💡DeFi has an underwriting problem

Adverse Selection is a big problem in DeFi

There have been few attempts in DeFi to solve for tokenized private credit. Incumbents have struggled with one issue across platforms hindering their growth: Adverse selection i.e low quality borrowers which further leads to defaults and losses. Common argument is the best borrowers go to TradFi lenders and the worst left come to DeFi because they can't get loans from TradFi lenders. While, that's the true for few cases. There are a lot of high quality institutional borrowers, willing to borrow from DeFi. It's already evident with significant active laons on tokenized private credit platforms. Lot of traditional borrowers in with TradFi lenders on their books, still they want capital from DeFi. Because, it enables access to new capital source and cheaper rates in some cases. So, what's the real issue here? Adverse selection is an underwriting problem, which is two phased - data and incentives

1. Lack of infra or willingness to capture complete info on borrowers financials and creditworthiness. Moreover, most protocols only do due-diligence on asset originators and not the underlying financial risk, quality of the asset pool and risk correlation. Also, there isn’t active collateral/covenant monitoring post-loan. fintech lenders in Tradfi lend to same set of borrowers and have significantly low NPAs compared to DeFi cause they follow the best practices.

2. Underwriting is done by asset originators/pool delegates/credit committees with very little or no skin in the game, having no incentive to select the best assets for lending pools. It's all crowdsourced capital that's being deployed in the lending pools. Also, the Underwriting process is highly centralised and opaque creating the environment for "trust me bro" and vibe based borrower/asset selection rather than having a transparent, data driven process.

This has improved a bit post the defaults recently, but still not the ideal state for the market to grow.

1. Improved credit underwriting/monitoring infra to avoid adverse selection(low quality loans) and credit defaults/losses.

2. Standardised and transparent risk assessment to make the products easier to understand for the broader investor base.

3. Qiro's underwriting infrastructure leverages a data-driven approach and distributed risk evaluation, ensuring transparent on-chain risk management.