TL, DR: Umoja’s IOU tokens are digital assets tied to real-world assets and represent the underlying liquidity. They allow liquidity providers, borrowers, collateral providers, and approvers to earn rewards, trade, and stake for additional benefits.

Umoja IOU tokens are digital assets that represent the capital deposited into the protocol. These tokens are backed by the underlying liquidity and are classified as RWA (Real-world assets).

When you deposit capital into any of our pools, such as the Lending Pool (as a liquidity provider), Borrower Pools (as a Junior Tranche backer), or the Collateral Pool (as a collateral provider), you receive IOU tokens. Your IOU tokens represent your share in the underlying liquidity in the pool, along with your accrued interest.

This article explains the different RWAs on Umoja (IOU tokens), their functionalities/utility within the protocol, and the benefit of holding them.

$uLP (Lending Pool)

When liquidity providers deposit liquidity (capital) in $USDC, $DAI, or other approved stablecoins into the lending pool, they receive $uLP tokens in exchange. The capital is locked and not accessible to the liquidity provider until they redeem their $uLP tokens.

$uLP token holders have to submit a withdrawal request when they want to access their underlying capital.

✅ However, like other IOU tokens, LPs can trade/lend their tokens on a secondary market if they need to get out of their position quickly. Learn more about finding liquidity on the secondary market here.

By holding $uLP tokens, LPs can redeem the Annual Percentage Yield (APY) earned from borrower pools that opted for senior tranche financing. This Lending Pool yield is distributed to $uLP holders based on their stake in the lending pool.

Additionally, $uLP holders can stake their tokens as $suLP to receive a portion of the protocol’s token emissions. To participate, $uLP token holders must stake their tokens into the LP vault, which qualifies them to a proportional claim to 10% of the token emissions within the protocol.

Withdrawal Requests for $uLP Holders

A Liquidity provider makes a withdrawal request to the Lending Pool to withdraw their capital. It should contain the following information:

• Amount to withdraw

• Withdraw fee (specific to the pool)

Here is how to redeem uLP tokens:

• The stakeholder submits a withdrawal request for the specific amount of uLP tokens locked.

• This request will be added to the waiting list.

• The request is fulfilled as soon as Lending Pool liquidity is available.

The liquidity distribution from each pool to fulfill withdrawal requests is available monthly.

🚨 If the withdrawal request is canceled, the person who made the request will pay a fee.

$uBP (Borrower Pool )

$uBP tokens (i.e., Umoja Borrower Pool’ token) are issued when an investors finance or provides collateral for a specific Borrower Pool. Each uBP token is annotated with the ID of the borrower pool it is associated with.

uBP tokens are distributed proportionally to:

• Junior Tranche investors that invest in the pool

• The lending pool for Borrower pools that elect to have senior tranche investment

• The collateral pool, which provides optional loan collateral

• 3rd Party uBP token holders (people that bought $uBP on the secondary market)

Each $uBP token goes through four stages before they are taken out of circulation;

• $uBP tokens are minted when a Borrower Pool becomes active

• $uBP tokens are distributed proportionally to the stakeholders within the pool, including Junior Tranche Investors, the Lending Pool, and Collateral Pool. $uBP tokens can also be sold on the secondary market.

• $uBP tokens are redeemed for accrued APY and the capital as it is available

• $uBP tokens are burned once redeemed for the underlying principal and interest. A Borrower Pool is deactivated once all the $uBP token is burned.

Investors receive $uBP tokens in exchange for deposited stablecoin in a 1:1 ratio. Furthermore, uBP token holders have a proportionally right to the Borrower Pool loan’s interest.

For example, if Alice owns 50% of uBP-1 tokens (Borrower Pool 1), they are entitled to 50% of the monthly payment that the Borrower Pool collects.

$uBP holders can withdraw the interest payment on capital as it is paid by the borrower monthly. The $uBP tokens are exchanged on a 1:1 ratio for USDC as loans are repaid. Holders must also submit a withdrawal request to withdraw their principal from a Borrower Pool.

Withdrawal Request For $uBP Holders

To submit a withdrawal request, the $uBP holder must first lock up an equivalent amount in the withdrawal request. Also, the holder must pay a 0.25% withdrawal fee to redeem the locked uBP tokens for DAI or USDC.

After submitting the withdrawal request, the holder may have to wait for the distribution period before processing the request. Distribution periods last for a week every month.

💡 A 0.5% fine is removed from the locked $uBP token if the withdrawal request is canceled before it is fulfilled.

$uCP (Collateral Pool)

Collateral providers (CPs) provide the optional loan protection (collateral) available for borrowers and approvers to de-risk a borrower pool. Like LPs, Collateral providers crowdsource their capital into the collateral pool and get $uCp in return.

The amount of $uCP tokens a collateral provider gets is proportional to their stake (principal + accrued APY) within the Collateral Pool. The Collateral pool rents collateral to the Borrower Pool to help lower their default risk. The pool maintains and receives offers from different Borrower’s Pools and only accepts the highest bids to maximize profits for CPs.

Furthermore, idle Collateral Pool capital will be vested into Aave to generate additional yield for the pool. This yield is also paid to $uCP token holders with their accrued interest. When the vested capital is required as collateral, it is unvested and made available to the Collateral Pool.

Lastly, $uCP holders can stake their uCP tokens and earn more on their capital. In exchange for staking their uCP tokens, a holder gets sCP tokens representing a claim in the transaction fees. Each sCP token holder receives a proportional share in 40% of all the transaction fees generated by the protocol.

$uCP Withdrawal Request

Collateral providers must submit a withdrawal request to the Collateral Pool to withdraw their underlying liquidity. Here is a quick rundown of how to submit a withdrawal request:

• Lock up the equivalent amount of uCP for the amount they want to withdraw.

• Pay the withdrawal fee for redeeming uCP for USDC. The withdrawal fee is 0.25% of the withdrawal amount.

• Wait for the distribution period; the distribution period is monthly and last for one week.

Note that if the withdrawal request is canceled, the collateral provider has to pay a fine of 0.5% of the total amount. This fine is removed from the $uCP tokens locked up before making the request.

$aUMJA

$aUMJA are issued to approvers after they stake $UMJA to approve a Borrower Pool. Approvers are Junior Tranche investors who act as underwriters that perform the due diligence on a Borrower’s request before approval.

To become eligible to perform this role, a J.T. investor must stake at least 0.5% $UMJA of the Borrower Pool size. In exchange for the staked $UMJA, an approver gets $aUMJA at a 1:1 ratio.

💡 Approvers are not rewarded for staking $UMJA for $aUMJA; $aUMJA only makes them eligible to approve a loan. However, they get variable APYs for investing in a Borrower Pool.

Stacked $UMJA ($sUMJA, $sAP, $sLP, $sBP, $sCP)

Stacked $UMJA tokens are tokens that are gotten in exchange for staking $UMJA or any of the IOU tokens. Below is a breakdown of stacked tokens available

• $uBP token holders that stake their $uBP in the BP (Borrower Pool) Vault receive $sBP and get a proportional claim in 20% of the protocol’s token emissions

• $uLP holders can stake their tokens in the LP (Lending Pool) vault to receive $sLP and get a proportional claim in 10% of token emission

• $UMJA token holders can stake their token into the protocol’s Default Insurance Vault in exchange for $sUMJA tokens. $sUMJA token holders get a proportional claim to 20% of the protocol’s token.

• $aUMJA token holders can further stake their $aUMJA in the Approver Vault for $sAP and a claim in 20% token emission

• $uCP that stake their tokens in the CP (Collateral Pool Vault) get $sCP in return and a claim in 20% of the token emission.

Join the Financing Revolution & Become Shujaa

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.

TLDR: Default risk is one of the biggest problems in lending, and DeFi loans are not exempted. At Umoja, we use effective strategies like tokenized RWAs to handle default risks and protect lenders. We discuss these strategies in this piece.

When a lender provides financing to a borrower, they face the possibility of the borrower not repaying the loan. This is called the default risk, a situation in which a borrower defaults on a loan.

According to the Federal Reserve Bank of St. Louis, the default rate on U.S. commercial and industrial loans peaked at 5.5% in February 2021, up from 1.7% in February 2020.

What if the borrower decides or cannot meet the repayment terms? How can you protect your investment?

These are valid questions that every lender should want answers to providing liquidity. This article will delve into default risk, how it works, and how we handle it at Umoja Protocol.

What is Default Risk?

Default risk (default probability) is the probability that a borrower will fail to promptly and fully pay the principal and interest of a loan according to the loan terms. It is one of the credit risks lenders face when they provide financing; default and loss severity are the two components of credit risk.

According to a report by the Federal Reserve Board, credit risk is one of the financial institutions’ most significant risks. Credit risk is the potential for a lender to lose money when financing a borrower; it is the probability that the borrower will fail on their obligation.

How to Measure Default Risk

According to the International Finance Corporation’s (IFC) report on Private Sector Credit in Sub-Saharan Africa, default rates on loans in the region vary widely depending on the country and sector. The report also notes that “default rates tend to be higher in sectors that are more exposed to economic shocks, such as agriculture and small and medium-sized enterprises.”

However, measuring default risk is complex, as it involves predicting the borrower’s future actions using present factors. The question remains, “How can we determine what a borrower intends to do in the future?”

Note that the measurement of default risk is usually probabilistic; it involves using present factors to forecast what will happen in the future. That said, the level of default risk depends mainly on the borrower’s capacity.

What is the Borrower’s Capacity?

Borrower’s capacity refers to the borrower’s ability to make timely and complete debt payments. It is one of the five Cs of credit analysis that financial institutions use to assess a borrower’s creditworthiness.

The other four Cs include character or credit history, capital, collateral, and loan conditions.

• Character or Credit history: the borrower’s reputation based on record for repaying debts

• Capacity: the ability to refund debt payment

• Capital: the borrower’s overall financial strength

• Collateral: asset pledged to the lender as security against credit exposure

• Conditions: the general conditions of the loan, including interest rates and principal amount

The borrower’s capacity is influenced by many factors, which are the significant factors that contribute to default risk.

Factors That Cause Default Risk

• Borrower’s financial health: Generally, borrowers with a lower amount of cash flows, cash reserves, or assets relative to debt are less creditworthy

• Economic cycle and industry conditions: External economic conditions can affect a borrower’s performance. Inflations and macroeconomic downturns can cause an increase in their default risk.

• Currency risk: High volatility within the currency market can cause a significant impact on a borrower’s creditworthiness

• Political factors: political issues like war, corruption, or regime change can make it difficult for borrowers to meet their obligation

• Sector-specific risk: Certain sectors, such as agriculture and small businesses, may be more vulnerable to economic shocks, leading to higher default rates.

These factors are compounded in emerging markets because of the following:

• Economic instability: Emerging markets may experience more volatile economic conditions, which can make it difficult for borrowers to meet their debt obligations

• Political instability

• Weak legal systems: Weak legal systems can make it difficult for lenders to enforce contracts and recover assets in the event of default.

• Currency devaluation: Emerging markets experience currency devaluation more often than developed countries introducing another factor that can lead to default risk

How Umoja Defends Against Default Risk

Umoja aims to democratize loan financing for MSMEs in Africa by providing affordable financing for borrowers and low-risk and flexible investment opportunities for lenders. We understand that traditional DeFi lending methods like overcollateralized loans are not sustainable in emerging markets like Africa.

Apart from raising the cost of loan financing, overcollateralized loans increase the barrier to entry. But, traditional DeFi lending platforms use methods like over-collateralization to mitigate default risks. Therefore, a major question a lender might have is, “How does Umoja defend against default risk?”

In this section, we’ll cover our approach toward default risk and all the strategies in place to help us manage credit risk.

Hyper-Crowdsourced Financing Model

Umoja depends on several stakeholders, including lenders, collateral providers, insurers, and borrowers, to maintain a hyper-crowdsourced financing model. What this means for lenders is more collateral securing their capital against default risk — simply put, more security.

Our lending process has five stakeholders instead of the traditional two.

Learn more about how the Umoja Protocol work here. Liquidity providers are the least exposed to default risk because their capital is protected by the loan collateral and the Junior Tranche investor’s capital. On the other hand, backers limit their risk exposure with the Collateral Pool. The Collateral Pool offers optional loan protection that Backers can rent to reduce risk exposure and protect their capital.

Stakers provide default insurance to protect collateral providers by limiting their risk exposure. The Default Insurance pool crowdsource staked tokens.

The rule is that if the protocol’s default percentage exceeds 14%, 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) 14%.

Borrower’s KYC and KYB

The Borrower’s KYC (Know-Your-Customers) and KYB (Know-Your-Business) provide loan underwriters with the necessary information to approve loans.

Umoja employs UID (Unique Identification) as the identification method for borrowers. The UID is an NFT that represents each borrower’s KYC and KYB.

Risk-Gradient of Tokenized, real-world assets (RWAs)

Umoja’s IOU tokens are tokenized RWAs that offer investors high investment flexibility. As an investor, you can invest in RWA tokens with the risk exposure you’re comfortable with.

For example, if you prefer a low-risk position, $uLP tokens are low-risk RWA tokens protected against default risk. On the other hand, $uBP tokens are variable risk RWA tokens; their risk exposure is higher than $uLP. But that also means that they get more APYs than $uLP.

By bootstrapping liquidity with high-quality RWAs, Umoja provides more secure loan financing for lenders. Note that tokenized loans are more protected against credit risks. The image below compares how effective Umoja’s tokenized loans are against industry standards.

Zero FX devaluation Risk

To counter FX fluctuation and settlement risk, Umoja is introducing the first DeFi FX AMM (Automated Market Marker).

With the FX AMM, Borrowers can get loans directly in their local currency and avoid FX fluctuation and devaluation. Therefore, borrowers don’t pay more on loans because of the extra cost due to FX devaluation. In turn, lenders experience lower settlement and default risk caused by FX devaluation.

Collateral to Limit Risk Exposure

Junior Tranche or Approvers can decide to rent collateral for their Borrower pool to adjust their risk exposure at any time. An Approver changes the risk level of their $uBP tokens by renting collateral from the Collateral Pool.

This feature offers lenders with higher default risk exposure a way to level the field. When lenders rent collateral, they further de-risk their debt position and reduce their risk exposure.

Affordable Loans with Flexible Payment Options

Umoja offers borrowers affordable loan options with flexible loan terms. Borrowers propose their terms for loan financing, including their repayment plan for approval.

Renegotiation Plan For Borrowers

Umoja understands that a borrower’s financial condition can change during a loan cycle. This can be due to several reasons — economic instability and sector-specific risk. Umoja introduces a renegotiation plan for borrowers to deal with this factor.

With renegotiation, a borrower can renegotiate their terms during the course of the loan. If a borrower thinks they can’t meet up with repaying their loan, they can submit a renegotiation request. They can change the loan period and repayment plan in the renegotiation request.

Learn more about lending on Umoja in this article. Read our whitepaper for a more comprehensive look at the Umoja Protocol and how we work.

Join The Financing Revolution and Become Shujaa

Umoja offers lenders and borrowers flexible credit structuring options. For lenders, this means more secure and flexible debt investment opportunities.

But, Umoja can only meet its vision of providing over $100 billion in MSME financing through partnership and community participation. Join the Umoja DAO and become a Shujaa (warrior in Swahili)

✅ $rUMJA token is Umoja’s pre-liquidity token that is paid to DAO-bounties freelancers after completing bounties. $rUMJA is tied to $UMJA (the protocol’s token) at 1:1 and will be redeemable at 1:1.

Bounties can be anything from quick tasks like likes or comments on Twitter to technical multi-month engagements like software development. Below are some of the tasks already available as Umoja DAO bounties:

• Simple Social media tasks like following our social media accounts

• Inviting people to the Discord server

• Writing Twitter Threads

• Writing blog posts

• Protocol branding

• UmojaDAO POAP design

• Protocol website graphics

Umoja bounties are part of our Initial Freelance offering; they are intended to generate real-world value for community members while bootstrapping protocol liquidity before launch.

Umoja’s Initial Freelance Offering (IFO)

Umoja is launching the world’s first Initial Freelance Offering (IFO) as a liquidity-bootstrapping model that maintains the credibility of the token’s launch. The IFO model leverages web3 work platforms like Zealy and Dework to host bounties and as a token distribution mechanism.

The tokens paid out as part of bounties reward will come from the “Community Airdrop” and the “Protocol Labs DAO” bounty budget. The image below gives an overview of the IFO model we’re adopting:

An Overview of Umoja’s Initial Freelance Offering Model

Learn more about Umoja’s Initial Freelance Offering (IFO) here.

Who are Umoja DAO-Bounty Freelancers?

Umoja DAO-bounty freelancers are simply community members who participate in the community bounties to earn $rUMJA and high liquidity tokens like USDC.

Our community members can find an easy source of income by participating in simple tasks like liking or commenting on posts on Twitter. While skilled freelancers can showcase and hone their skills with technical tasks like protocol branding and earn money.

✅ The more $rUMJA you hold, the more priority application status you get. DAO-bounty freelancers with more $rUMJA are selected before those with lesser or no tokens.

Interested in hunting Umoja DAO bounties? The next section will guide you through becoming a Shujaa and earning bounties.

How to Become a Shujaa

• Join the Umoja DAO discord server here.

• Once you’re on the server, you’ll need to verify first. Follow the instruction in the Verify-first channel. You should see something like this:

• To activate the Shujaa and become qualified to participate in bounties, enter the Umoja-entry channel and follow the instructions.

The Umoja DAO bounties can be anything ranging from writing articles to banner design, Twitter threads, and making videos. Currently, Umoja DAO bounties are hosted on Zealy and are available to all verified Shujaas (community members).

A bounty is called a “Quest” and comes with a description, assessment criteria, reward, and instructions on submitting. The image below shows what a typical Umoja Quest looks like:

To get started, go to our Zealy to see the full list of the available quests you can enter. Your dashboard should look like this:

You can also access the leaderboard to view the leading bounty hunters and their points. Once you’re ready to hunt for bounties, here are the simple steps to follow to start earning from Umoja Bounties:

• Click on any quest to view the description, assessment of the quest, and how to submit.

• Follow the instruction on how to submit to make a submission once you complete the task.

• For simple social media tasks like likes and follow, you can claim your rewards immediately after you complete the task.

• For tasks that are reviewed, you’ll be rewarded if your submission is accepted on the bounties.

✅ Moving forward, bounties will be paid in USDC on the Avalanche network rather than on the Ethereum network to save you gas fees.

Tips to Help You Maximize Your Earning Potential

• Pick bounties in your area of specialization: Go for tasks in areas with your skill sets to ensure your submission meets the requirement. For example, if you have some writing experience, you may be more suited to writing tasks like creating blog articles or Twitter threads instead of design tasks.

• Follow the Instruction and Assessment criteria: You want to be sure your submission follows the task’s guidelines. Therefore, read and stick to the assessment criteria thoroughly. Each bounty will come with its criteria that will be used to accept submissions. If your submission doesn’t meet these criteria, then your submission may not be accepted.

• Make several submissions if you can: You can make several submissions on a bounty as long as you keep up the quality. Work on a task from different perspectives to create new submissions.

✅ ProTip: Start with the #onboarding quests — these are simple DAO tasks like following the protocol on Twitter and inviting people to the discord server. You can quickly get more $rUMJA and points to boost your level.

Happy hunting!

FAQs About Umoja

• What is Umoja?

Umoja is a decentralized credit protocol that crowdsources loan funding and collateral to provide affordable financing to African institutions and retail borrowers. Our purpose is to ‘democratize DeFi credit’ globally.

• What is the Umoja DAO?

The Umoja DAO is the governing body that manages and decides the economic parameters of the Protocol. DAO members are in charge of voting to make important decisions that concern the protocol.

• Who is a Shujaa?

Shujaa is a Swahili word for “warrior.” Shujaas are members of the Umoja DAO

Join the Financing Revolution & Become Shujaa

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.

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.

What is 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.

How is Umoja Different from Traditional Credit Institutions

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.

Umoja’s Credit System

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.

How to Borrow on Umoja

A successful loan on Umoja goes through five stages:

1. Borrower Whitelisting

2. Borrower Pool Creation

3. Borrower Pool Activation

4. Borrower Pool Financing

5. Borrower Pool Maturity

Borrower Whitelisting

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.

Borrower Pool Creation

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.

What is Borrower Pool?

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).

Borrower Pool Activation

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.

Borrower Pool 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.

Borrower Pool Financing

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.

Borrower Pool Maturity

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.

Borrower Pool Deactivation

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.

Loan Renegotiation

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.

Join the Financing Revolution & Become Shujaa

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.

TLDR: Stablecoins are not without their risks. While designed to maintain a stable value, they are still prone to operational, liquidity, and settlement risks. These risks can cause peg instability and loss of value.

Stablecoins play a significant role within the DeFi ecosystem because they are fiat-referenced crypto assets on blockchains. They act as a bridge between traditional currencies and digital currencies.

While they are designed to be as stable as the asset they are pegged to, stablecoins are not without risks. In this piece, we’ll go into an in-depth analysis of stablecoin risks.

What are Stablecoins?

Stablecoins are designed to maintain a stable value relative to a specific asset or store of value outside the crypto ecosystem. These underlying assets are usually fiat (national) currencies like the U.S. Dollar (USD) or commodities like gold.

To maintain this stable value, stablecoins usually employ a pegging or collateral mechanism that maintains its ratio to the reference assets. Here is a simple analogy to help you understand that better.

USDC is pegged to the U.S. dollar (USD) at a ratio of 1:1. This means that every time, 1 USDC should be equal to 1 USD more or less. So, if you buy 1000 USDC with $1000 now, at the end of the year, you should get $1000 if you sell your USDC. USDC uses a collateral mechanism to achieve this peg by maintaining a reserve of USD. So, for every issued USDC token, some U.S. dollars are deposited into the reserve.

Note that although stablecoins are pegged to fiat currency, they differ from fiat currencies in several ways. First, they are cryptocurrencies, i.e., they are secure with cryptography. Second, they are built on blockchains, i.e., all transactions are recorded and stored on blockchains.

These differences position stablecoins to support innovative and emerging financial markets like DeFi, where traditional currencies don’t work.

The Stablecoin Market

The total stablecoin supply is currently capped at around $130 billion, as shown in the chart below. Notice that at the peak, the total stablecoin supply was at $182 billion, over 16% of the entire crypto ecosystem.

Stablecoins are so crucial that “more than 75% of the trading on large crypto exchanges in 2022 involved a stablecoin,” according to data from Theblock.coand The Reserve Bank of Australia (RBA).

Stablecoins within Crypto and DeFi Ecosystem

Stablecoins play an essential role within the crypto and DeFi ecosystem. Most importantly, they act as an onramp (bridge) between traditional currency and other digital tokens. This is important because most exchanges don’t allow users to convert their crypto assets into fiat currency for holdings.

Due to their stable nature, stablecoins can be a safe haven for investors during a market. In fact, according to data from Federal Reserve Board, stablecoins might appreciate more during market distress. The Image below shows instances of stablecoins appreciating when Bitcoin and Ethereum prices were falling.

However, stablecoins are not only important as a safe haven for investors. Stablecoins are also an important part of the DeFi ecosystem. DeFi protocols depend on stablecoins to facilitate lending, borrowing, yield farming, and other DeFi services. Due to their less volatile prices, they are useful for

• Borrowers as collateral because they maintain stable value, so borrowers don’t have to worry about losing their position due to a reduction in market price

• Liquidity providers/lenders to avoid impermanent losses

Stablecoin Risks

Although stablecoins are designed to maintain stability, they are not without risks for both investors and users. Stablecoin risks vary based on the collateralization type of stablecoin and their pegging mechanism. Generally, stablecoins are group into three main groups:

• Fiat-backed stablecoins (off-chain, fiat-collateralized stablecoins)

• Crypto-backed stablecoins (on-chain, cryptocurrency-collateralized stablecoins)

• Algorithmic stablecoins (non-collateralized stablecoins)

Fiat-based stablecoins (off-chain collateralized)

Fiat-backed stablecoins maintain a reserve of cash, cash equivalent, Treasury bills, corporate bonds, and commercial papers as collateral to back issued coins. Fiat-backed stablecoins are also called off-chain collateralized stablecoins because the collateral reserve consists of assets that off blockchains.

The fiat reserve is maintained on a one-to-one basis with issued coins. So, for every unit of the stablecoin issued/minted, a unit of fiat currency is deposited in the reserve.

The largest stablecoins by market cap — Tether (USDT), USD Coin (USDC), and Binance USD (BUSD) are fiat-backed stablecoins. However, it’s important to note that both USDT and BUSD are heavily suspected to be under-collateralized (i.e., don’t have the proper reserves to warrant the tokens that have been minted on-chain — see the “Fiat Stablecoins” subsection in The State of Crypto Regulation in the US).

USDC has also exposed that fiat-backed stablecoins are particularly susceptible to the insolvency risk of the financial institutions that custody the stablecoin’s reserves (i.e., $3B of USDC’s reserve at collapsed Silicon Valley Bank).

USDC and BUSD tend towards maintaining a conservative reserve holding of cash, cash equivalents, and treasury bills. On the other hand, USDT reserves include more risky assets like commercial papers and corporate bonds.

Provided that traditional financial institutions are notoriously non-transparent, the assumed risk of fiat-backed stablecoins (i.e., custodian insolvency risk & rising federal interest rates of the fiat peg), it is not correct to assume that they are less risky than, at the least, crypto-backed stablecoins, which offer softer asset collateral with much higher transparency.

Crypto-backed (On-chain collateralized)

Crypto-backed stablecoins (on-chain collateralized) are backed by a reserve of other cryptocurrencies like Bitcoin and Ethereum. They are on-chain collateralized because they are supported by blockchain-based assets.

An example of a crypto-backed stablecoin is Marker’s DAI backed with USDC, ETH, WBTC, and others. The image below shows DAI’s total crypto assets used for its on-chain collateralization.

Crypto-backed stablecoins use an over-collateralization model to withstand the volatility of their reserve assets. However, crypto-collateralized stablecoin protocols are quickly diversifying their collateral into tokenized real-world assets as the regulatory risk (and economic burden) of using some weaker cryptocurrencies as collateral is beginning to threaten the protocol’s economic sustainability.

Algorithmic (Non-Collateralized) Stablecoins

Algorithmic stablecoins depend on algorithms and smart contracts to maintain their peg. Algorithmic stablecoins may be partially collateralized or non-collateralized at all. They are non-collateralized stablecoins because they don’t depend on a reserve to maintain their peg even if they have a partial reserve. Rather they maintain their peg based on market demand and a minting/burning mechanism.

Algorithmic stablecoins are considered the least stable within the crypto ecosystem. This is because they are the most susceptible to runs caused by market sentiments and speculative attacks.

Effectiveness of Peg Stabilization Mechanisms

The effectiveness of the peg mechanism varies depending on its stabilization mechanisms. We have covered the effectiveness of each model in this section.

Fiat-Backed/off-chain collateralized

Fiat-backed stabilization mechanism works based on the confidence users have in the stablecoin to maintain its peg

However, this stabilization mechanism can break down if the market loses faith in the stablecoin's ability to maintain its peg. Several things can trigger a loss of confidence in the stablecoin:

• A drop in the collateral reserve like the recent USDC and SVB event

• Lack of confidence in the custodian or issuers

• Market speculation that can lead to FUD among holders

According to the Federal Reserve Board:

“The incentives of stablecoin holders are similar to those of depositors who withdraw their real-world currency from an uninsured brick-and-mortar bank if they suspect it might fail, thus precipitating a run on such a bank.”

An example of this failure is the recent de-pegging of USDC. The stablecoin lost its peg after SVB (Silicon Valley Bank) suffered a bank run with over $3.3 billion of USDC’s reserve. As a result, investors and users were uncertain about the collateralization of the stablecoin.

Crypto-backed/On-chain Collateralized

Like fiat-backed stablecoins, the effectiveness of crypto-backed stablecoins also depend on the trust the holders have in the stablecoin. However, the integrity of this pegging mechanism is less than that of fiat-backed stablecoin because of their reserve's quality.

Crypto-backed stablecoins have to depend on on-chain assets as their collaterals which means other stablecoins and cryptocurrencies. Depending on cryptocurrencies like Bitcoin and Ethereum means that crypto-backed stablecoins have to use over-collateralization to maintain their peg.

The degree of over-collateralization must be large enough to cover any decline in the collateral assets’ value. In most cases, stablecoin protocols include provisions for reevaluating the ratio of collateral to issued stablecoins at regular intervals. This ensures that the ratio is always greater than the standard collateralization ratio.

Furthermore, the market for the collateral assets must have enough liquidity for selling the reserve in case of a run.

However, crypto-backed stablecoins are still more subjected to panic runs due to:

• The market volatility of the biggest cryptocurrencies (Bitcoin and Ethereum)

• a sudden change in regulation

• panic resulting from other stablecoins run

Algorithmic stablecoins (Non-Collateralized)

Algorithmic stablecoins maintain their peg by using smart contracts preprogrammed with the set of rules that control the stablecoin. Typically, the smart contract dynamically match kgvbnmb the supply and demand of the stablecoin to maintain price stability.

Algorithmic peg stabilization is similar to the central banks’ system of expansion and contraction of money supply to control the economy. In this case, the smart contract mints (create new tokens) when the price exceeds $1. This increase supply and brings the price down. On the other hand, the system removes coins from circulation (burns tokens) when the price goes below $1. This reduces supply and brings the price up.

Algorithmic stablecoins can be categorized into two subgroups depending on the type of stabilization mechanism they adopt:

• The rebase model

• The coupon model

The rebase model maintains price stability by adjusting supply across all wallets that hold the coin proportional to the percentage of price increase or decrease. This model can only sustain the peg if holders believe the price will return to normal. In case where the holder thinks the price will keep falling, they will sell their holdings, causing a total depeg.

The coupon model, also the seigniorage model, maintains prices by adjusting supply to meet market demands. However, the coupon model gives stablecoin owners incentives/rewards to sell or buy more.

The problem with the coupon model is the same as with rebase model; the model can sustain its peg if enough holders believe that the stablecoin will revert to normal. Once holders think otherwise, they start to sell their holdings, generating a run that leads to de-pegging.

An example of algorithmic stablecoin failing is Terra USD losing its 1:1 peg to the U.S. dollar. UST maintained its peg with the coupon model; holders were rewarded with its sister coin Luna.

Current and Emerging Risks of Stablecoins

This section discusses some of the most significant risks stablecoins face.

Peg Instability (Loss of Value)

A stablecoin loses its peg when it can no longer maintain its original ratio to the reference asset. This usually happens when there is a spike in redemption requests which is generally triggered by the following:

• Price fall

• Concerns about collateral reserve

• market speculation

Two prominent examples of peg instability are USDC and UST. USDC lost its peg and regained it a few days after concerns about its reserves were resolved.

Payment System Risk

Payment system risk arises from a stablecoin transfer mechanism between issuance and redemption. Stablecoins also face the same basic risks as traditional payment systems, including

• liquidity risk,

• operational risk,

• settlement risks, and

• threats from ineffective or improper governance

When a stablecoin fails to manage these risks properly, it makes them less reliable and can lead to peg instability.

Liquidity Risk

Liquidity risk arises from misalignment between the settlement timing and the stablecoin arrangement with other systems. For example, if the stablecoin operates 24/7 but the payment system for funding stablecoin issuance and redemption operates on regular business days and hours.

That can cause a shortage in stablecoins and fiat currency available to make payments. Liquidity risks make stablecoins vulnerable to market runs that the slightest rumor of instability can trigger. In practice, stablecoins usually limit their exposure to liquidity risk with over-collateralization.

Operational Risk

Operational risk disrupts the user’s ability to make a payment or use the system, which in turn, disturbs the whole ecosystem. Operational risk results from:

• deficiencies in information systems or internal processes

• human errors

• management failures

• interruptions from external events

Settlement Risk

Settlement risks arise when a position’s settlement doesn’t occur when expected. Most stablecoins arrangements don’t clearly define the point where payment is final during redemption or issuance.

The Bottomline

Stablecoins are not without risks, even though they are designed to be stable. Some factors that determine the stability include the effectiveness of the pegging mechanism. In this piece, we have covered the effectiveness of the different peg stability mechanism and their risk level.

At the end of the day, a stablecoin will remain stable as long as users trust in its peg stability. Therefore, there is a need to invest in risk-free assets. RWAs (Real-world assets) to mitigate these risks. Learn more about RWAs and how they can help with diversification and risk management here

At Umoja, we offer a risk gradient of tokenized real-world assets (RWAs). These RWAs help investors reduce their risk exposure while earning variable APYs.

Join the Financing Revolution and Become a Shujaa

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.