Unsecured Liquidity & DeFi with Clearpool’s CEO Robert Alcorn
The debt capital markets are being changed by DeFi company Clearpool, sparking a change in the way that institutions obtain uncollateralized liquidity.
Summary
Overcollateralization is one of the biggest challenges facing DeFi borrowers. To address this issue, Singapore-based startup Clearpool created a decentralized capital markets ecosystem as well as a tokenized credit and risk management system that provides lenders with more flexibility.
Through the use of its native token CPOOL, Clearpool seeks to offer a market for institutional unsecured liquidity. Through their unique model, they increase liquidity in the capital markets for borrowers and lenders while offering a return to investors that are on the hunt for yield.
“In early 2021 my former banking colleague Alessio Quaglini and I were discussing DeFi, the idea for Clearpool came up, and a few days later, I resigned. We knew we had a great idea and the right mix of knowledge and experience to execute it,” Clearpool CEO Robert Alcorn told SGC. With the help of Quaglini, the CEO of SGC portfolio company Hex Trust, they brought Clearpool to life.
Alcorn’s career has spanned over two decades, having worked for ten years as an entrepreneur and 12 years in the international financial markets in total. He’s also a CFA Charterholder and holds the Massachusetts Institute of Technology's Fintech Certificate in Future Commerce.
Having worked in a variety of traditional credit market sectors, he quickly understood how DeFi had the ability to significantly alter the environment in which debt may be issued and traded.
Two years onward, Clearpool is now approaching a paradigm shift that may cause big waves not only in the DeFi community but also draw substantial inflows from TradFi institutions. We chatted with Alcorn on the past and future of Clearpool’s journey in the DeFi space, here’s what he had to say:
How would you explain what Clearpool does?
Clearpool is a marketplace where institutions can borrow from a decentralized network of lenders without posting collateral. Borrowers are vetted and public, and rely on their credit reputation. Anybody can be a lender. Lenders are compensated for taking on the credit risk of the borrower with higher interest rates, there is no lock-in, and funds can be withdrawn at any time.
How did the idea of creating a permissioned liquidity pool come about?
Financial institutions love the innovation in Clearpool’s permissionless pools, but they currently still need to have visibility on who the lenders are and the ability to verify that they have met KYC standards. We had many early conversations with some of the largest institutions entering DeFi, and it became clear that a permissioned pool product would be necessary in order to attract them into our ecosystem. We are now building a more sophisticated permissioned product which will launch soon and which we have significant interest in from multiple institutions.
How does Clearpool work without collateral?
Very simply, borrowers on Clearpool are relying on their credit reputation in order to attract lenders. Lenders are compensated with higher interest rates for taking on the credit risk of the borrower. Unsecured lending is commonplace in TradFi. Clearpool has taken the concept of unsecured lending and innovated using blockchain technology and the tenets of decentralization to create a new infrastructure that is significantly more efficient than traditional incumbent systems.
How do you determine credit risk scores for borrowers while maintaining their privacy?
Clearpool is a smart contract application and therefore does not do any underwriting. The protocol's smart contracts match borrowers and lenders and determine interest rates through a unique utilization curve. There is an automated process in place in the event of default. So everything is quite decentralized. For that reason, we partnered with Credora, a third-party credit scorer. Each of the borrowers has to obtain a credit score from Credora before they can launch a pool on Clearpool. Ultimately, it is the lenders who use this information to do the underwriting themselves.
How do you determine optimal utilization rate? What’s the thinking behind this algorithm and how does this work?
Each permissionless pool has a utilization curve embedded within it. There is a corresponding interest rate at each point along the utilization curve. Therefore, the rates that the borrowers pay and lenders receive are determined through utilization; how much of the pool’s liquidity is currently being borrowed.
The first version of Clearpool’s permissionless utilization curve was a linear slope with a kink at 85% utilization, after which the slope became steeper. The idea was to discourage borrowers from utilizing more than 85% of the pool's liquidity in order to ensure adequate exit liquidity for LPs. However, we found that borrowers were not optimizing sufficiently with this curve and therefore developed a unique u-shaped curve using a cosine function. As you can see in the image below, the lowest interest rate on the curve is now found at 85% incentivizing borrowers to maintain utilization at or around that level. The result is a much more efficient use of capital and higher rates for lenders, but borrowers can still use the utilization function to manage borrowing costs and to either attract or repel liquidity.
The interest rates that ‘price’ the curve are now determined through Clearpool’s unique Oracle and staking mechanism. Oracles are institutions that vote on the parameters that price the curve. CPOOL holders can stake and delegate tokens to an Oracle staking pool in order to earn a yield and help to secure this pricing mechanism.
Does the higher risk-adjusted return of DeFi lending protocols make more investment sense in an inflationary environment?
Investors should always first consider the risks of unsecured lending. Unsecured lending will always offer higher returns but comes with higher risk. This should be considered first, regardless of inflation.
Since its inception, the DeFi market has been experiencing exponential growth due to the unregulated nature of this sector. What do you foresee for the future of the space once more regulation sets in?
Blockchain technology and the concept of decentralization have already provided us with financial products that are more efficient than traditional equivalents. Regulation is required, but it needs to evolve. I believe that the blockchain industry must work harder to educate regulators and help them to understand how regulation can fit into this new financial paradigm. If we can achieve this, then the future of DeFi will become the future of finance. The potential of decentralized finance is as vast as it is historic, not just in terms of operational and cost efficiencies it can bring, but in terms of capital creation and capital distribution that will help expand economic freedoms for everyone.
What gaps do you see in the DeFi space and how do you see the industry filling them in the future?
In order for mass institutional adoption of DeFi, the sector must advance in terms of implementing and aligning with compliance requirements. Whilst traditional compliance requirements themselves must also evolve, they are here to stay and ultimately will create value for market participants in terms of increased transparency and protection. Additionally, we must see advancements in the ability to use blockchain technology to provide more thorough and transparent credit assessments. Clearpool's innovations have made the process of borrowing and lending significantly more efficient through technology and decentralization. I believe we will soon start to see similar improvements in compliance and credit underwriting capabilities, which will open the space up to a much wider institutional audience.
What are some misconceptions about unsecured lending you can clear up?
DeFi cannot prevent the inevitable loss that will occur if a borrower defaults on an unsecured loan. Otherwise, it would not be called unsecured, and it would not provide a higher return compared to collateralized loans. We often see people asking questions like, "What guarantee is there that we will not lose our money?" As with all finance throughout history, the simple answer is there isn't any. DeFi can vastly improve credit risk management processes, hedging capabilities, default processes and provide more transparency. Products will be built that enhance all of these things and more, but DeFi is not a magic wand that can eliminate the risk of losses in unsecured lending.
How would you compare your time in traditional finance versus DeFi?
I spent 12 years working in traditional financial markets, first as a bond broker and then in fixed-income sales. I enjoyed a very rewarding career in TradFi, it was a great learning experience, and I left with a great deal of knowledge, some great memories and some lifetime friends. My experience designing, building and launching Clearpool, and working within the DeFi industry, has challenged me in different ways but has been equally as rewarding. I try to have fun in everything I do, and although we take what we do seriously, we also have a great time doing it. Nothing is more exciting than playing your part in building the future financial markets.
Where are you expanding now and where do you plan to expand into in the future?
We are currently testing our new permissioned product that has been developed over the last few months. This product offers much more sophistication to institutions that are looking for KYC-compliant access to decentralized lending and borrowing. We will announce a launch date in the coming months.
We are also working on a number of new products that will significantly enhance the Clearpool product ecosystem. Term pools will allow lenders and borrowers to agree on lock-up periods for liquidity, providing lenders with additional yield opportunities and borrowers with guaranteed term liquidity. Diversified pools will provide single-transaction diversification for lenders. A secondary market will be built for cpTokens which will support permissionless pools, term pools, diversified pools and lead to the creation of leveraged lending.
What advice would you give a new entrepreneur in this space?
Don't take a traditional financial product and replicate it on a blockchain. The improvement will not be enough to compel users to switch. Use the technology to innovate something new that provides at least a 10x improvement on its traditional equivalent. Then it cannot be ignored, and it will still be relevant in the future as the old systems become obsolete.
Why was Sino a good investor to team up with in your view?
When we first spoke with Sino about Clearpool, there was an immediate and clear understanding of the vision, which gave us tremendous confidence and a desire to work closely with your team. We had a shared understanding of the current state of the DeFi credit market, especially the challenges that borrowers had in securing uncollateralized liquidity and building an on-chain credit profile. The level of engagement and support throughout this journey has been unparalleled and continues to this day. We have a great relationship with the whole Sino team, and we could not be happier with how it has gone. The key word in your question is "team up" and it does feel like more of a team relationship rather than that of an investor and portfolio company relationship, and I think there can be no higher accolade.