On-chain lending bull market logic: The turning point has arrived, how to position?

Source: X

Author: Noah (@TraderNoah)

Translation and compilation: BitpushNews

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Core Summary

• Product Upgrade: On-chain lending will undergo necessary product improvements to better meet the demands of scaled capital.
• Demand Release: With features unlocked, the current low borrowing rates will trigger strong borrowing demand.
• Capital Reflow: Lending rates will begin to stabilize above risk-free rates, driving capital inflows.
• Valuation Reversion: The valuation multiples in the industry are compressing towards fintech levels, providing potential entry points for next year’s investments.

The Cyclical Pattern of On-Chain Lending

Historically, on-chain lending has followed a four-phase cyclical behavior:

1. System capital is low, interest rates are low.
2. Interest rates rise, capital flows into the system.
3. Due to excess capital, interest rates start to decline.
4. Because interest rates are too low, capital leaves the system.

Token prices of lending protocols often follow a similar pattern: prices rise with increasing interest rates and capital inflows, and fall as interest rates decline and capital exits.

We are currently in the fourth phase. In the past, the lending market relied on the positive beta coefficient of the crypto market to induce leverage demand, thereby pushing up interest rates; or used token subsidies to stimulate higher yields. Token subsidies work well in highly “reflexive” markets (high price = more subsidies = more platform capital = higher prices), but now there may no longer be an excess capital base willing to participate in such behavior. I believe most lending protocols are no longer willing to rely on the crypto market’s beta coefficient, and subsidies are difficult to scale without increasing costs.

The current issue causing stablecoin lending rates to be below the US risk-free overnight rate (SOFR) is: 1. Insufficient borrowing demand; 2. Protocol-induced low capital efficiency (such as cash drag caused by point-to-pool models, lack of re-mortgage mechanisms, etc.). Additionally, on-chain lending rates are far below most alternative capital sources, which clearly indicates this is not a long-term equilibrium.

How to Stimulate Borrowing Demand?

The key to inducing borrowing demand is offering prices lower than alternatives. Currently, the problem is that lending protocols cannot yet provide borrowers with the collateral assets and loan structures they are accustomed to.

1. Higher-quality Collateral Assets

The security of “monolithic” lending protocols depends on their worst-quality assets, making them overly conservative when introducing new assets. Currently, almost all protocols are shifting towards modular architectures to allow higher-risk lending.

Many traditional collateral assets are still difficult to access on-chain. Securities lending is a multi-trillion dollar market, with settlement rates typically at $SOFR + 75-250 basis points. Although still in early stages, we have seen prototypes of securities lending, such as Kamino’s Superstate market, Aave’s Horizon market, and Morpho’s select markets.

2. Protocol Design Improvements

Historically, lending protocols mainly provided “point-to-pool” floating-rate margin loans for high-liquidity crypto assets. This only suited a narrow borrower base and caused substantial cash drag for lenders due to utilization-based interest rate models.

This year, Kamino, Aave, and Morpho have all released upgrades to significantly expand loan types. With features like fixed-term loans, address whitelists, tripartite agreements with compliant custodians, and direct matching, lenders will see interest margin compression (more paid by borrowers to lenders), while borrowers will gain more flexible loan options.

This will stimulate borrowing demand, push interest rates higher, and attract capital supply, moving us into the “second phase” of the lending cycle.

Creating High-Yield Opportunities

High-yield opportunities are crucial for the survival of crypto yield funds. While the market might survive without them, it’s better not to take that risk. Historically, on-chain yield funds require a 12-15% return to justify their existence and raise capital.

Due to tokenized basis trading and improved capital efficiency in CME basis trading, basis yields have been compressed in the foreseeable future. Borrowing demand above 10% requires an (unpredictable) crypto bull market.

This means funds will be forced to seek slightly riskier but well risk-adjusted opportunities. The most likely opportunity is the entry of tokenized yield products. For example, Figure has launched a tokenized HELOC with an 8% yield, allowing yield funds to achieve returns exceeding their target via cyclic leverage on Kamino.

By 2026, more credit fund equivalents may be tokenized, offering 8-15% yields. It’s important to note that cyclic leverage carries difficult-to-quantify risks, and the legal structures of tokenized credit products must be properly established.

Conclusion

I believe there is a plausible logic: even if token prices continue to decline, on-chain lending demand can still grow. While I do not comment on the valuation of crypto market beta, if the above logic holds, protocol valuations will become very reasonable at some point in 2026.

Data estimate:

Assuming on-chain lending companies extract 5-10% interest as revenue, with an average rate of 6.5%. Currently, the total market cap to sales (P/S) multiple in this sector is between 21x and 42x, while listed fintech lending companies are around 8.4x.

Although the subtle differences are not worth debating, you must remain optimistic about on-chain lending over the next two years, as current valuation multiples will only make sense if that is the case. Even so, these multiples are rapidly compressing due to falling token prices and growth in key performance indicators (KPIs).

I believe 2026 will be a big opportunity for this sector to “make a major push.” Although short-term growth may slow due to declining crypto asset prices, upcoming fundamental catalysts could provide another growth inflection point for on-chain lending activity, with stronger sustainability.