Welcome to Edition #3 of "This week in onchain credit" 🏃 The week's credit stories in one thread. Lending markets, RWAs, tokenization, and whatever else the credit stack is up to this week 👇

Introducing the first edition of "This week in onchain credit". The week's credit stories in one thread. Lending markets, RWAs, tokenization, and whatever the credit stack is quietly doing underneath. Here's what moved this week 👇

How an RWA credit facility blows up 1. You deposit USDC into an onchain credit facility and get a yield-bearing stablecoin in return ("USDX"). USDX is backed by a portfolio of loans to offchain borrowers, according to the marketing. 2. USDX's issuer creates a Morpho market where you pledge USDX and borrow USDC, up to a 91.5% LLTV. You go to Morpho, post your USDX, borrow USDC, buy more USDX, and repeat. You now have 10x leverage. 3. Morpho values USDX using the portfolio’s NAV, relayed onchain by a “Verified NAV Oracle.” The oracle doesn't verify that the loans are worth that amount, or that the collateral can be liquidated. They pass along the issuer's self-reported NAV, which increases mechanically at par plus the coupon rate. If you bought on Day 1 at $1.00, and the annual coupon was 7%, it would be worth $1.07 on Day 365. 4. The borrowers begin to deteriorate offchain, payments stop flowing in, covenants are busted. Your Morpho position looks fine because the USDX price from the oracle continues to increase. 5. Finally the issuer marks down the NAV, on the quarterly schedule. Assuming a 91.5% liquidation threshold, a position at 90% LTV only needs a 1.64% decline to be liquidated. Several looped positions immediately fall underwater. 6. The markdown causes a run. USDX holders submit redemptions at the published NAV. The issuer pays the first redeemers from its cash sleeve, leaving the remaining token supply backed by a less liquid loan book. 7. Once the cash is exhausted, the issuer pauses redemptions, or begins selling loans at a discount. USDX is listed on DEXs - to facilitate orderly liquidations in situations like this - but it trades far below NAV because it can no longer be converted into cash. 8. On Morpho, USDC suppliers withdraw the remaining liquidity, causing borrowing rates to spike and pushing the debt positions further underwater. 9. A liquidator shows up and buys USDX, repaying a portion of the debt. They try and trade it on the DEX but it can't absorb the volume. They try and redeem directly with the issuer but they are stonewalled. They find out the token doesn't actually represent a legal claim on the collateral, or really anything, despite what the marketing said. 10. No other liquidators show up. At a 91.5% LLTV, the liquidation bonus is only ~2.6%, not nearly enough to step in and pursue recovery. 11. You lose your initial investment. The CEX "Earn" depositor who unknowingly funded the whole operation (via an embedded curator vault), loses their entire position.