Onchain Tranching Emerges as Promising Growth Vector in DeFi

Onchain tranching is gaining traction as a promising growth vector in decentralized finance (DeFi), despite its current small market share. According to Silvio Busonero, advisory lead at Blockworks, onchain tranching has the potential to bring structured finance online, mirroring the $15 trillion traditional finance market.

The mechanics of onchain tranching involve splitting a lending pool into tranches with different risk profiles. Junior tranche depositors absorb losses first, protecting senior tranche depositors who sit higher in the repayment waterfall. In return for taking on this first-loss risk, junior participants earn higher yields, while senior participants receive lower but more stable returns.

The existing DeFi lending market is dominated by looping, which accounts for roughly 40% of revenues. Looping involves recursive borrowing and generates significant protocol fees. However, Busonero argues that tranching offers superior risk-transfer capabilities in various scenarios.