Author: Prathik Desai
Compile: Block unicorn
Credit is the time machine of the economy. It enables businesses to bring future cash flows into today's decisions.
I think this is one of the most underestimated aspects in the financial world.
People rarely notice the role of credit, but it is indeed reflected in the way businesses operate. An effective credit system allows businesses to restock before shelves are empty, enables factories to upgrade before old equipment is completely obsolete, and allows founders to hire new employees before a human resource surplus crisis erupts.
The gap between good ideas and actual implementation often stems from limited credit channels. Banks commit to filling this gap.
Banks accept deposits from customers through bank accounts and provide credit to people who need loans. They pay depositors a lower interest rate and charge borrowers a higher interest rate; the difference is their profit. However, bank credit also faces many challenges. One of the most significant challenges is the mismatch between credit supply and demand.
Private credit fills the gaps that bank credit cannot cover, but the gap still exists. This gap reflects investors' unwillingness to lend in the current credit market.
In March 2025, a report titled "Financing Gap for Small and Medium-sized Enterprises" jointly released by the International Finance Corporation and the World Bank estimated that the financing gap in 119 emerging market and developing economies (EMDEs) is approximately $5.7 trillion, accounting for about 19% of their combined GDP.
Against this backdrop, I find the recent developments in the on-chain credit field last week exciting. On-chain lending is not a new thing. We went through a frenzy cycle in 2022, and to this day, people are still discussing it for various reasons. But this current cycle feels different.
In this article, I will delve into all the changes happening in the on-chain credit markets and tell you why I think it might revolutionize the credit industry.
Let's get started.
For years, there have been money markets on Ethereum. Over-collateralized lending, liquidation bots, interest rate curves, and the occasional chain of liquidations are not new things. Therefore, when a credit-related announcement was released last week, what really caught my attention was the players involved and how they repackaged credit, rather than the money markets themselves.
What excites me is that these scattered collaboration announcements collectively signal a broader trend of integration. In the summer of 2022, the previously fragmented DeFi sector is converging into a powerful force. Treasury infrastructure, non-custodial wrapping, specialized risk management, and automated yield optimization are being integrated and popularized.
Kraken has launched DeFi Earn, a platform for retail users to channel lenders' deposits into vaults (in this case, Veda). The vaults will then direct the funds to lending protocols such as Aave. Chaos Labs will serve as the risk manager, responsible for monitoring the entire engine. Kraken promises lenders an annual percentage yield (APY) of up to 8%.
What changes have vaults brought? They provide lenders with self-custody and fund transparency. Unlike traditional credit markets, where funds are handed over to fund managers and monthly disclosures are awaited, vaults integrate smart contracts that can mint claims against the funds and display fund allocations in real time on the blockchain.
At almost the same time, the world's largest crypto fund management company, Bitwise, launched a non-custodial vault strategy on the on-chain lending platform Morpho.
This is not the first time on-chain lending has received institutional recognition. In 2025, Coinbase launched a USDC lending service, enabling smart contract wallets to connect and route deposits through on-chain vaults to the Morpho platform. Steakhouse Financial utilizes this platform to allocate capital across markets to optimize returns.
This coincides with the on-chain lending market about to experience explosive growth, and the data confirms this.
The total value locked (TVL) in lending protocols has reached $58 billion, a 150% increase over two years. However, this figure is only 10% higher than the peak in 2022.
Here, the outstanding loan balance dashboard can more accurately reflect the actual situation.
This dashboard shows that the foundation laid by leading protocols such as Aave and Morpho is very solid, with active loans exceeding $40 billion in recent months, more than double the 2022 peak.
The dashboard shows that existing institutions, including Aave and Morpho, have laid a solid foundation, with active loans exceeding $40 billion in the past few months, more than double the peak level of 2022.
Currently, Aave and Morpho's revenue is six times what it was two years ago.
Although these charts show investors' confidence in the loan agreement, I think the growth of the vault deposits over time is more convincing.
In October 2025, the total deposit amount in the treasury surpassed the 600 million U.S. dollar mark for the first time. Now, the deposit amount has reached 570 million U.S. dollars, more than twice the amount from the same period last year (234 million U.S. dollars).
These charts indicate that users are choosing products that offer a comprehensive ecosystem, including treasuries, yield optimization strategies, risk allocation, and professional managers.
This is the evolutionary path I am optimistic about, which is completely different from what we observed during the DeFi summer.
At the time, the lending market seemed to be a closed loop. Users exploited this loop by depositing collateral, lending funds, using the proceeds to purchase more collateral, and redepositing it to earn higher returns. Even if the price of the collateral dropped, these users could still receive rewards from the platform for using the lending protocol. But when these rewards themselves disappeared, the loop broke.
Even the current cycle, whose foundation remains the same basic element—over-collateralized lending—is built on a completely different and more solid foundation. Today's vaults have evolved into wrappers that transform protocols into automated asset management tools. Risk managers play a central role, responsible for setting up security measures.
This transition has changed the appeal of on-chain lending to investors and lenders.
During the DeFi summer, lending protocols were nothing more than another quick way to make money. This model worked until the incentives failed. Users would sign up for an Aave account, deposit funds, borrow against collateral, and repeat the process until the incentives disappeared. We saw this in Aave's Avalanche deployment: incentives attracted deposits and maintained the cycle in the early stage. But when the subsidies weakened, the cycle collapsed as well. As a result, the outstanding debt on Avalanche dropped by 73% quarter-on-quarter in the third quarter of 2022.
Today, the loan business has developed into a well-established ecosystem with specialized participants responsible for risk management, profit optimization, and liquidity management, respectively.
The following is my method for assembling the entire stack.
The bottom layer is settlement funds, existing in the form of stablecoins. They can be transferred instantly, stored anywhere, deployed at any time, and most importantly, are easy to measure.
Above this is the money market we are familiar with, such as Aave, where lending and borrowing are enforced by software code and collateral.
Next is the world of wrappers and routers, which aggregate funds and route them from lenders to borrowers. Vaults act as wrappers, packaging the entire lending product in a way that is easy for retail investors to understand. For example, it can be presented as "Deposit X dollars to earn up to Y% yield," just as the Veda Wallet does on Kraken's Earn platform.
Custodians override these agreements to decide which collateral is allowed, liquidation thresholds, risk concentration, and when to liquidate when the value of collateral declines. Think of Steakhouse Financial's approach on the Morpho platform, or how asset management companies like Bitwise embed their judgments directly into vault rules.
In the background, artificial intelligence systems operate 24/7, managing on-chain credit risk and acting as the nervous system of the lending ecosystem when human intervention is not available. Manual risk management is difficult to scale. Constrained risk management increases credit risk during market volatility. At best, returns fall below benchmarks, and at worst, liquidation occurs.
The AI optimization engine tracks loan demand, oracle deviations, and liquidity depth to trigger timely withdrawals. When the vault's risk exposure exceeds a preset threshold, it issues an alert. Additionally, it provides recommendations on risk-reduction measures and assists the risk team in decision-making.
It is precisely this round-the-clock optimization, risk mitigation, audited vaults, carefully crafted strategies, institutional endorsements, and professional risk management that make the current market feel safer and less risky.
But these measures cannot completely eliminate the risks. Among them, liquidity risk is one of the most easily neglected risks.
Although the vault provides better liquidity than isolated protocols, it still operates in the same market as these protocols. In markets with sparse trading volume, the vault increases the cost of liquidating funds, making it difficult for funds to exit.
In addition, there is the risk of the curator's discretionary power.
When users deposit funds into a vault, they are actually placing trust in certain institutions to make investment decisions based on market conditions, select appropriate collateral, and set corresponding redemption thresholds. Credit operations vary widely, but lenders should understand that non-custodial does not necessarily mean zero risk.
Despite these challenges, on-chain lending is also changing the cryptocurrency landscape, and thereby changing the economic landscape.
The cost of operating in the credit market depends on time and operating costs.
Heavy investment in verification, monitoring, reporting, settlement, and execution of transactions makes traditional credit expensive. A large portion of the interest they charge borrowers is avoidable and may not necessarily relate to the "time value of money."
On-chain credit saves time and reduces operating costs.
Stablecoins minimize settlement time, smart contracts reduce execution time, transparent ledgers reduce audit and reporting time, and vaults simplify user complexity. When addressing the credit gap issue for small and medium-sized enterprises, these cost savings will be even more significant.
On-chain credit will not close the credit gap overnight, but lower credit costs will make verification more convenient and make credit access more inclusive. And this could reshape the economic landscape.