Note: Cicada Partners and its affiliates hold no economic interests in Arkis, or its related entities.
Summary View
Cicada Partners have been working with the Arkis team for over a year, from first diligencing the technical capabilities and roadmap of the project (along with all of Arkis’ competitor projects), to being a user of the platform. DeFi will never scale without risk-managed credit and the Arkis team provides a range of skills and back-end functionality that can add material value accrual to the DAOs front-end, aggregation, and origination layers.
As such, Cicada Partners are in strong support of this proposal for the following reasons.
(1) Strategic Value Proposition: Improve Risk-Reward to Drive Lender Flows
For those active in crypto-credit conversations, it may not come as a surprise to hear that unsecured credit to crypto-natives remains stuck in the murky shadows of Luna and FTX’s demise. Since Luna’s demise in May ‘22 spawned a chain of collateral shortages, liquidation events, and corresponding bankruptcies, we’ve been collecting data with respect to defaults, recoveries, and secondary trading of liquidation claims. These data have formed the basis for our conviction to help the DAO launch unsecured lines of credit to creditworthy counterparties.
At Cicada Partners, we think about the on-chain investment world through a risk-adjusted yield framework of implied and historic probabilities. Leveraging our data set on defaults and implied recovery values back in 1Q24, we viewed lending to crypto-native firms decomposed as follows, with a c. 400bp alpha opportunity available for willing Lenders:
Chart 1:
While crypto-native yields have come down c. 100-250bps since the time the above chart was produced, off-chain credit spreads in the high yield bond market (where probabilities of default and recovery values are in fact deteriorating counter-cyclically to crypto credit) have come down c. 50bps, with single-B credit spreads (our view of the closest LGD comparable that is a, reasonably, tradable index) near lows not seen since before the GFC (!). As such, the relative return opportunity of taking on-chain/crypto risk remains very sound.
Chart 2:
And yet, flows into TrueFi and its competitors have remained subdued because two problems remain: (1) The bulk of crypto curious lender capital looking to deploy into yield-bearing opportunities remains outside of DeFi, and (2) the means of attracting this capital and non-crypto native capital requires additional investment to further improve risk-adjusted returns.
As a consequence, over the past year we’ve engaged in various initiatives to improve the fundamental credit proposition of crypto-lending by focusing on downside protection to improve risk-reward. Chart 3 below provides a view on Collateralized Lending from our 1Q24 research. Key assumptions underlying this chart are the improvement of recovery values to 85% vs. 30% in the case of unsecured, but offset by incremental counterparty risk (assumes 150bps below, but wide variability) due to reliance on third-party custodians or smart contracts. Despite the incremental operational risk, one can see a 100-150bps improvement in our Alpha estimates for collateralized crypto lending vs. uncollateralized crypto lending. As such, if the Arkis team can deliver a more efficient means of collateralizing lending positions, the DAO can materially improve LOCs and Credit Vaults to the target borrower audience, better positioning TrueFi’s products to both grow organically and take market share over time.
Chart 3:
(2) Better Value for the Money: Dollar Comparison of Tech Service Provider
In addition to the strategic value proposition Arkis brings to the table, we’d like to also highlight the proposal in terms of value for the money. Arkis has a large team of engineers and three executives. Based on our conversations with the team, they will look to hire additional members to take the pure engineering team to nine, excluding three technical executives focused more on commercialization. Ignoring those three executives, you will see how costs per head compare quite favorably vs. prior proposals. Net-net, the DAO is getting a team with valuable skills, building products with a complementary use case, and at a fraction of the existing cost base.
Chart 4.
Conclusion
Simple ideas scale, overly complicated use cases drown in deep explanations with lenders. Arkis’ proposal is simple, they can help bring more capital-efficient collateralized lending to the DAO while also support assuming TrueFi’s service provider responsibilities.
Cicada Partners endorses this proposal.