Credit Delegation

In a traditional overcollateralized lending protocol like Aave or Compound, a user must deposit more value in collateral than they can borrow. Credit delegation unlocks this idle borrowing power. A trusted party, the delegator, deposits collateral (e.g., ETH) and receives a credit delegation token (like a debt token). They can then delegate the right to borrow against this collateral to a delegatee, who can draw a loan without posting their own collateral. This enables under-collateralized or uncollateralized lending within a secured framework.

The mechanism relies heavily on trust and often off-chain agreements. The delegator and delegatee typically establish terms—such as the loan amount, interest rate, and repayment schedule—through legal frameworks or smart contract modules that encode these terms on-chain, like Aave's Credit Delegation Vaults. The delegator's collateral remains locked in the protocol and is at risk if the delegatee defaults, making this a tool for institutional or known-counterparty lending, supply chain finance, and DAO-to-DAO credit lines.

Key technical components include the delegation approval, where the delegator authorizes a specific delegatee address and credit limit, and the debt token transferability, which represents the right to incur debt. This structure separates creditworthiness from capital provision, enabling new financial primitives. For example, a corporation with strong on-chain treasury holdings can delegate credit to a subsidiary, or a liquidity provider can earn additional yield by renting out their unused borrowing capacity to a trusted partner.

Risks are asymmetrical. The delegator bears the full default risk of the delegatee, as the protocol will liquidate the delegator's collateral to cover any bad debt. Therefore, credit delegation is not permissionless peer-to-peer lending but rather a trust-minimized extension of existing relationships. It is a foundational primitive for building decentralized credit markets, working capital loans, and complex structured products that require flexible credit arrangements beyond simple overcollateralization.

Credit delegation is a decentralized finance (DeFi) mechanism that enables a user with collateral to delegate their borrowing capacity to a trusted third party. The core innovation is the separation of the collateral provider (delegator) from the borrower (delegatee). The delegator deposits assets like stablecoins into a lending protocol, such as Aave, and receives a credit delegation token (e.g., aToken) representing their collateral. This token is then used to grant a credit line to a specific delegatee's address, allowing them to borrow funds up to a predetermined limit without posting their own collateral. This creates a form of trustless undercollateralized lending, as the delegator's locked assets secure the loan.

The process is governed by a credit delegation agreement, often implemented as a smart contract. This agreement defines the critical terms: the maximum loan amount, interest rate split between parties, and repayment conditions. The delegatee can draw funds from the delegated credit line, and the borrowed assets are transferred directly to their wallet. Crucially, the delegator's original collateral remains locked in the protocol, acting as a safety net. If the delegatee fails to repay, the protocol can liquidate the delegator's collateral to cover the bad debt. This mechanism shifts the credit risk from the protocol to the individual delegator, who must perform due diligence on their delegatee.

Key technical components enable this system. The credit delegation token is often a modified version of a protocol's deposit token, with added functionality to approve specific delegatees. Smart contracts manage the state of the credit line, tracking drawn amounts and available limits. Oracles and keepers monitor loan health, potentially triggering liquidation of the backing collateral if the delegatee's position becomes undercollateralized relative to the agreed terms. This architecture allows for complex financial relationships, such as a corporation providing a credit line to a subsidiary or a DAO funding a contributor's operational expenses, all executed transparently on-chain without traditional intermediaries.

The primary use cases for credit delegation include working capital loans for DAOs and crypto-native businesses, institutional leverage strategies, and supply chain financing. For example, a decentralized autonomous organization (DAO) with a treasury full of USDC could delegate credit to a development guild to pay for cloud services, avoiding the need to sell treasury assets. The risks are significant and include counterparty risk for the delegator and liquidation risk if the value of the backing collateral fluctuates. Success depends heavily on the delegator's ability to assess the delegatee's credibility and the robustness of the smart contract code governing the agreement.