On The Brink with Castle Island - Darshan Vaidya (Credora) on Risk Management and Credit Markets (EP.445)

Episode Date: August 21, 2023

Darshan Vaidya, the founder of Credora joins the show. In this episode we discuss: The crypto credit markets, what went wrong in the last cycle and how the market functions today Thoughts on Real-World-Assets on chain Comparisons of risk management approaches in tradfi versus crypto markets How Credora is working with firms to protect customers from idiosyncratic risk The capital raising environment To learn more about Credora visit www.credora.io

On today's episode, I sat down with Darshan Veda, the founder of Kradora, to discuss the crypto credit markets, risk management, and the future of digital asset market structure. This was a fun episode, so without further ado, here's my conversation with Darshan at Kredora. Matt Walsh and Nick Carter are partners at Castle Island Ventures. All of these expressed by them or the guests on this podcast are solely their opinions and do not reflect the opinions of Castle Island Ventures. Guests and host may maintain positions in the assets discussed in this podcast. You should not treat any opinion expressed by anyone on this podcast as a specific inducement

who make a particular investment or follow a particular strategy, but only as an expression of their personal opinion. This podcast is for informational purposes only. Brought down by bad mortgage investments, Lehman, which has 25,000 employees, will be liquidated. The federal government loans American International Group, AIG, $85 billion. This is a different kind of market, and the Fed is asleep. The federal government is stepping it to stabilize Fannie Mae and Freddie Mac, the two mortgage giants that have been threatened by the housing crisis. The Bank of England has pumped 75 billion pounds more to British.

and sailing economy with a new round of qualitative easing. You print a couple trillion dollars and all of a sudden people started to worry. So out of this worry, we have something called the Bitcoin. Darshan, thanks so much for joining us today on the podcast. Thanks so much for having me. It's a pleasure to be here. I'm really excited to talk about the lending markets in the crypto space, which I didn't think I would say that ever again after what's happened over the past few

years. But excited to dive deeper. Maybe why don't we just start with your background and how you got into this space? Yeah, I kind of didn't start in lending for sure. I was like a lot of people in crypto came from traditional financial markets, was an options market maker for about 11 or 12 years. And kind of got curious about crypto around 2014, 2015, and then came across Deribut in 2016, which suited my skill set

and basically became one of the first market makers. And yeah, it was, I guess, as a result, in crypto, opportunistically than I was from some sort of ideological viewpoint, but then had this issue with scaling the fund where we were trying to hedge across multiple exchanges, trying to get credit from OTC dealers to be able to manage our book more efficiently and was struggling to scale the fund that we were running. And the core problem was how do I prove our fund's credit worthiness without sharing our underlying position. And that's kind of where Cordora started and what we've been working on since. That's awesome. Well, so much of this has to do with market

structure. So maybe we could just start there in terms of what is your take on how this market operates, both from a spot perspective and from a derivatives perspective now? Yeah, I guess fragmented is kind of a word that we've used in crypto quite a lot. And I'd say as a result, capitally inefficient for a lot of the participants in there where it's kind of a odd mix where there's a market which is very difficult to actually access credit, but one that needs it desperately, and especially with the way crypto settlement works and how it's much more instant than traditional settlement mechanisms. And so also I'd say the market is split into this unregulated and regulated split, which again creates its own problem.

when trying to facilitate credit into those venues. So from a lending biased lens, I feel like there are a couple of different problems that magnify in crypto. So maybe you could just set this up in terms of what Cordora looks like today in terms of the types of folks that are using it and what they actually use the platform for. I guess like Cordora is a credit intelligence platform that is used to trying to help facilitate credit in a more transparent and seamless way. So if you look at basically how private credit markets work for businesses broadly in traditional markets and in crypto, generally underwriters look at snapshots in time of someone's creditworthiness through financial statements, balance sheets, whatever.

And those tend to be stale and difficult to validate. So even if they're audited, they're even more stale. So if you get an audited financial statement from September last year, I'm not sure you would care about it. for a crypto company especially. So that's kind of the problem that you have in both crypto credit and private credit generally is that the data is hard to validate and old. And so what we realize when we're running the fund and also what we realize about generally a lot of companies have is this real-time data, either through banking APIs, through their exchange accounts, custody accounts, their loan management system, whatever it may be.

There is a lot of real-time data, but it's generally sensitive. something that you wouldn't want to share, especially once you reach a certain level of sophistication as a firm. So what we've built to try and unlock that data is privacy preserving infrastructure that pulls data from really any API, but can compute on that privately and can guarantee that it was done privately and guarantee that it only did a specific set of functions. And so you get a lot more data on that particular borrower and in real time that can help both validate those snapshots in time and produce like a proxy for where those financial reports are going to be in the future going forward. And so maybe to bring that to life a little bit more, there've been a number of blowups

in the space, obviously, over the past a couple of years. Some of those blowups, there are allegations that some of the financial statements that the borrowers produced were fictitious, erroneous, outright fraudulent, I would argue. Suffice it to say, I think your position would be that if people were using Cordora, that would not have happened? I agree with your assessment. I think that that's been prevalent in crypto, but it's also been something that's happened across traditional financial markets all the time. And I don't think there is such a thing as a hundred percent picture of a borrower. Just money is fungible, it's difficult to ascertain whether it's an asset or a liability,

etc. But what you can do with real-time monitoring is make it much, much harder, someone to basically show themselves to be low risk and well capitalized when they're not. So for something like Three Arrow's, if they were positioning themselves, just a random example, but if they were positioning themselves as delta neutral or if they were positioning themselves as low risk and well hedged, this would make itself evident on real-time data that that wasn't the case. And if it didn't show itself to be low risk, a lender could certainly dive in and ask questions about why it showed it to be such high risk,

and could they show some information that allowed you to offset it? So I obviously think that Crador is a big part of uncovering more intelligence on that borrower than was previously available to the lender. But at the same time, I think it's important to understand that. I don't think in credit that you can have a silver bullet, you can basically add incremental data until you have as close to 100% picture as possible. And really, like, what Rador is built on is this fact that there is, all of this data that's private and available to be added to the picture, but borrowers can't

for either compliance or business reasons make that available to be able to just get a loan. And I guess there's, there are probably a lot of things you could do in the context of digital assets that you couldn't do for other asset classes. So in the non-crypto world, you'd have prime brokerage firms that are going through and looking at audited financials, but also looking at trading history and forming a point of view there. We're talking about an asset class where a lot of this stuff is happening on chain. So you would think the visibility would actually be a lot more real time and theoretically a lot purer.

Yeah, and even the off-chain venues have fairly robust APIs that are accessible to everyone. So you can monitor a lot more of a crypto firm's assets, whether it's happening off-chain or on-chain, purely because the venues are more recently built and built with APIs in mind, whereas a lot of FCMs, for example, is difficult to plug into your positions in real time, necessarily in traditional markets.

But yeah, I think that also the positions themselves settle more instantly. So, you know, you see the derivatives position that you've taken on finance or on Deribut essentially represent itself on the API more instantly, whereas that might not be the case if you're trading like OTC traditionally on some OTC derivatives. So certainly I think that there was a great starting point for us as a company to start with crypto trading firms and crypto businesses broadly, because you could get as close to that 100% picture more easily. What we've done since is, obviously, branch out to different types of businesses where we, again, collect more private

data. So we look at fintechs, we look at insurance companies and a variety of other businesses where if you can plug into various real-time data, you can validate the financial projections and financial metrics that they're showing on their statements, do line up to what we're seeing happen over time. That's kind of why crypto was a great starting point for this technology, even if it was somewhat accidental. And do you imagine that this is a with tokenized assets, with some of the things that might be on the horizon here, that something like a Cordora would feature prominently in that type of a world with security tokens? Yeah, I mean, I think that one of the fallouts of last year was the move.

away from purely unsecured lending in the space. So I feel like a lot of lending that happened was unsecured, uncollateralized, and as a result, perhaps underpriced based on where it was trading last year. We still see a big demand for that kind of borrowing. And I guess lenders that we work with are asking for more information and more data, which is something that we're happy about. But in that spectrum of secured lending deals, certainly I can see tokenized assets, something that can play more of a role in crypto credit and crypto lending broadly, where you can have more productive assets as collateral. So there's a bunch of great companies in crypto that are using tokenized treasuries as a way to give people yield. I feel like we're not far away

from people being able to use that as collateral as part of lending conversations, as part of lending arrangements, where those assets underneath are yielding. Now, where Cordora comes in, is when those assets are not like the US government, but perhaps a little bit more difficult to validate what's happening under the hood. If you have a security that's yielding something, but you need to validate that that security is actually doing what it's saying is doing,

that's where Cordora has been working with some firms to validate that the underlying assets are actually there and doing what they're doing. So kind of like the equivalent of having lots of different loans in a CLO, when we speak to more traditional firms, their biggest issue is what are the underlying borrowers actually doing and what is their financial health and how can they get a better picture on those? And so where we're looking at is being able to monitor those more closely and in real time. And similarly, for like tokenized securities, it's kind of

the same. Can you monitor that that basket is actually that basket of stocks sitting on X, Y, Z brokerage? Can you monitor that, yeah, there is that particular yielding activity happening. It's not super leveraged, it is what it says it is. And then it's much more easy to use that as collateral when you have a third party verifying it. That makes sense. I mean, it's been such an interesting market to watch. It started from a place where everything kind of made sense, where you'd have these market-making firms that were highly reputable that had a clear need for the funds that they were borrowing. And obviously, we escalated into a lot of Ponzi schemes and just a crazy fallout here. But it's really wiped out all of the lenders,

really. So someone once told me that he viewed the whole market as a bunch of row houses and a couple of them had dynamite in them, but they took down all the row houses, even the ones that didn't have dynamite in them. So what does the market look like now? I mean, in terms of, it just seems to me like it's starved for lenders. There's just not a lot of them. Looking back at what went wrong in the crypto lending space in the first place is the principal Lending model by definition is relatively opaque. You know, the way that we do in traditional markets isn't that dissimilar. You essentially lend money to a bank and that bank goes off and makes a spread.

But generally, you trust that the bank is doing what they're saying because they're like heavily regulated. It's not always correct to make that assumption. It's probably like a much longer different podcast. But like the problem with replicating that within crypto was that those principal lenders weren't properly monitored or aren't properly monitored or regulated. And then when you are VC-backed or not that there's anything wrong with that, but when that entity is VC-backed, your goals incentives perhaps aren't necessarily the same, where you are competing with each other, and hence

you need to keep going further and further out the risk spectrum to attract more and more capital. And when no one has transparency on how you're deploying, you're going to keep going further and further out to be able to attract more at UM and that it keeps carrying. And so generally we think that whatever happened was obviously not great for the space, but what we believe that it will do is move away from this principal lending model,

which we think is a worse option for a lender, to more of a transparent and open marketplace, like a lot of the DPI partners that we work with, where lending happens in a transparent way. The ultimate lender can choose where they want to deploy. And really where Credora comes in is providing the data for them to be able to make that choice. What does the landscape look like today? I think that the landscape essentially involves going to find that ultimate lender that was

previously lending to the principal lenders that used to sit in between and giving them access to, like I guess the rails that we've now created across the D-Fi credit applications that exist, like Maple and Truffi and Cleopold, etc. And then hopefully with our data as like a decision-making factor in that process. It's nothing that I'm saying here is that surprising. But the question that a lot of people have started to ask more of is where is the yield coming from? And I think that what's positive from the fallout of last year is that lenders want to understand the credit risk a bit more, what the counterparty risk is. generally why is it X, Y, Z yield?

It's not like a given that 10% yield is just what's happening in crypto. It's like, where why? I'd say on the other hand, we see some of the same trends coming back, like where once you isolate a risk-free yield, like, for example, staking or treasuries, there are lots and lots of products that then get built on top of it. They lever it up and juice that yield up. and we're seeing that play out and staking at the moment, I imagine that it will continue.

And I don't think that's necessarily bad in itself. It's something that we see happen in traditional finance as well. But in the more like digital slash crypto age that we're in, the unwind of all of that leverage can happen really, really quickly as we've seen in the past. And often it happens to people that don't really understand the risk in the first place of why that yield was 10 on the underlying instrument, where the yield was for. The negative is you kind of see signs of similar things happening again, which may and may not be okay, but like, yeah, that's my SEC hat coming off now.

I think that's a really astute observation. I mean, I'm sure there's another bubble being built here, some pocket of this market, and not everyone will see it until it's maybe too late, unfortunately. Yeah. Like I said, hopefully more people are going to ask, like, where's that yield coming from, just based on what happened really not that long ago. How do you think about ETH staking yield as maybe competition for some of these folks that would want to earn yield on their crypto through like a centralized intermediary? Does that change the market dynamics for retail and maybe even institutional lenders? Yeah, I think there's some really cool products coming off the back of that. I think it's definitely an alternative source of yield.

I think there are some other products that have popped up more recently. I think I saw that offer like a delta neutral element where you can deposit. USD and get eat staking yields on the back of that. There are complications around securities law, et cetera, around all of those things. But I think that it's providing that base yields that most people in the space are somewhat comfortable with taking that risk and can create like a crypto-native equivalent of collateral, where you can start using that staked eth as collateral for some other transaction or to gain trust in some other. other way. So increasingly for any secured lending deals or collateralized lending deals that we see

on the platform, we get asked if a staked asset is something that they could post as collateral as part of that package. And I think that that will be a trend going forward where there is more and more yielding assets available. And I think ETH is a great starting point for that. In terms of it being competition, sure, I think that you're not going to be able to borrow ETH at less than 4%. So that is natural that they've created a floor. But I think that that will be a good thing generally for the space in terms of whether you're trying to get yield from ETH or whether you're trying to use that yield to borrow a different asset. Yeah, that makes a ton of sense. You mentioned that you work with Clearpool and Maple and some of these D5 platforms. To me, that does seem like an

objectively better market structure to just have that visibility. And obviously, there are things that could still go wrong. But do you think that that model has the potential to scale with this market and get institutions deploying capital in size on platforms like that? Yeah, I think so. I think we've always really liked the approach. And I think when you say, like, things can definitely go wrong. I think that's good to just for everyone involved to know, right? Because it is credit. There's yield for a reason. And as long as people understand that there's yield for a reason, like that's known upfront and you're going after that audience that wants to take that risk, I think that's a good thing. And I think what's great about the likes of Maple and of course, Cleopold and various others,

is you can choose exactly where you deploy your capital and you can verify that that's exactly what they're doing with your capital. If it's collateralized lending, you can see exactly where the collateral is being held. And really, that's in line with our ethos, is that you give lenders optionality in terms of where they deploy. That can be traced. It can be tracked and it can be validated. So in the case of smart contract-based lending, essentially that is one way to ensure transparency. Of course, you can do similar things with Bitcoin and various things that can't be natively integrated into smart contracts. But yeah, we definitely think that that avenue is much more scalable from a ultimate lender perspective. You can't deny that there is a negative

from a business running perspective when you can't re-hypothecate certain assets or whatever essentially what's happened in this really good effort to make everything more transparent is that you have crunched to the net number of assets to be slightly less that are being circulated because what was happening before was you would pledge Bitcoin, Celsius or BlockFi would give you dollars, and then they would go lend out the Bitcoin and then get some more dollars against it and create like that loop where more and more money was circulating through that particular ecosystem. But when it is transparent and locked up and not re-hypothated, obviously that's much better for the ultimate lender. But for the business in between,

there's going to be more of a transaction spread that needs to be taken versus just you can make it back on business. That's definitely an astute point. I mean, it gets to the addressable market here. And if you look at this market, obviously it would be a lot more exciting if there were more banks and broker dealers participating in this market and more kind of trad-five participation. You probably won't get that wave, though, until there's a market structure bill in the U.S. There's some more regulatory clarity. So just curious your perspective on how the SEC has handled the post-FTX fallout and what you see on the horizon with respect to the U.S. regulatory landscape.

I mean, I think it's kind of a strange environment with the SEC. see, I think that what's frustrating, I guess, for anyone left in the US and trying to do things the right way, is that it seems to be much more of those people that are trying to go about it in the regulated framework, in the most compliant way possible, that are being penalized for trying to do it that way, whereas you're much more rewarded for going offshore and not behaving in that way, which is compliant and in line with what you believe is the right thing to do in the US. I feel like the incentives are kind of backwards at the moment in the way that it's being run. But what would be good is if there was a regulatory body, whether it's the US or somewhere else,

that set a bunch of transparent standards where people had to adhere to, whether that is certain standards around lending, credit, transparency, or even around trading and issuing tokens. But obviously all of that stuff takes time. and when the crypto space is evolving so quickly, it's hard to keep up your regulations with, I don't know, how we're going to keep up with, I think we barely are able to keep up with the stuff that comes out. So it's hard to imagine a regulator that's able to keep up with everything.

But at the same time, like the bar here is quite low. All we're really asking for is a common set or some set of rules that someone puts forward around trading X, Y, Z types of tokens versus ABC type of tokens, and lending XYZ type of tokens versus ABC type of tokens. I don't think that's like a lot to ask, and I feel like there have been some strides in Asia and Europe that seem to be moving in that direction.

Ultimately, I feel like the US is kind of its own thing at the moment where it seems to be how been ongoing a different approach. Yeah, it's been frustrating for me to watch as well, especially given one of the mandates of the SEC is to promote capital formation. We're not saying that these need to be pro-crypto regulations, necessarily. It's just that we want some regulations so that banks and broker dealers who've built out custody and trading platforms actually deploy them and employ people to go deploy them. It's kind of an interesting market when the EU is just an order of magnitude ahead of the US

in a technology paradigm, right? Like it's, Micah is not perfect, but it's something. And you're seeing actually companies leave the US to go build in Europe. We've definitely seen that with a lot of companies that we work with on the defy credit side and I guess generally like trading firms and various others that have just migrated away from that problem. And yeah, personally, I've moved to Europe. It's not all down to the SEC, but I can see why a lot of people do it. Now, what do you think on the other end of this when we do get some clarity? Because I think eventually the US usually gets things right. It just takes some time. But you end up in a world where banks and broker dealers are able to hold Bitcoin and trade Bitcoin.

and other cryptocurrencies, what does the lending market look like then? Do we have prime brokerage desks that are active in this market? How do you think this unfold? So actually, interestingly, at ECC last week, I spoke to the guys that are doing the defy stuff at S&P. And one of the things that I asked about was, I guess the context here is that they were excited about the prospect of debt being issued on chain and being somewhat involved or around the space while that happens.

And obviously you see them do reports publicly around certain risks around crypto assets and trying to quantify that. So I kind of asked them like why they're excited about it. And I think what was interesting to me was the reasons were quite simple. It was like instant settlement, potentially 24-7 trading and lowering fees of the intermediaries, which all just seems so logical in 2017. Like, you know, all of this stuff about like, I'm not saying that they don't, I want to put words in their mouth, but all of this stuff about like immutability and like sovereign risks and various other like things that are important to crypto-native people.

I don't think that's what traditional banks, etc. are getting in the game for. They see it for efficiencies. So I do think that it makes sense that it will happen at some stage, whether all of it happens on public blockchains or private blockchains, it really depends behind the motivations behind those people getting involved. But I definitely see a lot of the different aspects of the building blocks that we're all building being part of that. And yeah, I just think that it was refreshing to hear, I guess, a simplistic take on why this is somewhat inevitable. But in what form it takes and which chain and all of that stuff feels quite micro to worry too much about, I guess the way that I see it essentially growing out is that there will be some aspect of it that will lean on public blockchain,

and public applications and some aspect of it that will leverage the security of those, but have been more in like private blockchains or walled off ledges. Definitely no question to me that it will happen because you just have to have a profit motive in order for it to really make sense. You look at a custody bank that probably makes one basis point on custody for a non-crypto asset, and you can make 45 basis points on Bitcoin. It's crazy, right? Like you really have these powerful incentives.

And so I think at some point the bank love. starts to get active here. I guess the question is, does that hurt certain market participants? You see the bank lobby is getting really active right now in the U.S. on cutting down on New York trust charter banks issuing stable coins because they want everything to be federally issued, which that obviously benefits the banks, doesn't really benefit startups that are trying to go that path where the door's not really open with the OCC, with the OCC rather. So I agree with you. I think it's ultimately it's just these banks and broker dealers will see that a lot of customers are asking for these products. A lot of customers are using defy, a lot of customers are using fintechs

and they'll want to offer these services because they can make money. Yeah, no, exactly. Usually boils down something quite simple. So you guys recently announced a fundraise. Talk a little bit about that and brought on some exciting members to the cap table. Yeah. So we, I guess, saw, as we were discussing, more use for our technology last year. There was definitely more fear around credit and more of an appetite to get a deeper underwriting on a borrower. So we started to scale a fair amount last year. Obviously, the lending market has been relatively quiet since FTX, but we're starting to

see that come back as well. I'm really excited to see the participants in the space value deep underwriting and risk management and things that, I guess, kind of seems silly saying out loud that people didn't care as much about before. So overall, we're really excited about where we can be over the next few years as the lending market comes back in crypto and beyond and think that essentially private data and privacy preserving infrastructure can unlock a lot of the efficiencies that have been lacking from the space. So we decided to do a small strategic round, which was led partly by Coinbase and S&P Global. What we're excited about is essentially learning from both the teams, but

essentially with S&P, we're keen to understand where we can use our technology in traditional private credit markets, where we can unlock data that is currently not accessible for privacy reasons or compliance reasons, and how you can unlock the value of that data or the underlying messages of that data without necessarily having to see it. And broadly, like, hoping to bring some of that expertise that S&P has in their methodologies and then they're underwriting into the crypto space and try and learn how to better improve our own processes that we currently built today. That's exciting.

And where should we send people that want to learn more about Cordora, maybe learn about the product or see some of the open roles that you have post-financing? Thank you. Our website is credora.io. And we're on Twitter as well, Cordora platform. So we'd love to have people reach out and see if they want to be part of our company. But also, yeah, I'd love to speak to lenders and borrowers in the space and see if we're able to provide them tools that will help them be.

more active in the space. I definitely wish more people were using Kradora over the past couple of years. It was exciting to talk about the credit markets on this podcast. We've been reticent to hop back into it, but I enjoyed the chat. So thanks for coming on, Darshan. No, thank you. I appreciate your time. Great to come to you. Thanks for listening to another episode of On the Brink with Castle Island. To find out more about Castle Island, visit castle island.V. To listen to all of our podcast episodes, please go to On the Brink-podcast.com or just click on the tab in our website. Thanks for listening.