In May 2021, the decentralized credit marketplace for cryptocurrencies known as Maple Finance was launched with the audacious goal of bringing together lenders and borrowers.
The Maple model would not require additional cryptocurrencies to be deposited as collateral that could be captured or rapidly liquidated in the event of a default, in contrast to many other decentralized finance (DeFi) lending platforms that have emerged in recent years in the developing digital-asset industry. As an alternative, underwriters of different lending “pools” would decide whether to approve loans, essentially determining the borrower’s capacity to pay based solely on their creditworthiness.
But the turmoil in the cryptocurrency markets this year has served as a brutal stress test, and Maple is now dealing with the worst crisis in its 18-month history.
Approximately $36 million in loans have defaulted in the last two weeks alone, with another $18 million in distressed loans. Sixty-six percent of the outstanding balance in Maple’s four active lending pools is made up of soured debt, with some of the largest borrowers admitting that the spectacular failure of Sam Bankman-Fried’s FTX cryptocurrency exchange left them devastated. MPL, the native token of Maple, has dropped by 50% during that time to a record low.
Analysts and Maple project participants are currently debating what went wrong and how the policies and procedures might be changed to make the platform more durable. Since Maple is only the project’s operator and not a lender to any of the pools, it is not going through a credit crisis of its own. But a crucial question is whether participants will stick around given that depositors to Maple’s lending pools have been scarred by the recent losses.
Analysts have been concentrating a lot on what seems to be the weak point of the uncollateralized crypto lending business model. Depositors were left unprotected and exposed to losses of up to 80% due to poor protocol design choices and questionable human choices.
According to Walter Teng, vice president of digital assets at market research firm Fundstrat, Uncollateralized loans in DeFi are still reliant on centralized parties for underwriting, antithetical to the ethos of transparency and decentralization.
Cryptocurrency credit crunch
Maple increased its loan book to $900 million in a year by riding the wave of the cryptocurrency lending boom. The protocol was initially well-liked by cryptocurrency trading companies and market makers in need of borrowing liquidity. Depositors include yield-seeking institutional players and common retail investors. The depositors in Maple’s decentralized model are actually the lenders.
Smart contracts written in computer code control the loan process in Maple. The protocol does have centralized components, though.
Every credit pool has a representative, a financial company, that oversees the loan underwriting and purportedly ensures that the pool’s funds are lent to companies that can repay the loans.
Given that loans are undercollateralized, the credit pool manager position is essential for Maple and its competitors. It implies that borrowers put up less valuable assets—and sometimes even nothing—to guarantee a loan. In the event that the loans default, not much can be seized because there is no lien on the property, similar to a mortgage.
Deposits and loans on Maple rapidly decreased earlier this year after the Terra blockchain’s failure caused a wave of cascading losses and a crypto credit crunch. The swift collapse of FTX in November was a further setback. According to data, total loans outstanding decreased to $82 million.
Celsius Network, a cryptocurrency lender, and Alameda Research, a sister trading company of FTX, two former credit pool managers, are currently in bankruptcy and are being criticized in court and the media for allegedly questionable business practices.
Orthogonal Trading, a third credit pool manager, was expelled from Maple on December 5 after it was claimed that it had falsified its financial statements to cover up losses from FTX.
M11 Credit, a division of investment firm Maven 11, one of the two remaining pool managers, has recently come under fire for allowing bad debt to amass in its three lending pools.
Large borrower from the M11-managed Maple credit pools, Orthogonal Trading missed payments on loans totaling $36 million.
Despite Auros Global missing a payment on a $3 million loan, M11 decided to pursue restructuring rather than going into default. Even before that, on November 13, M11 Credit allowed the troubled borrower to postpone repayment of a total of $10 million in loans by two weeks. The debt was then renewed on November 27.
What use is blockchain technology if arbitrary extensions are permitted other than to observe the goal post move? On Maple’s Discord channel, one user voiced their displeasure.
“Far from ideal”
In an email response to a question regarding the extension, M11 Credit stated that it had only refinanced the loans “after receiving very strong commitments” and “comprehensive conversations with stakeholders.”
According to Maple’s design, the email continued, terms are determined at the discretion of the M11 Credit team.
Unfortunately, because of this reliance, it is impossible for outside observers to tell whether Auros can service its refinancing or if they are simply buying time before its inevitable demise, according to Fundstrat’s Teng.
The protocol will be updated and released as Maple v2 next week, the company said in a statement on Thursday.
According to Charlotte Dodds, Maple’s head of marketing, the upgrade will include changes to the withdrawal procedure, a redesign of the pool cover mechanism, and more information on the dashboards for public pools.
Joe Flanagan, a co-founder of Maple, admitted during the community call on Friday that they are far from perfect.
First-mover advantage for escaping quickly
To avoid any systemic risk, pool managers should strive for a diversified portfolio of loans to various borrowers.
After the FTX crash in November, there was a severe lack of liquidity and a sharp decline in borrowing interest, making it very challenging to maintain a balanced loan book. According to data, Maple’s loan book decreased by two-thirds from $260 million over the past month.
According to an update by Maple on Nov. 17, most borrowers, including Nibbio and Folkvang, paid down their loans early after FTX filed for bankruptcy, and pool managers de-risked their loan books. To maintain high cash deposits, M11 decided not to issue any new loans during this time.
Depositors who were alarmed by the FTX drama were able to withdraw money thanks to the abundant cash that the prematurely closed loans released from the credit pools. (According to Maple’s code, users must wait 10 days after initiating withdrawals before they can withdraw any money.)
According to Maple’s credit dashboard, this ultimately resulted in highly concentrated pools with bad debt to distressed borrowers and mostly depleted cash deposits in the three problematic pools.
As of Dec. 9, Orthogonal Trading was the recipient of 80% of all loans made in one of M11’s USDC stablecoin pools. As of August 31, this number was 14% below the cutoff, as per Sherlock’s statement.
With regard to wrapped ether (wETH), another well-liked cryptocurrency in the DeFi ecosystem, 55% of all loans still owed to Auros and Orthogonal are held by the M11-led pool. Nearly 50% of the total outstanding debt in M11’s authorized USDC pool is owed to Auros.
Allowing cash withdrawals and depleting pools, as one Twitter user noted, meant that those who weren’t quick enough will take the majority of the losses rather than spreading the losses among many creditors.
Poor design
Experienced bankers understand that defaults are inevitable in the lending industry, which is why there are safety checks in place for when it does. It’s possible that not enough safety measures were taken in Maple’s case.
In the event of a default, each credit pool on the platform has a separate fund called “pool cover” that serves as insurance to cover the initial losses, or at least a portion of them. The manager of the pool must lock up assets in the pool cover to ensure that they act responsibly and do their best to avoid any defaults.
Now that users are upset, they wonder if the underwriters had enough at stake.
M11 Credit is in charge of managing three pools totaling $74 million in loans and has assets in the pool covers totaling less than $1.2 million.
By depositing USDC and Maple’s own token, MPL, any investor can increase this insurance fund and receive rewards for taking the risk of first loss.
However, as soon as they detect trouble, savvy investors may act quickly to exit the pool cover, depleting the fund’s ability to pay creditors.
At the time of publication, only a small portion of the bad debts were covered by the pool covers in all three of the M11-managed pools.
Walter Teng of Fundstrat called it a “faulty design.”
Another issue is that pool cover investors deposit a mixture of MPL and USDC stablecoins.
According to Kyle Doane, a digital asset trader at Arca, if the money set aside to pay the bad debt is designated in the protocol’s native token, the value of this insurance goes lower when the protocol itself is in trouble.
MPL fell 35% last week, which might have helped to deplete the funds available to pay creditors.
What’s going on with Maple Finance now?
Tens of millions of dollars are at risk of loss, though the full picture isn’t yet clear.
According to major creditor Sherlock’s forecast, assets lent to Orthogonal Trading are probably lost forever or may become the subject of a protracted legal dispute.
Less than $2 million total is available in the three troubled credit pools’ covers to compensate depositors, which is alarming news for lenders. M11 Credit contributed $1.2 million of that total.
Maple also considered seizing an additional $1.2 million from the insurance fund for the Orthogonal-managed credit pool, which the bankrupt trading firm had contributed to the fund.
However, this means that the majority of the losses are likely to be borne by creditors who were unable to leave in time. Numerous retail investors as well as two cryptocurrency companies, DeFi insurance substitute Nexus Mutual and smart contract auditing platform Sherlock, are among the victims.
Similar events occurred at Maple’s first default in the company’s history. Creditors suffered a $7.9 million loss in July as a result of Babel Finance’s default on a $10 million loan from Orthogonal’s credit pool. However, due to a much larger pool size, that only amounted to a haircut of 3.8%.
Maple doesn’t stand to lose significantly from the defaults as a result of its design. In the long run, though, the harm to one’s reputation and loss of trust might be detrimental.
The protocol for Maple, according to Dustin Teander, an analyst at Messari, “will probably be fine.” The most effective way to stop this is to base credit decisions on open cash flows and assets rather than on general trust.
According to Timo Lehes, co-founder of Swarm Markets, a regulated provider of DeFi infrastructure, where Maple’s model could succeed is offering companies a real-time view of collateral and accounting, meaning underwriters can adjust accordingly.
The “process of how losses are socialized” and the composition of the assets that are pooled to cover losses, in the words of Arca’s Doane, are two things that must be improved.
According to Teander, the upcoming Maple upgrade may present a “opportunity to implement some features to better manage risk on the protocol.”
It’s possible that Maple’s rapidly declining business illustrates how urgently needed these changes are.
