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In this case study, we dive into how the recent Goldfinch FIDU pool default can be viewed as a distressed debt opportunity. We highlight the deal structure, NAV discrepancy, and provide analysis for the token's recovery prospects.
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Guest Post: Nathan Howard is a Partner at Switchpoint Strategies, a research and advisory firm focused on emerging blockchain use cases that improve the real economy. Switchpoint’s founders are entrepreneurs with direct operational experience in FinTech & DeFi. That experience has led to a conviction that blockchain tech can and will solve the many pain points of complex transactions and data management.
In this case study, we dive into how the recent Goldfinch FIDU pool default can be viewed as a distressed debt opportunity. We highlight the deal structure, NAV discrepancy, and provide analysis for the token's recovery prospects.
Tokenization of real-world assets (RWAs) opens the potential for improving the efficiency, accessibility, and transparency of debt capital markets and private credit. DeFi lending exploded because overcollateralized lending for fully digital assets creates a truly trustless and seamless marketplace for debt. Digital assets are built for digital rails. However, If you’re not posting natively digital assets as collateral, then you have to rely on trust and counterparties. And you have what we traditionally call credit risk.
In other words, real-world assets come with real-world problems.
Recently, Goldfinch, a pioneer of private credit in the RWA space, experienced a default in one of its deals. An update posted on the governance forum suggests there may be a total loss of the $5 million loan. In short, a borrower company (Tugende) on the Goldfinch platform provided an unauthorized intercompany loan to a subsidiary and the hole was so large that it may drag the business under. According to the post, Tugende will go through a restructuring process, and the prospects of collecting on the $5 million are slim. Fortunately, no investor is experiencing total wipeout from that loss because the Tugende deal is part of the Goldfinch Senior Pool. The Goldfinch senior pool is represented by the FIDU token. FIDU has fully collateralized exposure across eleven different loans, and in most cases, FIDU has a senior position to junior capital on the platform. More on that later.
The default is unfortunate, but innovation invites these mishaps. You’re only doing something truly interesting if things go wrong from time to time. And it highlights something obvious. Private credit transactions represented on a blockchain (i.e., onchain) still carry credit risk. Blockchain technology doesn’t magically eliminate emerging markets credit risk. In traditional finance, you see an entire industry of capital that seeks opportunities to buy credit at a discount. This was often called “distressed debt investing,” but that has some pretty bad optics. So, you’ll see fluffier terms like “strategic opportunities” or “opportunistic investing.” Regardless of what you call it, this capital is looking for debt or bond set-ups where things aren’t going perfectly, but sellers may be willing to sell for less than what a buyer expects to recover from borrowers.
As far as I can tell, the situation with FIDU and Tugende represents one of the first such strategic opportunities in the on-chain RWA space. FIDU is available for trading on Curve, so there’s a secondary market for the asset. And that market is currently pricing at a significant discount to the protocol assigned value for FIDU. To be clear, I’m not making any recommendation to buy or sell an asset here, but I do hold FIDU that I purchased before the Tugende post in July. I’m writing this because it’s worthwhile and instructive for builders in RWA to be aware of the dynamics at play. And credit funds should start paying attention to this space to be able to better analyze the unique risks posed as more assets integrate with public blockchains.
Strategic opportunities and distressed debt are blanket terms. Each situation requires a different approach. But a general framework would be:
At what price can I obtain the debt/bonds and what is the Net Asset Value (NAV)?
As of 9/17, the Curve pool was pricing FIDU at roughly $0.80. The protocol’s “share price” (the amount of USDC you can redeem FIDU for at any given time) or NAV reflecting accrued interest was ~$1.15 (exact share price per the protocol can be found here). Goldfinch allows you to exchange FIDU for USDC at the protocol price if there are sufficient funds to satisfy the withdrawal request. While this largely works as intended, there has been a long withdrawal queue for the better part of a year. More detail on that below. There will be a write-down of as much as 6.31% to account for a worst-case total loss from the Tugende deal, though there is some hope of recovery. Accounting for that with rough math you get a net NAV of ~$1.087. Stated simply, you’re seeing a market price of $0.80 for an asset with a NAV of $1.08 after accounting for known write-downs, reflecting a ~26% discount to the published protocol FIDU share price with a full write-down of the default.
What are the risks that mean sellers are willing to sell at that price?
In my view, there are three primary reasons you’re seeing FIDU selling at a discount to NAV. They are:
What recovery amount can be expected given the risks and their severity?
This is where the rubber meets the road for credit funds and debt analysts. I will take the above risks one-by-one and give my take, but stop short of assigning probabilities to calculate an expected value.
Goldfinch launched during the 2021/2022 crypto bull market where there was significantly more onchain activity. DeFi yield farming may not have been at its height, but it was certainly still ongoing. Users were used to being able to jump into positions boasting high (but temporary) yields. This is a very different liquidity and return profile for your typical private credit investor.
Onchain markets also experienced a liquidity shock across the board as Luna collapsed. This produced an environment of fear and a flight to cash as people exited yield positions regardless of quality. You can also see how this directly affected the utilization of the Senior Pool as it shot to nearly 100% (meaning there was no excess cash for withdrawals).
FIDU’s price in the Curve pool was tighter to NAV for much of 2022 and spent time above $1. It’s steadily ticked down in 2023; the opposite of what you’d expect for an asset that accrues interest.
One clue as to what’s going on comes from a proposed change in September 2022 to the withdrawal mechanics of the Senior Pool. The change was prompted by arbitrage bots clogging up the first-come, first-serve nature of pool withdrawals as payments came in. The response was to transition to a pro-rata withdrawal queue. This produced a long queue of withdrawal requests that were (and continue to be) partially met during each withdrawal period.
When the Senior Pool was established, there was an expectation that investors in the Senior Pool would act like credit investors in that they would have the patience and full understanding of those deploying their capital for a set term. But, it seems that a combination of retail investors with DeFi product expectations and opportunistic (automatable) arbitrage bots messed with those expectations. Interestingly, those bots may have kept the Curve price closer to NAV for a time due to the arbitrage opportunity as payments came in, but when the withdrawal mechanics changed to prevent arbitrage sniping, the only way out was through either the (gated) withdrawal queue or the Curve pool. And this has continually widened the gap between the NAV and the Curve price over time.
So, you have several factors at play:
All of this points to liquidity pressure on the sell side of FIDU regardless of the credit risk.
I summarized this briefly at the top, but it’s worth diving into the Tugende situation and how it fits into the overall picture for FIDU. Here’s a brief description of Tugende’s business from Goldfinch.
“Tugende is a for-profit asset-backed fintech lender that provides asset-backed financing to small businesses in Uganda and Kenya. Their core customer base is motorcycle taxi drivers (e.g., think about how many Uber drivers get financing for their cars), specifically in Uganda and Kenya. The company was founded to provide an alternative for the millions of motorcycle taxi drivers in Africa who are forced to rent their motorcycles at exorbitant costs. Tugende provides value to its customers through its leasing structure. By switching from a perpetual lease to a lease-to-own system, Tugende customers can double their profits within 1-2 years.”
The update post on July 28th was actually a follow-up from February when Goldfinch/Warbler became aware of an intercompany loan in violation of covenants in Tugende’s loan agreement with Goldfinch. At that time, no payments were missed, and the post was actually a request to appoint Warbler Labs to act on behalf of Goldfinch to engage with Tugende to try to resolve the issue. Tugende’s operational issues were described as “recent rise in fuel costs due to Russia’s invasion of Ukraine, as well as global high inflation, have made it harder for drivers to meet their obligations leading to an increase in lease cancellations and resulting repossessions (i.e., Tugende borrowers give their motorcycles back to the company).”
As of the time of writing, FIDU had $79,258,807.68 in principal outstanding. So the $5 million represents 6.31% of the asset and is gradually being written down by the protocol. That alone wouldn’t justify the secondary market discount of >20% that we’re seeing, so the question is whether the Tugende default presages more pain to come for other FIDU deals.
There’s reason to say the Tugende deal is qualitatively different from the other ten deals where FIDU provides senior capital. It’s the only one that is both exposed to a single company and the only deal that has no junior “Backer'' capital taking a first-loss position before FIDU within the Goldfinch platform. In other words, if Tugende was structured like the other ten deals in FIDU, then the loss to FIDU tokenholders would have been reduced by $1-$1.25 million. That detail prompts the eyebrow-raising caveat to one of their claims about FIDU being protected by first lost capital “all deals protected by 20-25% first-loss capital bar one legacy investment...” As far as I can tell, that underlined portion wasn’t there before the July announcement.
The phrasing “legacy investment” also tracks with the fact that it’s the oldest deal in FIDU by over a year. The rest of the deals are all loans to credit funds, five deals to Almavest, two to Cauris Fund, and one each to Lend East, Addem Capital, and Stratos with investment track records that predate Goldfinch. Essentially, FIDU represents senior financing on five different emerging markets credit funds (with the exception of the Stratos deal being earmarked for deployment towards US-based FinTechs).
Adding to the Tugende news, there was also some limited information shared with junior backers of the Lend East deal: one of Lend East’s portfolio companies was going through a restructuring. According to a Warbler employee, “[t]he excess spread on Lend East's other deals means that they are still generating sufficient revenue to continue paying our coupon in full and Lend East does not need to write-down our position at all for now.”
To summarize, FIDU has 11 deals supporting it and one of them has defaulted representing 6.31% of the outstanding principal. That deal is the smallest of the outstanding deals and is qualitatively different in two respects. Simply put, it’s a structural outlier.
My read is that, while some details are concerning (and perhaps some of Goldfinch/Warbler’s communication about it), Goldfinch is well aware of these issues and have improved the deal structures and borrower quality/diversity in the time since the Tugende deal. However, it doesn’t mean that the rest of the portfolio isn’t susceptible to the same kind of global disruptions that sank Tugende. And that further fallout in the global private credit markets aren’t still making their way through reporting timelines and courts. In the time between the Tugende update and now, we’ve seen FIDU reprice from ~$0.90 to ~$0.80. And it’s hard to argue that’s due to anything other than a loss of confidence related to these announcements.
Before getting into the specific characteristics of Goldfinch and FIDU, it’s worth restating that there are perfectly rational reasons for caution with smart contracts and permissionless financial markets. Institutional capital will always be concerned about hacks and maintain healthy skepticism about how Curve pools work and counterparty risk across borders. As RWAs and onchain private credit mature, it will be important to communicate risk. None of these things are inherently any riskier than what you might find in a traditional securitization offering memorandum. But some of these risks are novel in their type. And it will be important for industry players to educate others thoughtfully about those risks.
For Goldfinch and FIDU specifically, there are a few things that jump out. One is the change to withdrawal mechanics that was approved last September. While I’m sympathetic to the rationale, it’s an important risk factor to note that Goldfinch governance token holders can change how FIDU functions for the good of the protocol – sometimes in ways that might not be neutral to the FIDU holder. Also, FIDU is theoretically open-ended, which exposes tokenholders to extension risk. In other words, while it doesn't seem likely at this point, more deals could be added that would push out capital return timelines even further. Finally, the remaining loans are bullet structures; which means that all principal is repaid at the end. This does make sense for credit funds who are deploying with their own terms at the end, but can also mean that concerns about the ability to pay are concealed until the end of the loan. This means it’s critical to have a view of when those deals are maturing.
As you can see, the latest maturity date is February 2026, representing $19.9 million of the pool’s $79.2 million in outstanding principal. A key date is the April 3rd, 2024 maturity date of Lend East. That will be the moment of truth for the troubled portfolio company for that deal vis-a-vis FIDU. For those watching this asset, there are maturity “seasons” in Q1 and Q4 of next year that will significantly alter the risk profile of the outstanding principal.
Growing Pains for Bringing Assets Onchain
This is not intended as a condemnation of Goldfinch as a platform. Far from it. Rather, my hope is that it promotes more sincere analysis of the opportunities in RWAs and serves as a test case for platforms as the industry grows. Simple yet painful lessons like, “if you create a bond-like product, then you’re going to spook investors if you change the terms” don’t need to be learned multiple times. Packaging a loan that doesn’t have the same first-loss backing as the rest of the capital in a senior part of a structure similarly shouldn’t happen. But again, it’s inevitable that financial experimentation will repeat some of the mistakes of the traditional finance industry.
For what it’s worth, I think Goldfinch has learned these lessons and will continue to iterate on an innovative model. And the folks at Warbler have even shown initiative by proactively engaging in recovery efforts. Blockchain technology can be a great enabler, but it isn’t going to fix everything. We’ve seen onchain lending break out in emerging markets and I expect that to continue due to reduced the friction of processing fees and currency management. While there’s some adverse selection of credit creating noise in the system, careful analysis will help ensure there are more success stories in on-chain private credit.
Nathan Howard is a Partner at Switchpoint Strategies, a research and advisory firm focused on emerging blockchain use cases that improve the real economy. Switchpoint’s founders are entrepreneurs with direct operational experience in FinTech & DeFi. That experience has led to a conviction that blockchain tech can and will solve the many pain points of complex transactions and data management.
He was previously Head of Business Development for DeFi Pulse’s Indices arm, Co-Head of Institutional Business at Index Coop and spent the prior decade as General Counsel for fintech lenders, presiding over the origination and securitization of several billion dollars of credit assets.
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