In the first week of May 2022, it was widely reported that a DeFi platform got a credit rating for the first time even though it was below investment grade.
This was quite significant because it points to a completely new array of opportunities for cryptocurrency investors and stakeholders alike within the capital market.
As if acting on a written script, the following week in May, the Securities and Exchange Commission (SEC) in Nigeria broke the ranks and released new rules for Digital Assets as part of its efforts to regulate digital/virtual assets such as Bitcoin and Non-Fungible Tokens often referred to as NFTs.
Short for Decentralized Finance, DeFi is an umbrella term for a variety of applications and projects in the public blockchain space geared towards disrupting the traditional finance world. Inspired by blockchain technology, DeFi is referred to as a financial application built on blockchain technologies typically using smart contracts. Smart contracts are automated enforceable agreements that do not need intermediaries to execute and can be accessed by anyone with an internet connection.
DeFi consists of applications and peer-to-peer (p2p) protocols developed on decentralized blockchain networks that require no access rights for easy lending, borrowing, or trading of financial tools. It is argued that DeFi started in 2009 with the launch of Bitcoin (the first cryptocurrency) which was p2p virtual money built on top of the blockchain network. Through Bitcoin, the idea of ushering transformation into the traditional financial world using blockchain became an essential next step in the decentralization of the legacy financial system. It also created opportunities for other Virtual Assets Service Providers (VASPs).
Virtual Assets require a platform upon which they can be traded and exchanged. This is where VASPs become functional. A VASP is a platform used to buy, sell, exchange, or otherwise interact with the cryptocurrency market.
The rated DeFi, Compound Prime LLC’s product, Compound Treasury which converts US dollar deposits into stable coins is said to have inherent weaknesses including operational and convertibility risks between fiat money (government-issued currency) and stable coins, which are cryptocurrencies typically pegged to reserve assets such as gold or the US dollar.
Compound Prime’s Compound Treasury converts investors’ dollar deposits into stable coins, USDC, to use for its lending projects. In return, Compound promises investors a 4% interest rate.
The Credit Rater cited potential government regulation, Compound’s low capital base and the potential hurdles to generating a 4% return as risks contributory to the non-investment grade rating.
It said the outlook is stable for Compound, indicating that it expects limited loan losses on the DeFi platform along with very low profitability and an expected fast expansion of the balance sheet.