In December 2022, a borrower defaulted on $36 million in blockchain-based loans. The loans had been recorded perfectly, with every term, transfer, and repayment schedule onchain for anyone to read. The asset in this particular case, was a loan made onchain. The problem was that no one knew that the borrower had misrepresented its own financial position. While the ledger itself was flawless, the issue lay with what it was pointing to: the ‘fundamental quality’ of the asset, and the lack of transparency for chain based investors in its understanding.
Tokenized private credit is now the largest non-Treasury real-world asset category onchain, with approximately $14 billion having moved through these rails, at yields of 8 to 12 per cent and higher. As the returns are impressive and the settlement is fast, capital continues to flow in. But a large proportion of that capital sits on top of collateral whose quality hasn’t been properly proven onchain and is unable to verify. If this problem isn’t addressed, we could easily see more significant failures in the future.
Tokenization hasn’t solved the complete problem
Tokenization is a huge achievement that has solved complex problems around transfer, settlement, and composability. Asset transfer time, in particular, has gone from days to seconds, and it can plug into other systems without a middleman. Tokens must solve many existing problems that traditional securitization can’t solve.
In credit, the hard question has long been whether the asset is worth what the holder claims. How can we know that the loan is real and was underwritten to the standard claimed? With complete documents and numbers that all match up? Tokenization doesn't answer any of that. It just moves the claim faster, between anonymous parties, with almost no recourse if the claim turns out to be wrong.
Crypto accepted TradFi's weakest habit
Incidentally, we’ve had the same problem in tradfi too. And despite the obvious unlocks that crypto has provided along the way, the anonymity of crypto heretofore has only compounded it. The traditional finance world establishes trust through loan files being signed off by a third-party reviewer. We call this an attestation layer. With attestation, an auditor confirms a pool once a year, and a trustee issues a report months after the fact. Servicers may remit payments and everything is reported.
Through these different layers of people, each one vouches for the documents they combed through by hand or in some cases leveraging instances of automated technology. Still, the limit in tradfi is that a chain of humans manually reviews various asset files, that results in more errors, longer processing times, and the requisite assumption that being that attestations in the chain of attestation can be trusted. When this process fails, investors find out after they’ve already experienced potentially significant losses.
This isn't hypothetical. When New Century Financial, once one of the largest subprime originators, collapsed in 2007, the bankruptcy examiner found that management had known for years the loan quality was slipping and kept originating anyway. By then, almost all of those loans had already been sold off. The dealers were covered. The end investors weren't.
Crypto promised so many improvements to the traditional financial systems. But it failed when it took an asset whose quality rested on manual attestation, wrapped it in a token, and called the result an “upgrade.” It further failed to recognize that it produces the same trust assumption, just in a faster wrapper.
Proof is possible
So, while incredible advancements have been made, the digital asset industry hasn’t yet considered the major implications of not properly confirming an asset. Rather than continuing this passive process, there are multiple steps that could be put in place.
Reduce a loan to a single canonical record, and anyone can recompute it straight from public information. Prove eligibility against a standard with a cryptographic proof instead of a reviewer's signature, and do it without ever exposing the borrower's private data. Anchor a pool's composition so any investor can check what's actually inside it. Chain the reports together, and a change to last month's numbers gets caught this month, not next year.
The signed PDF gets replaced by a machine-readable record. The promise that someone checked gets replaced by a credential that proves it.
None of this should require trusting the issuer. Verification that only works if you already trust the party being verified isn't verification, it's a courtesy, and we've already seen what that courtesy costs. Real proof holds up whether or not you believe the person who published it, because a total stranger can reproduce it from public data alone.
The uncomfortable part
If proof is available, why does so much tokenized credit still run on assertion? Realistically, the weaker standard has been good enough to raise capital. Yields are high, demand is strong, and investors have been willing to fund unverified collateral because the returns compensate for a risk they have not fully priced. Nobody cares to adopt a harder standard while the easier one keeps working. The standard simply keeps working until it doesn't, and then it works for no one.
This matters the most in private credit, as though it’s still incredibly opaque, it’s growing rapidly. While tokenized Treasury is backed by an asset the whole market can already see, a tokenized private loan is backed by a file most investors will never read. This type of asset needs to carry its own proof, but it, unfortunately, it rarely does that.
While being onchain proves an asset exists, it doesn’t prove that it’s worth anything. Until the asset can prove what it claims, on its own, and to anyone who asks, we are just running TradFi's trust model while pretending we’re evolved. Yes, the rails are new, but they continue to function on an outdated assumption. We can do better than assertion now, and we need to stop pretending we already have.