According to the SME finance forum, “around 161 million MSMEs have unmet financing needs.” The problem is that not enough traditional credit institutions are attending to these needs, and the available financing options are expensive, not easily accessible, and don’t benefit borrowers.
DeFi lending protocols introduced a new financing system that makes it easier for borrowers to get loans. With DeFi, the entry point is minimal, and loans are accessible.
In this piece, we’ll cover how Umoja works and how you can get affordable financing for business with Umoja.
Umoja Protocol is a decentralized credit protocol that provides secure, affordable, and flexible financing to businesses in emerging markets. Umoja helps the borrower offset the cost of borrowing by crowdsourcing loan financing and collateral from investors.
To further support developing economies, Umoja is introducing the first DeFi FX AMM (Automated Market Marker) to help borrowers get loans in their local currency. Therefore, borrowers from countries like Nigeria, Kenya, and South Africa, can get loans in their currency without going through a complicated process.
Learn more about how Umoja is bridging the $8T Financing gap.
Umoja leverages Blockchain technology as a DeFi lending protocol to offer an open, decentralized financial system.
Traditional lending institutions and DeFi lending protocols like Umoja differ in several ways. Here are some of the key differences:
Accessibility: Traditional lending institutions require extensive paperwork, credit checks, and collateral to secure loans. DeFi lending protocols like Umoja require minimal entry points, allowing borrowers to get loans with minimal hassle.
Cost: Traditional lending institutions often have high-interest rates and fees, making loans expensive for borrowers. DeFi lending protocols like Umoja offer competitive rates and fees, making loans affordable for borrowers.
Decentralization: Traditional lending institutions are centralized, meaning they are owned and operated by a single entity. DeFi lending protocols are decentralized, meaning they operate on a blockchain and are not owned or controlled by any single entity.
Transparency: Traditional lending institutions often lack transparency, making it difficult for borrowers to understand the terms and conditions of their loans. DeFi lending protocols offer full transparency, allowing borrowers to see exactly how their loans are structured and how their funds are being used.
Global Reach: Traditional lending institutions often have limited reach, meaning they are only able to offer loans in certain geographic regions. DeFi lending protocols have a global reach, allowing borrowers from anywhere in the world to access financing.
The Umoja ecosystem depends on the following:
Liquidity Providers (Senior Tranche)
Backers (Junior Tranche)
Collateral Providers
Stakers
Borrowers
The flow chart below shows the ecosystem
An overview of the Umoja Protocol
Borrowers: Borrowers get access to affordable and flexible loan options on Umoja. They are individual entities (MSMEs) looking to borrow capital to fund their business (and soon retail consumers!).
Backers. Backers are junior tranche debt investors who directly invest into Borrower Pools (i.e., loans). Backers earn higher, variable yields from financing loans, provided that they take on more risk. Backers may be retail and institutional investors.
Liquidity Providers. Liquidity Providers (LPs) are senior tranche debt investors. LPs provide capital to the Lending Pool, which distributes senior tranche financing across all Borrower Pools that elect to have such financing. LP capital is protected by Backer capital and loan collateral in the case of default and thus is the safest (lowest risk) participant in the Umoja ecosystem other than Insurers. LPs earn a lower, fixed yield from financing loans because they take on less risk. LPs may be institutional and retail investors.
Collateral Providers. Collateral Providers provide capital to the Collateral Pool, which rents capital to Borrower Pools to further de-risk debt investors from the default (i.e., top up their collateral). Collateral Providers help minimize the cost of financing for MSMEs by requiring them to put up less collateral themselves. All loan collateral, either rented from the Collateral Pool or provided by the Borrower, protects debt investor capital. Collateral Providers earn a portion of the APY paid back on the loan, APY generated by Aave on their idle capital, and 40% of the protocol’s transaction fees (as they take on considerable risk).
Insurers: Insurers (a.k.a., “Stakers”) provide capital to the Default Insurance Pool to limit the risk exposure of Collateral Providers by pooling capital that may be used as default insurance should the protocol-wide default percentage exceed 5%. Should the protocol’s default percentage exceed 5%. the Default Insurance Pool will reimburse Collateral Providers for all capital they have lost until the protocol-wide default rate is back to (or lower than) 5%. In exchange, Insurers earn 30% of the protocol’s transaction fees (in proportion to the capital they stake to the Default Insurance Pool).
Approvers: Approvers, who are Backers that have staked capital within the Approver Safe to become eligible to underwrite loans on the protocol, review and approve loan requests from borrowers’ pools. They make the decision to either approve or reject a loan request after reviewing it. Approvers may only underwrite loans that they are also debt investors (i.e., “Backers”) of.
A successful loan on Umoja goes through five stages:
Borrower Whitelisting
Borrower Pool Creation
Borrower Pool Activation
Borrower Pool Financing
Borrower Pool Maturity
To get started on Umoja, a borrower has to go through a KYC (Know-Your-Customer) and KYB (Know-Your-Business) verification process. KYC verifies the borrowers’ personal identity to ensure that a person is who they say they are and that they aren’t a part of notable criminal organizations. KYB verifies the borrower’s business entity and its representatives are legal and authentic.
Umoja uses a UID (Unique Identification) to ensure compliance with local regulations. UID is a non-transferable NFT (Non-Fungible Token) that represents each protocol participant’s KYC and KYB.
After the borrower is whitelisted, they may create a borrower’s pool to make a loan request. This allows you to propose your preferred loan terms and condition, including the borrower’s preferred interest rate, grace period, late fee terms, and loan currency. By submitting the loan request, an inactive Borrower Pool is created automatically.
🚨 Note: Just because a loan request is submitted does NOT mean it must be honored. The borrower’s loan request must still undergo underwriting and approval for their Borrower Pool, which helps the Borrower crowdsource loan funding, to become activated.
A borrower pool is a permissioned loan request that collects the debt financing for a specific borrower. It is simply the smart contract that contains the loan terms, including the interest rate and the repayment terms.
A borrower pool will contain:
Interest rate, which will be a fixed interest APR, e.g., 15% on the loan
Currency: the currency the loan is disbursed and repaid with
Loan limit — the total amount you can borrow
Payment period — the frequency of your payment, e.g, interest is due every 30 or 15 days
Grace period: The Grace period allows you to make payment after payment is due without paying a late fee.
Term: When the full principal is due. For example, the loan should be repaid in full in 365 days.
Late fee: Additional interest you have to pay when your payments are due
The borrower pool remains inactive until it is underwritten and approved by an Approver (i.e., an underwriter).
A Borrower Pool is activated when an Approver (i.e., Underwriter) performs due diligence on the loan, including business evaluation and verification.
If the Approver finds the business loan-worthy, they will move to approve it. To ensure that the Approver makes good underwriting decisions, they are required to stake capital to become eligible to underwrite loans on the protocol.
If an Approver rejects the Borrower Pool, the pool remains inactive, and the borrower will need to submit another loan request to be considered. The borrower is free to create another Borrower Pool (make another loan request) and wait for approval.
To approve the borrower pool, the approver must:
Invest in the pool
Determine whether to rent collateral from the Collateral pool or not.
Determine the permission level of the pool, i.e., whether the pool will be public (open to everyone) or private (open to a selected few).
Determine the structure of the pool. i.e., if the pool needs a senior tranche (institutional lender or not)
The pool/loan is set for financing when the borrower pool is approved.
A Borrower Pool financing is dependent on how the Borrower Pool’s Approver structures the loan. Approvers may set the Borrower Pool public or private to debt investment and/or elect for the Borrower Pool to have a senior tranche (i.e., receive funding from the protocol’s Lending Pool).
Once the borrower pool is fully financed, the loan is disbursed to the borrower. But, the loan is only disbursed if the borrower has contributed their agreed-upon collateral to the pool (based on the loan’s agreed-upon terms). Borrowers are free to submit their collaterals at any time, but they don’t get their loan disbursement until they do so.
The borrower pool matures when the borrower pays off the loan fully according to the loan terms. At this point, the borrowers get their collateral back, and investors can redeem their token for their underlying investment.
If a borrower defaults on their loan, the collateral is liquidated to cover the losses first. The remaining losses are covered by the junior tranche investor’s capital (second) and the senior tranche investor’s principal if necessary.
Once the loan payment is completed, the borrower pool is deactivated and closed. All stakeholders that financed or provided collateral are compensated based on their seniority and stake in the pool.
In the case of a default, the borrower pool is also deactivated and closed. But in this case, the stakeholders have to bear the loss.
Umoja also allows borrowers and backers to renegotiate their loan terms before the loan is foreclosed.
The renegotiation plan is part of the flexibility Umoja offers borrowers. We understand that a lot can change during the course of a loan cycle — market conditions and life circumstances. You can submit a renegotiation offer at any time during an active loan cycle or after it has expired but not foreclosed.
👉🏼 The renegotiation offer must be initiated before the loan is foreclosed (deactivated).
You can change the loan period and repayment amount as part of the renegotiation. You can also offer the approver an incentive to accept your new terms (kinda like gas fees). This incentive should be a payable fee in the protocol’s native token or protocol-approved stablecoins.
There is also a message option to send a customized message to add context to why you’re renegotiating your loan.
You can review, edit, or cancel your renegotiation offer before the other party (Approver) responds to your offer. The Approver can respond in three ways to your offer:
Accept the new terms,
Counter-offer with new terms, or
Reject renegotiation
🚨 Note that the Borrower Pool’s Approver can refuse to renegotiate and leave the loan terms as they were before. The Approver can also make a counter-offer as they deem fit. If renegotiation terms are rejected, the borrower must restart the process with fresh terms or continue with the initial loan terms.
Umoja can only reach its vision of providing over $100 billion in MSME financing through partnership and community participation. To join the Umoja DAO and become a shujaa (i.e., “warrior” in Swahili), learn more here.