Why will private credit usher in the next stablecoin cycle?

Author: Dogan; Source: X, @doganeth_en; Compiled by: Shaw, Jinse Finance

Low-collateral lending will lead the next stablecoin cycle. Here’s why.

Stablecoins are in a bull market: they help real-world businesses move money quickly, cheaply, and securely. This borderless payment infrastructure is built on crypto, and regulatory clarity (such as the Genius Act and MiCA) has led to major breakthroughs. Now, large institutions are entering the space, either by building their own stablecoins or joining existing stablecoin networks.

But this is just the beginning. We’re about to see a second wave of adoption, with low-collateral lending emerging. In this article, I’ll explain why we believe low-collateral stablecoin lending will be the next major trend.

Current On-Chain Lending

Currently, we already have an on-chain lending industry, with total value locked (TVL) close to $5 billion and active loans reaching $2.5 billion. These protocols operate in a very straightforward way:

• Lenders deposit stablecoins;
• Borrowers pledge other liquid assets as collateral to obtain loans.

But compared to traditional finance, the potential market size (TAM) of existing lending protocols is relatively small. These protocols assume:

• Users own on-chain assets that are liquid and accepted by the lending protocol;
• Users can accept floating interest rates;
• Users are willing to use cryptocurrency (either for leveraged trading or for actual payments—which is not very common).

Today, stablecoin lenders usually pay interest rates higher than the actual USD rate because the supply of on-chain stablecoins is still small relative to demand. But where does this demand come from?

1. Leverage Seekers: People love leverage, which is why “perpetual contracts (Perps)” exist in crypto. They typically pledge assets as collateral to borrow, aiming to amplify returns and positions. They also use leverage to boost yields.
2. Those who don’t want to sell assets but need to spend: Some only want to hold onto assets, don’t want to sell, but need funds to cover expenses. This group is relatively small but very important.

Everyone is happy for now: leverage seekers pay high interest to suppliers, and suppliers get yields higher than the base rate. But will this situation persist as stablecoins accelerate in adoption?

The Golden Era of Stablecoins

Citigroup recently published an article forecasting the total issuance of stablecoins: a base case of $1.9 trillion (previously $1.6 trillion), and a bull case of $4 trillion (previously $3.7 trillion). They predict that trillions of stablecoins will exist on-chain. So, in the future, there will be a huge amount of idle stablecoins, and it’s easy to foresee that the cost of collateralized lending will drop sharply. But in this context, will there be enough yield to pay high interest rates for such a massive supply of stablecoins? The answer is no.

This is where low-collateral lending enters the market. Because collateralized loans are safe and relatively low risk (if the protocol functions as intended, bad debt risk is almost zero), many stablecoin holders will be willing to lend to riskier groups: lending based on credit scores, future cash flow, asset holdings, etc. This is vastly different from our current on-chain lending market and comes with higher risks. Even if loan rates are only 20% of the actual rate, it would still be a brand new, massive market. So, how do we make this happen?

The Low-Collateral Lending Market

In the past, many protocols have tried low-collateral lending; most lent to market makers and investors, assuming they’d pay back. But unfortunately, as seen with TrueFi, Goldfinch, and Maple Finance, these protocols can go bust and never recover the debt. The reason: borrowers took on too much risk, accessing credit they couldn’t get elsewhere; the main problem was excessive leverage and high-risk investments. Additionally, some protocols focused on offering low-collateral lending to retail users, but they also failed because crypto retail has a bad habit: if they can game the system (even for just $1), they will, and they think it’s their right. We’ve seen this with rewards programs, affiliate marketing, etc. So, there should be effective ways to incentivize people to repay. What can force people to repay debt?

1. Cut off access to the product: Protocols can start with small amounts (e.g., $10, $50, or $100) and use zkTLS-like methods to ensure users can repay. If they default, the protocol can ban them and never issue any more credit to them. This sounds reasonable, but I’m sure people will use their family members’ identities to game the system and never repay.

• Advantages: This system can easily provide credit services to people around the world, with no geographic restriction. So it’s relatively easy to build, and current laws allow it.
• Disadvantages: This system will likely end up going bust with a lot of bad debt that’s uncollectible. It can only start with small sums, so high-net-worth individuals will never use it.

2. On-chain debt auctions: We can first ensure that borrowers have funds, credit scores, and/or future cash flow; then, if a borrower defaults, the debt is auctioned on-chain for debt collection agencies to buy from the protocol. For this mechanism to work, collectors must be able to take necessary legal action and force repayment. This system can easily scale to large players, including high-net-worth individuals, mid-sized borrowers, and even crypto gamblers.

• Advantages: This system can easily ensure people repay, because it can impact their lives (I don’t endorse this, but in a capitalist world there is no other way), and it’s easy to find credit applicants needing large amounts.
• Disadvantages: This means it’s unlikely to scale to all markets. It may start with small markets and exploit regulatory loopholes in credit creation. And in some regions, this system might require expensive licensing fees.

I don’t think there’s a one-size-fits-all solution. But this is definitely a proposal worth considering; I think it’s an effective way to enter the market and gain recognition.

What’s Next?

The supply of stablecoins is growing, and over the past four years, it has outpaced the entire crypto market. So, declining stablecoin yields in the coming years is inevitable. As a result, crypto will increasingly become a channel for businesses to access cheap credit. But given the nature of crypto, this system can’t be fully permissionless, because such a low-collateral lending system isn’t built on crypto primitives. We need more on-chain verifiable credentials, and private credit projects must find mechanisms to legally issue credit and enforce repayment if borrowers default.

Implementing this model globally is extremely hard, and it will inevitably break some of the seamless on-chain composability we have today. Still, I believe the emergence of large amounts of free stablecoin liquidity will give rise to some obvious scenarios: businesses will use crypto rails simply to earn extra yield beyond treasuries.