Financial institutions and key economic actors — micro, small and medium-sized enterprises, which account for up to 60% of GDP in developed countries — are experiencing a crisis of confidence that has a negative impact on the overall efficiency of the global economy.
Economists identify two significant problems, linked to each other, that complicate the work of the business financing market, namely the asymmetry of information about assets and the prisoner’s dilemma paradox.
The essence of this paradox is that in the absence of mechanisms to ensure full awareness of the actions of the parties to the transaction and the true [certain] quality of the goods, the rational and logical behavior of the parties is confrontation and mutual deception. If the parties do not have confidence in each other, then each of the parties tries to shift somehow the price of the transaction in a favorable direction as much as possible. The seller strives to sell as expensive as possible, the buyer seeks to buy as cheaply as possible.
Asymmetry of information is the cause of business financing problems
Asymmetry of information or imperfect, incomplete information is an uneven distribution of information about the goods between the parties to the transaction. As a rule, the seller knows more about the product than the buyer, although the reverse situation is possible. The SME financing market is fully in line with the definition of market with asymmetric information.
In the process of analysis of financial and economic activities of SMEs and their collateral assets financial institutions use the mechanisms and approaches developed more than 20 years ago that have already lost effectiveness.
The lack of accurate evaluation and forecasting mechanisms on the banks‘ side leads to the perception of the SMEs as a black box, and the risks are shifted to the collateral asset.
The evaluation of the collateral asset and monitoring its liquidity represent a complex process, which is often beyond the power of financial institutions. In this regard, a bank refers to independent appraisers and auditors who do not solve the problem of asymmetric information:
- There is no uniform quality standard for asset evaluation services on the market;
- Each appraiser, when preparing an evaluation report, follows his own understanding of what approach to use and what parameters to take into account;
- There is no single standard for asset inspection and look-over;
- It is allowed to conduct inspection and evaluation by the same expert, which in turn provokes a conflict of interest and often leads to corruption (evaluation in favor of client).
In such a situation, the financial institution is forced to protect its interests and apply various methods to minimize possible losses from incorrect evaluation. For example, in Russia 20,000 appraisers have 6000 auditors to recheck the reports on the evaluation after them, including 3000 employees of the banks. Such a staff of auditors costs the banks, on average, about 2.5 billion rubles per year.
Along with these mechanisms, banks resort to significant discounting in the calculation of limits, thus believing to minimize their losses in the default scenario. The statistics are not comforting here: the average loss in the sale of collaterals of banks in Russia is about 1 trillion rubles a year, and the average sale discount is 67% of the estimated value, which we understand is the result of evaluation of poor quality and the lack of a single quality standard.
In order to preserve capital, banks introduce high requirements to financial standing, credit history, collateral amount, create complex borrower validation processes and systems of barriers and restrictions for businesses.
MSME representatives, in such a situation, are almost completely deprived of access to financial instruments and are forced to resort to tricks and wiles in the hope of convincing the representative of a bank in the reliability and stability of its enterprises.
The problem of valuation of collateral assets is relevant for all countries, including technological North American, European and Asian markets. The size of the global collateral market, including debt securities and derivatives, exceeds the astronomical $10 trillion, and implies significant opportunities to optimize related processes.
Decentralization of processes in solving the problems of the real sector
Blockchain technology is able to completely eliminate the asymmetry of information and solve the prisoner’s dilemma for the markets of complex goods. The Internet and blockchain make exchanging reliable information among buyers, investors and other market participants, much easier, allowing you to directly receive the characteristics of the asset, the history of its operation, as well as to obtain reliable information about the current state of the market and the liquidity of the asset.
MUST Protocol is an open protocol of confirmation, evaluation and transfer of rights to assets through non-fungible tokens (NFTs) that solves these problems comprehensively. It was created in order to allow the real sector of the economy and real business to use blockchain technology in routine activities.
The main process of MUST Protocol corresponds to the four stages of any economic transaction (purchase and sale, pledge, lease, bond loan, etc.).
1. Inspection (look-over) of the asset
The first stage of any deal is to determine its subject. At this stage, MUST Protocol provides inspection (look-over) of the asset which involves asset digitization — creating a digital copy of any physical asset, including all its significant characteristics:
- technical information;
- photo report;
- video report;
- other characteristics.
2. Identification and confirmation of right to the asset
For the second stage of any transaction MUST Protocol provides three steps:
- Digitization (creation of a full digital copy) of documents of title;
- Asset tokenization — issue of non-fungible TAsset token (ERC-721 standard) in the Ethereum network containing a cryptographic key to the information and system of online monitoring and analysis of the asset;
- Tokenization of the right to an asset — issue of separate TRight NFTs for all specified types of rights (ownership, use, disposal, etc.), linked to the asset token.
This creates a digital basis for a future transaction on the blockchain — asset and right tokens, confirming the existence of the subject of the transaction and the legitimacy of its execution, which will be distributed as a result of the transaction.
3. Evaluation of the right to an asset
The implementation of the second stage of the transaction in a decentralized environment — evaluation of the rights to the asset, the subject of the transaction — is essentially a solution to the problems described in this article.
Integration of all automated and expert evaluation tools available on the market, application of a single inspection standard within each market, decentralized autonomous organizations (DAO, blockchain-analogue of SRO, self-regulatory organizations), a system of motivation and rating of market participants, multilateral audit, evaluation track record and anti-fraud solutions within one service will increase the speed of preparation of the valuation report up to 8 times, make the process open and competitive, and make the result trusted for all participants. The stage of asset (right to an asset) evaluation includes three steps:
- Automated evaluation — aggregation of all automatic valuation services, market analysis of similar transactions, automatic price forecast for different exposure times during sale;
- Expert evaluation — three or more independent asset evaluations within a minute;
- Application of Escrow DAO — audit of evaluation by market participants with the ability to challenge the result and initiate new independent reports, the system of motivation and depositing funds to ensure the highest quality form a self-balancing system, a trustless self-regulatory organization in the blockchain network.
4. Transfer of the right to an asset
At the third stage of the process, MUST Protocol will implement any possible transactions with tokenized rights to assets: purchase and sale, pledge, rent, lease, bond loan. Within the Protocol, all of them, in fact, differ only in the scheme and conditions of the distribution of various TRight tokens.
- The use of Escrow DAO will ensure the execution of the terms of the transaction for all parties declared in the smart contract, implementing the principle of inevitability of the transaction;
- Transaction in the blockchain will become part of a secure information registry that guarantees the safety and immutability of data.
Integrating blockchain into existing business processes
Addressing the issue of improving the quality and standardization of asset valuation, including collateral, will be a fundamental brick in the process of integrating blockchain solutions in the real sector of the economy. The MUST Protocol team plans to introduce the first implementation of the tokenized rights to the B2B sector, where there are less participants and the costs are higher.
The MUST Expert system, including the decentralized registry of evaluations of collateral assets, will solve many immediate problems for the participants of business financing market and will contribute to the mass adoption of tokenization technologies and blockchain.