Protocols such as Avee and Curve allow the borrowing of crypto assets given a collateral (other crypto assets) is provided. This is useful when the borrower initially possesses crypto assets to put down as collateral. However, it isn’t useful to borrowers that don’t have crypto capital and have off chain businesses that they need to fund. Goldfinch protocol allows borrowers to obtain capital from crypto investors without putting crypto (on-chain) assets as collateral using the principle of trust through consensus that determines the creditworthiness of a borrower based on collective assessment of protocol participants. This is useful to businesses that operate off chain and subsequently a solid use case for blockchain adoption.

Protocol Overview

The Goldfinch protocol is introduced as a solution to the limitations of current crypto lending systems that require over-collateralization. It introduces a trust-based system where borrowing capacity is determined by the consensus of other protocol participants rather than collateral, potentially widening access to crypto borrowing.

Key Components and Their Interactions

Borrowers initiate Borrower Pools to propose loan terms.
Backers supply first-loss (also known here as junior tranche) capital after evaluating the terms and potential of Borrower Pools.
Liquidity Providers contribute capital to the Senior Pool for a passive yield, which is then allocated to Borrower Pools using the Leverage Model.
Auditors conduct human-level checks to validate borrowers’ claims, reducing fraud risk. They receive GFI tokens as rewards for securing the protocol.
Borrower Pools are smart contracts that define the financial terms that the borrower must abide by in order to repay the loaned amount, terms such as interest rates and the repayment installments.
GFI are tokens used as rewards for protocol participants that can also be used for staking.
FIDU are tokens that are given to liquidity providers that contribute to the senior pool. They are also tokens that are given as member rewards. They can be staked in return for GFI tokens.
Community DAO is used to govern the protocol, it has the power to alter the protocol through participant votes.
Leverage Model a set of defined rules that allocates capital from the senior pool to the borrower pool.
Senior Pool accepts capital from liquidity providers and allocates it to the Senior Pool of the Borrower Pool based on the rules (formulae) defined in the Leverage Model.
Originator Fee paid to participants can help bring borrowers to the platform/protocol; the payment is determined as a percentage of the interest rate paid.
Members are liquidity providers or backers that want to increase their participation in the protocol and gain vip privileges (private channels and offers) by staking their GFI governance tokens. Members receive member rewards (in FIDU token) for staking their GFI. Members are not necessary for the protocol to function, but it helps with network participation and to increase TVL.

Borrowers

Create borrower pools smart contracts that define the terms of the loan to backers. The rules are arbitrary but usual characteristics include:

Interest Rate
Limit – Total capital that can be borrowed
Payment period
Term – when full principal expected to be fully repaid
Late Fee – late payment penalties

Borrowers concern themselves with convincing the backers to accept the borrower pool term-sheet since it is them who are taking the most risk and supplying the first loss capital. The amount that the borrowers can is determined by how much the backers supply and the amount the senior pool allocates. Backers can form offchain legal agreements with borrowers

Borrower incentives

They want to borrow again
When they’re late on repayments they will not likely be able to borrow further
Backers can determine borrowing ability of borrowers and can ultimately decide to stop lending if payments are regularly late.
Borrowers must publicize their on-chain address, this address’s reputation will depend on the successful repayments made.

Tranches

There are 2 main components that the funds accessible to borrowers come from, the senior tranche – funds supplied by the senior pool and the junior tranche – funds supplied by the backers. When the repayments are made by the borrower they will go to the senior tranche first then the junior tranche.

Backers

Backers are participants that take the most risk and are the first point of evaluation to borrowers and borrower pool. They are incentivised to get the senior pool to make additional funds to the borrower pool as they would get higher returns. Therefore to maximize returns the backers must evaluate the created borrower pool and convince others to invest in it. To account for the higher risk the backers take higher yields than investors.

Amongst the backers, the ones that join a borrower pool early get to claim bigger yields and accumulate rewards in the form of GFI tokens that can be used further or redeemed. Those rewarded at the end of the process to make sure that the borrower pool was actually valuable and successful. Backer A can also stake GFI tokens on Backer B this acts as extra verification on Backer B for potentially higher leverage. Backer A will also get reward tokens for staking

Auditors

Verify legitimacy of borrowers to secure the protocol against spam and bad actors. This verification is needed inorder to borrow from the pool. The verification is done via an approval vote. Auditors (who themselves should’ve passed a unique identity check) stake GFI tokens to have their vote counted. The protocol then selects 9 auditors. When selected for a vote the auditor can use whatever means they wish in order to perform checks on the borrowers, this could include legal documents and/or bank statements etc. The auditor check is normally on the identity of the borrower and their honesty about their intentions. Borrowers usually are the first to request an approval vote from the auditors, normally the pool would have reached at least 20% of its limit and enough GFI tokens have been staked to reward auditors for the vote. The approval request can be initiated by anyone and during the repayment period (incase the borrower starts to conduct his/her business in a suspicious manner.

Liquidity providers

These are the investors that want to earn passive income on their investment. They supply the senior pool and will then use the leverage model to allocate the capital to the senior tranches of the borrower pools.

Leverage model

Determines the capital allocation to the borrower pools from the senior pool, it uses Trust through consensus which effectively means the more participants i.e. Backers supply to a particular Borrower Pool, the more this borrower pool is trusted therefore the senior pool can increase the leverage ratio. This model and the protocol assumes that the borrowers, the backers and the auditors all pass a Unique Entity Check. We’ll come back to the leverage formula at a later point.

Unique Entity Check

A vital point of entry and a full/partial proof of identity for participants, namely, Borrowers, Backers and Auditors. The checks must prove that the participants have a unique identity; it can be carried out by an off-chain identity provider picked by the DAO.

Governance

The Community DAO is responsible for the governance of the protocol. The have the ability to;

Upgrade contracts
Change protocol configurations
Pick Identity Check providers
Pausing the event of an emergency
Modifying the GFI distribution amongst participants

Points of Protocol Attacks

Bad borrower, honest backer

Before a borrower can claim the loan, they must be approved by an auditor, since the auditors are selected at random to approve a particular Borrower Pool, this serves as a first point of guard against collusion between borrower and auditor.

Backers who supply first loss capital to the junior tranche (and therefore are at higher risk) are highly incentivised to carry out all possible due diligence (on and off chain) to make sure their investment is safe. Backers can create legal contracts between them and the borrowers to add another layer of safety.

Borrower and Backer collusion

Borrowers and backers can collude to gain access to capital from the senior pool. The first point of guard against this are randomly picked auditors who’ve been randomly picked. The second, it requires many backers (who have passed the UEC) to provide a large sum of capital in order to gain enough leverage from the senior pool to make the operation profitable as it will be expensive to execute. This attack needs further investigation. The third is the Unique Entity Check itself is needed for backers, this prevents programmatic creation of backers.

Borrower collusion with Auditors

Borrowers can collude with a number of Auditors to gain access to funds for fraudulent borrower pools. The first check is the UEC which makes sure that each auditor is an entity and cannot be created programmatically. The second, to be selected to approve a borrower pool an auditor must first stake GFI which can be slashed if the auditor votes different from the majority of the auditors. Third, it requires an auditor to stake relatively more than the rest to increase their likelihood of being selected, this makes collusion expensive. The fourth, approval of the borrower can be invoked by the participants at any time, this means that borrowers must collude with future auditors too. Backers also need to be convinced that there isn’t any collusion with auditors before they take the risk.

Bad Backers, honest Borrowers

Bad backers can game the protocol to get higher leverage from the senior pool and therefore higher returns, however, the fact that all loan payments must first be paid to the senior pool before the backers. The backers take higher risk, get higher yields but also get paid last. So their incentive is to get the loan fully repaid so that they enjoy the higher returns.

Goldfinch in the wild

How that we have the theory i will make another blog to see how the protocol is performing in practice