Onchain Tranching Gains Momentum as Next Big Thing in DeFi

Onchain tranching is gaining attention as a potential future of structured finance in decentralized finance (DeFi). According to Silvio Busonero, advisory lead at Blockworks, onchain tranching represents one of the most promising growth vectors in DeFi. Currently, it accounts for less than 1% of total DeFi lending deposits.

Busonero argues that onchain tranching is not about where it stands today but what it represents: the DeFi equivalent of a $15 trillion structured finance market in traditional finance. In onchain tranching, a lending pool gets split into tranches with different risk profiles. Junior tranche depositors absorb losses first, acting as a cushion for senior tranche depositors who sit higher in the repayment waterfall.

Protocols building in this space include Royco, Strata, Reflect on Solana, and Pareto's onchain credit facilities, including what's referred to as the FalconX vault. Tranching offers a fundamentally different philosophy compared to looping, the dominant revenue engine in DeFi lending today. Instead of relying on liquidation waterfalls to manage risk after the fact, tranching structures risk allocation upfront.

Busonero predicts that the fastest growth in DeFi will come from combining tranching with traditional lending practices, particularly through senior tranches. Senior tranches offer the kind of risk-adjusted returns that appeal to larger, more conservative allocators.