2 - The PACT Protocol
2.1 - Overview of the PACT Protocol
PACT is a permissioned protocol that provides blockchain-native solutions to longstanding barriers in lending, securitization, and capital access. Initially developed by Pact Labs, the protocol is managed through a decentralized autonomous organization (DAO) structure, with governance through $PACT tokens. This includes voting on consortium members responsible for approving new originators, ensuring transparency and scalability in its operation.
At its core, the PACT Protocol enables the issuance and management of financial assets entirely on-chain. It leverages blockchain technology to deliver lower costs by eliminating multiple layers of intermediaries and provides enhanced investor insight through unprecedented real-time visibility into loan pools and underlying asset performance.
The PACT Protocol is built on the high-performance Aptos Blockchain (aptoslabs.com) for scalability and security. It also integrates with the Celo Blockchain (celo.org) to facilitate low-cost, mobile-first transactions in the MiniCredit application in Africa.
The PACT Protocol optimizes lending and capital access in emerging markets by eliminating inefficiencies and creating a more transparent financial ecosystem. The protocol delivers significant value to borrowers, originators, and investors by addressing long-standing barriers through:
Native On-Chain Issuance: Loans are issued directly on the blockchain, ensuring transparency, auditability, and efficiency.
Cost Efficiency: Reduces reliance on intermediaries, significantly lowering lending and operational costs.
Transparency and Standardization: Provides a clear valuation framework and standardized protocols, building trust and predictability.
Liquidity and Risk Premiums: Offers transparent liquidity and fair risk pricing, benefiting borrowers and investors.
Accessibility: Mobile-first design expands financial services to unbanked populations in underserved regions.
Incentivization: Rewards borrowers for positive financial behavior, fostering trust and repayment discipline.
2.2 - Functionality of the PACT Protocol
The PACT Protocol provides a seamless, secure, and scalable infrastructure for lending, securitization, and capital management. It addresses the inefficiencies and complexities of traditional financial systems, making it especially beneficial for emerging markets. Key components include:
2.2.1 - Loan Origination
Streamlined Process: Loans are issued directly on-chain with clear terms, including principal, tenor, repayment schedule, and risk score.
Loan NFTs: Each loan is tied to a unique, non-fungible token (NFT) representing ownership and facilitating secure, traceable transactions.
Flexibility: The protocol supports funding from multiple parties and dynamic configurations, enabling tailored solutions for originators and borrowers.
The high costs and inefficiencies of securitization are significant barriers to improving access to credit in these markets. Smaller loan sizes and the smaller loan books of emerging market fintech generally make securitization unfeasible. As a result, small businesses and individual borrowers struggle to secure affordable credit, which stifles entrepreneurship, economic expansion, and financial inclusion.
2.2.2 - Securitization
On-Chain Securitization: Loans can be packaged into pools and securitized directly on the blockchain, eliminating the need for costly intermediaries.
Tranching Mechanisms: Support for senior and junior tranches allows tailored risk and return profiles for investors.
Transparency and Auditability: On-chain structures ensure clear visibility into loan performance, reducing audit complexities.
2.2.3 - Loan Management
Payment Automation: The protocol facilitates automatic repayment flows, with detailed breakdowns of principal, interest, and fees.
Risk Monitoring: Integrated tools for real-time risk assessment and credit scoring help maintain high loan portfolio standards.
2.2.4 - Liquidity and Investment
Asset Aggregation: Loans can be grouped into funds or deals, allowing investors to access diversified portfolios with varying risk levels.
Direct Payments: Investors can receive returns directly from loan
repayments, with options for stablecoin or fiat payouts.Off-Balance-Sheet Structures: Transparent financial arrangements simplify compliance and improve financial flexibility.
2.2.5 - Integration and Scalability
Multi-Blockchain Support: Built on Aptos for scalability and Celo for mobile-first access, the protocol seamlessly integrates into diverse financial ecosystems.
Customizable Framework: Originators and fund managers can configure terms, fees, and access controls to suit their unique requirements.
2.2.6 - Handling Personally Identifiable Information (PII)
The PACT Protocol employs a robust framework for managing Personally Identifiable Information (PII) to ensure regulatory compliance, data security, and seamless integration with blockchain operations. This framework is part of a UETA-compliant document management service designed to maintain data integrity and accessibility while meeting the highest standards of security and auditability. Key features include:
Off-Chain Encrypted Storage: PII data is securely stored in in-country databases and encrypted using advanced cryptographic methods to comply with local regulations and protect sensitive information.
Tamper-Proof Verification: Each off-chain document is hashed, with the hash stored alongside the corresponding loan on-chain. This ensures that documents served to users remain unaltered since origination, offering verifiable data integrity.
Web3-Enabled Policy Engine: Access to off-chain documents is governed by a web3-enabled policy engine that determines permissions based on wallet addresses and token ownership (e.g., loans, facilities, and funds). Documents are served based on wallet connections and signed messages, ensuring secure and efficient access control.
UETA Compliance: This document management service adheres to the requirements of the Uniform Electronic Transactions Act (UETA), ensuring that all electronic records maintain their integrity, accessibility, and legal enforceability.
By combining off-chain security with on-chain transparency, this system delivers a compliant, efficient, and secure solution for managing sensitive data while fostering trust among stakeholders and regulators.
2.2.7 - Key Participants in the Ecosystem
The PACT protocol has five main categories of participants:
Borrowers: A borrower is any entity that receives a loan from a loan book. The borrower has an obligation to repay the loan as well as interest and fees.
Originators: Financial institutions issuing loans and managing on-chain portfolios. By default an originator takes ownership of any loan issued through their loan book, but can delegate a third party to receive ownership upon origination.
Credit Owners: Holders of loan NFTs who receive repayments and own the financial rights to loans, and can configure an alternate address to receive payments if desired. If the credit owner is a smart contract any funds transfer will be enriched with information on how the payment can be broken down into principal, interest, and fees.
Fund Managers: Administrators of loan pools, managing tranches and investor returns. Managers can initiate coupon disbursements and operate within the bounds of covenants. Fund managers can approve/reject loans as collateral on a per-loan basis if enabled.
Investors: Any entity that owns shares of a fund. They are KYC’d and must be whitelisted on-chain by a fund manager.
2.3 - Flow of funds in the PACT Protocol
The PACT Protocol streamlines the flow of funds in lending and investment processes, ensuring transparency, efficiency, and security at every stage. PACT creates a seamless path from loan origination to repayment while maintaining detailed tracking of all transactions. Below is an overview of how funds move through the system:
2.3.1 - Loan Origination
Setting Loan Terms: The originator initiates the process by defining the loan terms, including principal amount, repayment schedule, and borrower details. Additional metadata, such as risk scores and document hashes, can be appended for transparency.
Funding: Depending on the configured structure, the loan is funded on-chain by either the originator or a third-party lender.
Disbursement: Once funded, the principal is disbursed to the borrower, and the loan officially begins.
Ownership via NFTs: The loan is tokenized as a unique Loan NFT, representing ownership and all associated rights. This NFT can be transferred to a whitelisted credit owner.
2.3.2 - Loan Servicing
Transparent Repayment Tracking: Borrowers make repayments in fiat or stablecoins, with all transactions recorded on-chain for real-time visibility and accountability.
Automated Payment Allocation: Repayments are automatically applied to principal, interest, and fees based on pre-configured rules, ensuring accurate and efficient fund distribution to stakeholders.
Seamless Loan Lifecycle Management: For Externally Owned Accounts, payments are directly disbursed to credit owners and originators, while smart contracts handle tranche-based allocations for pooled loans. Upon full repayment, loans are marked as settled, and Loan NFTs are updated or retired to reflect completion.
2.3.3 - Securitization and Investment
Loan Pooling: Individual loans can be aggregated into funds or deals, creating diversified pools for investment.
Tranching: These pools can be structured into senior and junior tranches, offering investors varied risk and return profiles.
Investor Returns: As borrowers make repayments, the funds flow directly to investors according to the tranche structure and pre-set terms.
2.3.3 - Securitization and Investment
Real-Time Reporting: All transactions are recorded on-chain, enabling real-time visibility into the flow of funds.
Automated Reconciliation: The protocol eliminates manual reconciliation by automating fund distribution and tracking.
Immutable Records: Blockchain immutability ensures that all financial flows can be audited at any time, providing stakeholders with unmatched trust and clarity.
2.4 - Benefits for stakeholders
he PACT Protocol benefits the financial ecosystem by providing borrowers, investors, asset managers, and service providers with familiar tools built on new rails. It addresses inefficiencies, fosters transparency, and enhances access to global capital markets.
2.4.1 - Borrowers in Emerging Markets
PACT fosters financial inclusion and empowers borrowers to participate fully in the economy by:
Expanding Access to Credit: Connecting borrowers with global capital markets, ensuring greater liquidity and fairer interest rates.
Lowering Costs: Reducing reliance on intermediaries decreases borrowing costs, making credit more accessible.
Empowering Growth: Affordable loans enable micro-entrepreneurs and small businesses to invest in growth opportunities, creating jobs and driving economic development.
2.4.2 - Investors
PACT democratizes access to emerging market loans, bridging the gap between global investors and high-growth regions. Key benefits include:
Enhanced Liquidity: Tokenized assets allow investors to trade positions seamlessly, ensuring flexibility and adaptability.
Transparency and Confidence: On-chain reporting provides real-time visibility into loan performance, reducing risks and enhancing trust.
Competitive Returns: Diversified loan portfolios offer attractive yields while mitigating risk through tranching and other mechanisms.
Collateral Utility: Tokenized loans can also serve as collateral, creating additional opportunities for leveraging investments.
2.4.3 - Asset and Investment Managers
For asset and investment managers, the PACT Protocol streamlines fund management, enhances operational efficiency, and enables scalability. Specific benefits include:
Collateral Utility: Automation of custody, administration, and execution minimizes expenses, increasing profitability.
Liquidity Mechanisms: Tokenization enables loans to be securitized and collateralized, providing investors seamless access to diversified portfolios.
Future-Proofing Operations: By adopting advanced blockchain solutions, managers stay ahead of industry trends and maintain a competitive edge.
2.4.4 - How an originator can reduce their cost of capital with PACT
Traditional credit funding and securitization processes in emerging markets are expensive, inefficient, and reliant on costly intermediaries. Fintech originators typically face high (15-25%+) borrowing costs, driven by counterparty risks, legal complexities, and high servicing costs.
While traditional securitization costs typically range from 0.50% to 1.50% for large loan books in developed countries, these costs are significantly higher for smaller loan books in emerging markets.
By using PACT’s on-chain infrastructure, an originator can:
Reduce borrowing costs by decreasing risks and opening up a wider investor pool..
Eliminate third-party investment banks, trustees, and verification agents, Tsignificantly lowering deal costs.
Automate investor servicing & reporting, reducing operational overhead.
Unlock new capital sources, such as stablecoin treasuries and digital asset managers, increasing available funding at competitive rates.
Quantifying Hypothetical Cost Savings for an Originator Securitizing Their Loan Book
Without PACT, an originator needs investment banks, custodians, and verification agents, adding significant inefficiencies and high costs while limiting access to competitive funding sources.
With PACT’s automated, on-chain capital markets, an originator can:
Reduce reliance on intermediaries and lower financing costs.
Increase investor confidence with real-time loan performance tracking.
Access a broader range of funding sources, such as stablecoin treasuries and digital-first capital allocators.