - have managed to avoid asteroid-sized balance sheet holes (so far). If performance is validated through a full down cycle, these protocols should be well-positioned to expand market share once the demand for leverage returns.
Maple, TrueFi, GoldFinch & the O2O Revolution
This will not be an O2O lender 101. I birthed this colorful 40-page monstrosity on O2O lenders back in May. For a deep dive into the individual players and the evolution of the space more generally, please take a peek.
O2O lenders are protocols aiming to bridge crypto liquidity and real world borrowers. They wish to use the upgraded infrastructure provided by crypto networks to more efficiently aggregate and distribute cross-border loans to productive real-world borrowers in a transparent manner, governed by a combination of smart contracts and aligned third parties.
As @qthomp has pointed out, in Q2, O2O lenders like Maple showed a material share gain against the centralized incumbents burned in the 2022 liquidity crunch.
However, part of this may have been due simply to longer loan terms as Maple’s volumes are also declining in Q3.
Both the crypto market and the credit cycle are reflexive in nature. The market caps, loans outstanding, and margin profiles of these O2O networks will all get slammed in a downturn as multiples and earnings contract simultaneously.
However, the key question is… will these networks last until the next cycle? If so, who is best positioned? And how much are they likely to be worth?
Who is Winning?
As much as I love qualitative pontifications… let’s let the numbers speak for themselves:
Fully Diluted Market Cap (Figures below as of Aug 29, 2022)
Sources: tokenterminal, coingecko, reflectiondigital.substack.com
The fully-diluted market caps continue to slide downward with the rest of the market - ranging from US$87m for TRU to US$174m for MPL. As the Fed resolve shows few cracks and loans outstanding contract, I suspect prices have more pain ahead.
Sources: Dune Analytics, reflectiondigital.substack.com
Earlier this year, Maple took considerable share from TrueFi, peaking at almost US$900m in loans outstanding. However, since the Terra collapse in May, both have unsurprisingly seen a material decline in volumes. GoldFinch has more extended loan terms, whereas Maple and TrueFi typically have ~3 month lockups. Loans made before the Terra collapse are now rolling off and the premium on liquidity is now trumping the demand for yield. Fortunately, both TrueFi and Maple have held up reasonable well on non-performing loans to date, while GoldFinch is still quite early. Despite strong initial indicators around loan book health, growing the loan book over the next year will be difficult.
Sources: TokenTerminal, reflectiondigital.substack.com
Note: revenues above are defined as total revenues generated by the protocol (inclusive of fees and interest payments which accrue to network participants outside of MPL, TRU, and GFI token holders). Over the last year, the implied annualized “take rate” of total revenues / total loans outstanding is ~8 - 11%, while the implied net take rate (i.e. protocol earnings to token holders) fluctuates between 0.5 - 1.5% (see high implied P/E below). This is unsurprising given the early-stage nature of these networks focused on growth as opposed to value extraction.
Price / Loanbook
Sources: Dune Analytics, reflectiondigital.substack.com
In terms of price to loans outstanding, both Maple and TrueFi have averaged roughly 0.25 - 0.3x FDV / Loans outstanding over the last six months; higher than many traditional alternative lenders reflecting their material growth prospects. GoldFinch, even earlier in its growth journey with arguably a larger TAM (and lower token float), commands a further valuation premium to be tested in the down cycle.
In terms of revenues generated, Maple leads the pack with LTM (last twelve month) revenues of ~US$50m vs. TrueFi’s of US$32m - and L6M P/S averages are 3.0x for Maple vs ~4.5x for TrueFi. On the other hand, TrueFi has proven superior at driving cashflows to token holders themselves with a P/E ratio of just ~20x avg. over the L6M vs. very high implied multiples for the competition.
While TrueFi is better at driving value to the token holders themselves, I’m more focused on market leadership at this early stage of development: network effects, utilization, and underwriting performance through the cycle.
If forced to choose only one, I would likely select Maple for the time being given its O2O leadership position. However, I like the long-term tailwinds of the industry and diversification is likely prudent, though I will be patient on entry.
The Big Picture: All three are likely to benefit from tailwinds this decade as more dollars flow on-chain and the tapestry between the on-chain world and the off-chain borrowers expand. A large end-market, first-mover-advantage in building out network effects, likely market share gains over time, and depressed “earnings” and multiples we will see in this years lending downcycle, mean attention is warranted.
For me, two things stand out:
Stablecoins have proven to be crypto’s killer app: swelling ~30x from US$5b at the start of 2020 to >US$150b today. This growth is likely to persist (med-long term) with on-chain capital continuing to search for yield: lending to traders or real world loans.
The Re-leveraging: crypto is cyclical. Increases in price → media attention → demand for leverage → further increases in price. The macro headwinds will eventually fade, and the demand for leverage will return.
Pre Terra implosion, Genesis had US$14.6b in active loans. Celsius had ~US$20b in deposits. BlockFi had US$10b in deposits. Clearly, this will not show up in Maple, TrueFi, and GoldFinch pools next year, but these data points do represent the high-water-mark for historical crypto lending and borrowing demand which will likely be exceeded in the coming cycles as the space matures.
In a highly simplistic bull case, we assume current leader Maple can reach 1/3 of the loans of Genesis peak: ~US$5b. This represents an aggressive, but achievable ~6x from this past cycle’s high in terms of loans. If we borrow the average Price / Loan book multiple over the last (bearish) six months of 0.26x, the simple math renders a ~US$1.3b valuation for Maple or a ~7.5x outcome for token holders in ~4 years from todays prices. Not shabby.
Near-term, however, I suspect valuations will continue to suffer as the size of the loan book continues to contract into macro headwinds. As a long-term investor, I will likely begin accumulating in the US$100 - 130m range (for MPL). A potential ~10x in ~4 years justifies the risk in my humble opinion.
However, I’m also likely to sell down once those price targets are met. While greater transparency can build trust, DeFi infra makes cross border flows more seamless, and crypto incentives help to align third-parties (in short, better mouse trap for large TAM), the barriers to entry (i.e. customer relationship, proprietary data, and regulatory moat) are far from insurmountable. Competitors will emerge, aggressive underwriting will ensue, and the Minsky moment will resurface anew.
My personal targets would likely be to start selling as the networks approach unicorn status. While I’m bullish O2O, the credit cycle will not be tamed by new rails alone.