Written by: Prathik Desai

Translated by: Block unicorn

Credit is the time machine of the economy. It allows businesses to bring future cash flows into today's decision-making.

I believe this is one of the most underrated aspects of the financial world.

People rarely notice how credit plays a role, but it is indeed reflected in how businesses operate. An effective credit system enables companies to restock in time before shelves are empty, upgrade factories before old equipment is completely obsolete, and hire new employees before a human resources redundancy crisis erupts.

The gap between good ideas and actual execution often stems from limited credit channels. Banks promise to fill this gap.

Banks accept customer deposits through bank accounts and provide credit to those in need of loans. They pay deposit customers a lower interest rate while charging borrowers a higher interest rate, with the difference being their profit. However, bank credit also faces numerous challenges. One of the most significant challenges is the mismatch between credit supply and demand.

Private credit fills the areas that bank credit cannot cover, but a gap still exists. This gap reflects investors' unwillingness to lend in the current credit market.

In March 2025, the International Finance Corporation and the World Bank jointly released the report "Financing Gap for Small and Medium Enterprises," estimating that the financing gap for 119 emerging markets and developing economies (EMDEs) is approximately $5.7 trillion, accounting for about 19% of their total GDP.

Against this backdrop, I find the recent developments in the on-chain credit space exciting. On-chain lending is not a new phenomenon. We experienced a crazy cycle in 2022, and to this day, people are still discussing it for various reasons. However, this current cycle feels different.

In this article, I will delve into all the changes happening in the on-chain credit market and explain why I believe it could fundamentally change the credit industry.

Let's get started.

For years, there has been a money market on Ethereum. Over-collateralized lending, liquidation bots, interest rate curves, and occasional chain liquidations are not new. Therefore, when announcements related to credit were made last week, what truly attracted me was the players involved and how they are repackaging credit, rather than the money market itself.

What excites me is that these sporadic collaboration announcements collectively signal a broader trend of convergence. The previously fragmented DeFi space from the summer of 2022 is coalescing into a powerful force. Treasury infrastructure, non-custodial wrapping, specialized risk managers, and automated yield optimization are being integrated and promoted.

Kraken launched DeFi Earn, a platform for retail users that can direct lenders' deposits into a treasury (in this case, Veda). The treasury then directs funds to lending protocols like Aave. Chaos Labs will act as the risk manager, responsible for monitoring the entire engine. Kraken promises to offer lenders an annual percentage yield (APY) of up to 8%.

What changes do treasuries bring? They provide lenders with self-custody and transparency of funds. Unlike traditional credit markets where funds are handed over to fund managers and monthly disclosures are awaited, treasuries integrate smart contracts that can mint claims on funds and display real-time fund deployment on the blockchain.

Around the same time, Bitwise, the world's largest crypto fund management company, launched a non-custodial treasury strategy on the on-chain lending platform Morpho.

This is not the first time on-chain lending has gained institutional recognition. In 2025, Coinbase launched USDC lending services, allowing smart contract wallets to connect and route deposits to the Morpho platform via on-chain treasuries. Steakhouse Financial utilizes this platform for cross-market fund allocation to optimize yields.

This coincides with the on-chain lending market poised for explosive growth, and data confirms this.

The total value locked (TVL) in lending protocols reached $58 billion, growing 150% over two years. However, this figure is only 10% higher than the peak in 2022.

Here, the dashboard for outstanding loan balances can more accurately reflect the actual situation.

The dashboard shows that the foundation laid by leading protocols like Aave and Morpho is very solid, with active loans exceeding $40 billion in recent months, more than double the peak in 2022.

The dashboard indicates that existing institutions, including Aave and Morpho, have laid a solid foundation, with active loans in the past few months exceeding $40 billion, more than double the highest level in 2022.

Today, Aave and Morpho's current revenues are six times what they were two years ago.

While these charts show investor confidence in lending protocols, I believe the growth of treasury deposits over time is even more compelling.

In October 2025, the total deposits in treasuries surpassed the $6 billion mark for the first time. Today, deposits have reached $5.7 billion, more than double the same period last year ($2.34 billion).

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 evolution I am optimistic about, which is entirely different from what we observed during DeFi summer.

At that time, the lending market seemed like a closed loop. Users leveraged this loop by depositing collateral, borrowing funds, using the proceeds to buy more collateral, and depositing again to earn higher yields. Even if collateral prices fell, these users could at least earn rewards for using the platform's lending protocols. But when those rewards disappeared, the loop broke.

Even in the current cycle, the foundation remains the same basic elements—over-collateralized lending—but it is built on a completely different and more solid foundation. Today's treasuries have evolved into wrappers that transform protocols into automated asset management tools. Risk managers play a core role, responsible for setting safeguards.

This shift changes the appeal of on-chain lending for investors and lenders.

During DeFi summer, lending protocols were merely another way to make quick money. This model worked until the incentive mechanisms failed. Users registered Aave accounts, deposited funds, borrowed against collateral, and repeated the process until the incentives disappeared. We saw this in Aave's Avalanche deployment: the incentive mechanisms attracted deposits and initially maintained the loop. But as subsidies weakened, the loop also collapsed. As a result, Avalanche's outstanding debt fell by 73% quarter-over-quarter in Q3 2022.

Today, the lending business has evolved into a well-rounded ecosystem with dedicated participants responsible for risk management, yield optimization, and liquidity management.

Here’s how I assemble the entire stack.

At the bottom layer are settlement funds, existing in the form of stablecoins. They can be transferred instantly, stored anywhere, deployed at any time, and, crucially, are easy to measure.

Above that is the familiar money market, such as Aave, where lending is enforced by software code and collateral.

Next is the world of wrappers and routers, which pool funds and route them from lenders to borrowers. Treasuries act as wrappers, packaging the entire lending product in a way that is easy for retail investors to understand. For example, it can present as "Deposit $X to earn up to Y% yield," just like what the Veda wallet does on Kraken's Earn platform.

Custodians sit above these protocols, deciding which collateral is allowed, liquidation thresholds, risk exposure concentrations, and when to liquidate as collateral values decline. Think of how Steakhouse Financial operates on the Morpho platform, or how asset management companies like Bitwise embed their judgments directly into treasury rules.

In the background, AI systems run around the clock, managing on-chain credit risk and acting as the nervous system of the lending ecosystem when humans are not present. Manual risk management is difficult to scale. Limited risk management increases credit risk during market volatility. The best outcome is yields below standard, while the worst outcome is liquidation.

The AI optimization engine tracks borrowing demand, oracle deviations, and liquidity depth to trigger timely withdrawals. When treasury risk exposure exceeds preset thresholds, it issues alerts. Additionally, it provides recommendations for risk reduction measures and assists risk teams in decision-making.

It is this round-the-clock optimization, de-risking, audited treasuries, carefully curated strategies, institutional backing, and professional risk management that make the current market feel safer and less risky.

However, these measures cannot completely eliminate risk. Among them, liquidity risk is one of the easiest risks to overlook.

While the liquidity provided by treasuries is superior to isolated protocols, it still operates in the same market as these protocols. In low-volume markets, treasuries can increase the cost of liquidating funds, making it difficult to exit.

Moreover, there is the risk of curator discretion.

When users deposit funds into a treasury, they are essentially trusting certain institutions to make investment decisions based on market conditions, select appropriate collateral, and set corresponding redemption thresholds. The ways credit operates vary widely, but lending institutions should understand that non-custodial does not necessarily mean zero risk.

Despite these challenges, on-chain lending is changing the cryptocurrency landscape and, in turn, altering the economic landscape.

The operating costs of the credit market depend on time and operational costs.

Investing heavily in verification, monitoring, reporting, settlement, and executing transactions makes traditional credit costly. A significant portion of the interest charged to borrowers is avoidable and may not necessarily relate to the "time value of money."

On-chain credit saves both time and reduces operational costs.

Stablecoins minimize settlement times, smart contracts reduce execution times, transparent ledgers decrease auditing and reporting times, and treasuries simplify user complexity. These cost savings will be even more pronounced when addressing the credit gap for small and medium enterprises.

On-chain credit will not fill the credit gap overnight, but lower credit costs will make verification more convenient and make credit access more inclusive. This could reshape the economic landscape.

This concludes the analysis; see you in the next article.

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