A one on one with Gilad Woltsovitch, founder of the online lending platform Backed, Inc. His personal journey navigating the turbulent times of the last two years, how Backed emerged from of the online lending chaos of 2016, and how he discovered a Blockchain-based solution to establish a secondary market for credit assets that can add at least another half a trillion dollars to the online lending industry over the next five years.
This interview consists of two parts. Part 1 is below. Part 2 will be published next Tuesday.
Tell us about the opportunity you see with the plateau online lending has hit and the maturity of Blockchain and Ethereum?
Alternative lending reached a point where it is a sizeable enough industry to remain a viable financing source for credit, we think there is a huge market to disrupt using Blockchain technology because right now this industry reached around $182 billion globally in online lending.
But the potential is much bigger.
The immediate addressable market is around $1.5 trillion globally. The only problem is that all of these assets are being generated in silos so every single company issuing borrower notes is doing its own underwriting, risk scoring, reconciliation, and issuance of notes all inside their own ecosystem.
Because there’s no secondary market, the industry has reached the point where it’s difficult to continue to grow because of these liquidity issues. In a short time, this new form of lending captured over 10% of the market. A new catalyst to move it forward is a real game changer.
How did you get interested in blockchain in the first place?
I read about Ethereum in a white paper. I got really interested in the technology and how it could bring disruption to the world of trust. It seemed like general purpose blockchain is the right way forward compared to the others who were trying to build on top of blockchain which wasn’t what blockchain was meant to be. That’s what got me interested in Ethereum. It is a very pragmatic and elegant solution to making a general purpose blockchain.
The ICO for Ethereum happened, I think, half a year later. I participated it in because I was emotionally invested in it already. I believed in the vision.
Vitalik reinforced the seriousness of this.
What role did you envision Ethereum and Blockchain at that point?
It’s interesting because we were just entering the FinTech space, after getting really excited about the revolution bitcoin brought about. At the time, we felt that the whole technology was too premature to go out and confidently raise funds from investors and be accountable for building a product on top of the protocols that were so young and so volatile. We thought it’s not a right time to build a blockchain business. Especially for us at the time because we are not cryptographic developers.
But, I knew from day one, and I told it to every single investor that joined Backed, Inc., that Blockchain technology should be the foundational kind of structure that we build on for our products.
So, in the back of my mind, even though Backed was started up as a very traditional alternative lender, I always knew that once the ecosystem matures enough, we will incorporate it into the business. That’s what led to the birth of Credium.
What was it that got you so interested in Blockchain technology?
The ability to transfer information transparently, and reduce the need for third party trusted intermediaries in between. It’s something that I began to understand when studying music. I studied the theory of electronic music, or, signals in general. There is a concept called the signal and system theory. When I look into a lot of networks in general, I always look at it from this kind of paradigm, thinking how is the correlation between the signal, as you transfer it throughout your network with minimal amount of loss. If you have signals floating through air, which is in music, you have minimal loss of information because the medium itself is just transferring the data. But once you need to digitize it, and start processing it, and reconciliating between two end points not necessarily speaking the same language, reducing it all to a failed information transference.
The bank hosts information about deposits. How many deposits does it have? How do those deposits behave usually? It needs to analyze through its systems how this information will help loan officers make decisions of how much leverage can it take, who can take the risk, and how does their profile look?
In a centralized system, you need a lot of intermediaries. They stamp the validation, the correctness, the kyc, the credit history, the amount of available funds, the risk model itself. Everything has to be vetted and audited, and when it’s transferred between entities within the same system, or even more complicated, between systems, you have more and more points of failure. Intermediaries cost money. In the end, the borrower pays more.
You see a problem when information has to go through too many hands, and the borrower pays for it?
Exactly. At the end of the day, everybody in the middle needs to get their piece of the pie. In the system of credit, the borrower is always in the lower position to incur all the markups and costs.
Do you see this as the problem that you set out to solve?
This is what drew me into the idea of blockchain. How can we share information that will help us transact transparently without the need of intermediaries? We wanted to start our own business that will help borrowers access credit. It was too early to take a head dive into blockchain back in 2014. The whole world of peer to peer lending was just emerging. We saw that as a great opportunity to focus on a niche market that wasn’t getting served by the big players who dominated the space.
What niche market?
We noticed that the whole experience of people who didn’t accumulate enough credit history in order to be scored sufficiently. The models that the growing industry has been using is taking the minimum risk possible by only rewarding the customers they can find. You were being penalized by the old models for not having enough debt, and then you are paying more for the debt that you do take, which makes it more difficult to pay off, or pay off on time, which makes it harder to get more debt, or pay it off at a reasonable cost.
I saw proliferation of many companies who tried to attack and bring novelty to the risk underwriting mechanism. Upstart is a notable example. It started looking into underwriting people based on their education.
You saw that there were populations that were being underserved, and that the models were not getting enough information, charging more money because they just weren’t assessing the risks efficiently?
The industry as a whole noticed that these arcane models needed to be updated. Every platform took their own approach on how to resolve this within the regulatory boundaries of risk scoring.
Backed was one of those novelty companies that was part of the Lending 3.0 revolution. Backed was the cosigning flow of the solution.
What niche did you see the most opportunity in during the online lending revolution of 2013?
I noticed that “thin filed millennials,” as I call them, were branded by the Consumer Financial Protection Bureau as “credit invisibles.” This population is basically mainly millennials or immigrants that do not necessarily have enough history in the system to get a sufficient score.
What opportunity did you see to serve their needs?
We looked into how they get through college, to their first job, and their first apartment. We noticed that they rely on their families much more than you would think traditionally.
After 2008, more and more millennials had to rely on their parents to either continue to subsidize their rent, or let them use their parents credit cards because their parents have a good credit score.
How did this fare?
We built up the system in 2015. We launched the pilot program, Backed, Inc, in 2016. We gave our first loans with capital from our equity investors. Our business is growing better than we anticipated.
Around 40% of the portfolio is backed by cosigners. Every borrower with us has seen his credit score increase by at least 10 points.
We reduce a lot of the risk for the cosigners themselves. We really believe in the model.
Has it ever happened that a cosigner had to make a payment to keep the loan from going bad?
We had a few incidents where a payment was missed, but it was paid back by the borrower – at the cosigner’s insistence. The leverage of the relationship between the borrower and cosigner was enough to keep the loan in good standing.
It sounds like this is a successful model. Did you get funded?
We scored a deal with one of the biggest hedge funds in New York. We had a signed term sheet for $20 million investment in our company.
So, the champagne was on the table and the check was ready to be signed?
We started hiring. While this was happening, a disaster happened in the industry that sent shock waves everywhere. It was the entire loss of trust between one of the lenders in the market, who had some issues of backdating their inventory.
Almost every single fund in the hedge fund industry pulled out, and we got a phone call basically saying that they are pulling out of the industry.
Was there any reason they pulled out that was about Backed?
It was clear that we were showing much better returns than expected. The Backed, Inc business model, the risk and underwriting side of the business I definitely think it’s a strong model. Its very niche specific so the challenges still remain on growth, and how big of a market it can achieve.
How is it doing from the Spring of 2016 to now, a year and a half later? Are more people taking out loans?
How has the industry reacted to the 2016 crisis?
It boils down to who has access to lending capital. Backed, in terms of the model is seeing organic growth. There’s more business to be done in our niche.
Until 2013, the model was pretty much peer to peer lending, and the platforms were just facilitating a marketplace between borrowers and lenders, basically allowing retail lenders to enjoy bank returns by diversifying their portfolio so they cut up every loan into securities, and investors with smaller amounts could diversify a whole portfolio of 100 loans without investing more than 10 or 15 thousand dollars, and earning returns just like the bank have on a pool of a hundred different loans.
So, instead of investing in 100 loans, you are investing in 100 fractions of different loan grades, and that was the whole peer to peer solution.
The problem that impeded our growth, just like any other niche platform, is the problem that the general model shifted heavily from 2013 onwards from peer to peer lending towards very centralized sources of capital, like institutional banks.
Gilad Woltsovitch is the Co-Founder and CEO at Backed Inc., responsible for designing the company’s first-class platform, UX and UI. Before Backed, Gilad co-founded iAlbums, a semantic curation engine for media players in 2010 where he served as the company’s CEO from 2011-2014. In 2013, Gilad also served as the entrepreneur in residence for Cyhawk Ventures and joined the Ethereum project, establishing the Israeli Ethereum meet-up group. Gilad holds a Masters of Art Science and Bachelors in Sonology from the Royal Conservatory of The Netherlands in The Hague, University of Leiden.