Can DeFi fix private lending?

Foreword

In 1719, Scottish gambler and monetary theorist John Law persuaded the French Regent to allow him to establish a system for packaging illiquid colonial assets into highly liquid paper financial instruments. He created the Mississippi Company, which monopolized trade with French Louisiana, a vast territory, mostly marshland.

John Law packaged these illiquid colonial assets into shares of a company convertible to gold. Ordinary Parisians flocked to it. A year later, this scheme made him the richest man in Europe and the French treasurer. Although only temporarily.

What happens when you hold shares convertible to gold? You wait for the share price to rise, then demand to redeem them for gold. That's exactly what investors did. A redemption frenzy began; they wanted their gold back. However, the gold supply was insufficient. John Law's response was to change the rules.

He limited the amount of gold anyone could hold. He devalued paper money by decree and stipulated that stocks could only be sold through his banks at prices he set. Each intervention bought him a few weeks, but destroyed trust. By 1720, investors' redemption certificates had become worthless. John Law fled France after leading it to the Mississippi Bubble. Three centuries later, the world's largest private lending funds are dealing with a surge in investor redemption requests in a similar manner. They are modifying their redemption rules to control losses. But is this a solution or just a stopgap measure? Can on-chain private lending help? In today's in-depth discussion, I will explore this question. Let's begin. Private lending refers to lending activities conducted outside of banks and public markets. Companies borrow directly from specialized funds such as Blackstone Group, Apollo Global Management, or Blue Owl Investments, rather than from banks or by issuing bonds. Borrowers are typically mid-sized companies that are not yet able to go public. Twenty years ago, this market was virtually nonexistent. Today, it exceeds $3 trillion and is projected to reach $5 trillion by 2029. The industry filled the market gap created by the 2008 financial crisis, when banks faced prohibitively high costs for holding high-risk loans due to regulatory and capital requirements. Private lending attracts investors with higher returns (8-10%) than the public market, but at the cost of poor liquidity. Investors' funds are locked up for years. This is the essence of private lending. Compared to traditional loans obtained through syndicated loans, private lending provides companies with greater flexibility and convenience in managing their operations. In return, investors receive a liquidity premium because their funds are locked up for extended periods. Subsequently, the industry decided to change the rules. They wanted to attract retail investors, either to offer more attractive returns or to develop the private lending market. To this end, the U.S. Congress established the Business Development Corporation (BDC) under the Investment Company Act in 1980. BDCs remained a niche product for decades, but they gained popularity as companies like Ares, Blackstone, and Blue Owl launched off-the-shelf BDC products specifically targeting retail and high-net-worth individuals. These products packaged illiquid corporate loans and set quarterly redemption windows to appease retail investors. Retail investors participated in this deal, but overlooked a major structural flaw: the private lending industry promised liquidity, while the underlying loans were illiquid. If the credit cycle bubble burst and retail investors rushed to redeem, the private lending funds that issued these retail investment products would be in trouble. Therefore, they set a redemption cap of 5%. This seemed to solve the fund manager's problem. But what happens if the market crashes, forcing redemption demands to exceed the 5% cap? Ultimately, the inevitable happened. In September 2025, two major crashes utterly destroyed retail investor confidence in private lending. First, auto parts supplier Brands Group filed for bankruptcy because its loan agreements failed to uncover and disclose hidden off-balance-sheet liabilities. Lenders underwrote the deal believing it to be a 5x leveraged buyout, when in fact the leverage was closer to 20x. Second, subprime auto lender Tricolor Holdings allegedly used the same collateral for multiple loans. Once the truth came out, redemption demands surged. This forced top private lending fund managers to arbitrarily modify rules or restrict redemptions. These responses all bear a resemblance to those of John Law. Some directly restrict redemption, while others modify the rules when a crisis occurs. What worries me is that this gatekeeping and arbitrary rule-changing practice is a double-edged sword. For investors, it sends a message that the terms they previously agreed to are negotiable, and only negotiable unilaterally. Investors are left at the mercy of fund managers, who can tighten redemption restrictions, or worse, completely halt redemptions and readjust profit distributions. Even more unfair is that these changes are made after the funds have been invested. This violates the spirit of any contract signed by both parties. On the fund managers' side, they become conservative. Funds facing continuous redemption pressure will not deploy capital with confidence. Instead, they will choose to hold cash rather than lend it out. Is on-chain private lending a solution? People might tout the advantages of on-chain private lending. They will show various data on tokenized dashboards and the total value locked in private lending protocols. But in reality, most of these are just repackaging of the existing traditional private lending industry. Why do I say this? Here's the truth: The core unique selling point (USP) of on-chain private lending lies in its ability to run smart contracts on any underlying financial system. These contracts can set withdrawal limits, collateral ratios, and allocation rules within the code. While on-chain private credit funds cannot guarantee higher liquidity than traditional funds, they ensure that once funds are invested, no fund manager can unilaterally change the contract terms. No board vote can expand a tender offer, nor can quarterly redemptions be changed to capital returns like in Blue Owl. Regardless of the manager's will or market conditions, the code continues to operate as is. Smart contract-based private credit funds also solve the problem of double-collateralization. The collapse of Tricolor involved using the same collateral for multiple loans. Tokenized collateral creates a single, auditable record, with each claim corresponding to a set of tokens. This structurally increases the difficulty of double-collateralization. In the months leading up to First Brands' bankruptcy, its valuation was maintained at par value by private credit funds. On-chain, every transaction and repayment is visible in real time. Any self-reported valuation cannot mislead investors. If an asset is valued at 60 cents on the on-chain market, it cannot be priced at 100 cents. If on-chain credit tokens can be traded on a secondary market, better price discovery can be achieved. This solves the pricing mismatch between the net asset value of non-trading business development companies (BDCs) and their underlying loans. We've seen this in the case of hedge funds Saba Capital and Cox Capital acquiring shares of Blue Owl at 20-35% below net asset value. Various protocols are already building this infrastructure. Maple Finance operates an institutional credit pool managing $3 billion in assets. Apollo partnered with Securitize to launch a tokenized sub-fund. WisdomTree introduced on-chain net asset value data to its private credit fund via Chainlink oracles. The infrastructure is ready. However, all of this infrastructure fails to address one problem: it cannot assess whether a borrower will repay the loan, nor can it assess whether a mid-sized software company can survive the disruptive changes brought about by artificial intelligence. As the cases of First Brands and Tricolor demonstrate, underwriting problems caused by human error can be minimized, but not eliminated, through on-chain records. However, a larger problem is that most business processes, including maintaining financial statements, supplier contract records, balance sheets, etc., reside entirely off-chain. Smart contracts cannot inspect a borrower's books or verify their financial statements. Even if some protocol exists to put this data on-chain for verification, businesses will not agree to publicly disclose their financial and other sensitive business details on a public blockchain. Therefore, under the current infrastructure, fully on-chain underwriting is simply impossible. Blockchain currently offers a range of different trade-offs. But failures in private lending through decentralized finance (DeFi) channels can be more severe than failures in the traditional private lending industry. Imagine a fund whose assets are constantly depreciating while redemptions are soaring. For this fund, the decentralized finance (DeFi) ecosystem, eager to generate high returns from real-world assets, is undoubtedly an ideal target. Investors seeking redemptions and fund managers seeking new sources of funding are highly motivated to tokenize these loans and sell them in on-chain liquidity pools. DeFi can easily become a dumping ground for illiquid and problematic products from traditional markets. We see this in the case of Goldfinch, a pioneer in on-chain lending: a borrower made an unauthorized, massive inter-company transfer that threatened the entire company's operations. Tokenization can only reveal the consequences of the event, not prevent fraud. There are also counterarguments. On-chain secondary markets can also provide liquidity for distressed assets and help with more reasonable pricing. However, the line between market function and exit liquidity venues is very blurred and prone to collapse. As long as key information such as borrower qualifications, contract validity, and financial reports remain off-chain, on-chain lending cannot solve the problems of traditional industries; it will only bring a series of new problems. If mainstream on-chain protocols direct hundreds of millions of dollars in DeFi deposits to defaulted or undervalued loans, the damage will spread to multiple protocols. On-chain private lending is still in its infancy. Currently, the total amount of active blockchain-native loans across all protocols is only $3 billion, while the traditional private lending industry is worth a staggering $3 trillion. A single high-profile default could set back the entire Real-World Asset (RWA) lending concept by years. If on-chain private lending wants to transcend the glamorous facade of traditional private lending, it must first address the issue of trust before it can address the issue of returns. This includes third-party verification of the underlying collateral, rather than relying on information self-reported by the originator. Furthermore, standardized risk disclosure mechanisms can be adopted to translate duration and credit risk into terms that DeFi participants can understand and value. It should even include credit ratings from traditional institutions for on-chain instruments, which Maple Finance CEO Sidney Powell expects to be implemented by the end of 2026. It should also include a framework capable of detecting and preventing originators from dumping bad assets into on-chain liquidity pools. Without these measures, the convergence of risks from traditional finance and decentralized finance will become exploitation rather than an additive effect.