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A guide for traditional finance users. No blockchain experience required.

What Is Web3 Lending?

Traditional lending uses debt: you borrow dollars against your house as collateral. If the house value drops too far, the bank liquidates — sells your house to cover the loan. You lose the house, often at a bad price.

Web3 lending brings this online: you deposit crypto assets as collateral into a smart contract, and it issues you tokens representing your deposit. The difference is that Web3 lending has historically used the same debt-and-liquidation model — just faster and more automated. When collateral values drop, liquidators compete to seize it, sometimes causing cascading failures and bad prices.

The Medici Protocol is different. It replaces debt with options — no liquidations, no cliff-shaped failures, no real-time oracle dependency.

How RWAs Enable Crypto Lending

Real-World Assets (RWAs) are traditional financial assets — currencies, commodities, equities, bonds — represented as tokens on a blockchain. Tokenizing RWAs makes them programmable: they can move 24/7, settle atomically with other tokens, and be used as collateral in smart contracts.

In the Medici Protocol:

• ETH is the base collateral (a native crypto asset)
• USDC is the quote asset (a tokenized RWA — US dollars on chain)
• P tokens track the index (BTC/USDC) — they are the synthetic RWA
• N tokens are the speculative leg — options on the same collateral

Physical settlement on Canton eliminates the oracle entirely for on-chain pairs like WBTC/USDCC. When both assets exist on the same ledger, the N holder exercises by paying strike in the quote asset and receiving the base asset — an atomic swap with no price lookup.

Options Instead of Debt

This is the core insight of the Medici Protocol. Traditional synthetic assets (like DAI or USDe) are debt-based:

    Deposit $150 ETH → Borrow $100 stablecoin → Must maintain 150% ratio
    If ETH drops → ratio breached → Liquidation → You lose ETH at auction price

The Medici Protocol is option-based:

    Deposit 1 ETH → Split into P (Protected) + N (Speculative)
    P = Bond minus Put     — tracks index, collects theta (option seller)
    N = Call option        — leveraged upside, pays theta (option buyer)
    P + N = 1 ALWAYS       — mathematically proven, no shortfall possible

Payoff at Maturity

With oracle price x and strike S:

P + N always sums to the collateral. No shortfall, no liquidation, no real-time oracle needed. At 50% strike with 30-day maturity, the embedded option costs ~0.1 bps/year — effectively zero. The real cost is execution slippage on rolls.

Why This Matters

What Is a Smart Contract?

A smart contract is a program that runs on a blockchain. Once deployed, its rules execute automatically and cannot be changed unilaterally. Think of it as a vending machine: you put in the right inputs, you get the right outputs, and nobody can tamper with the mechanism.

The Medici Protocol uses DAML (Digital Asset Modeling Language) smart contracts running on the Canton Network. DAML is designed for financial contracts — it enforces rights and obligations, models multi-party workflows, and provides mathematical proof of correctness.

Key properties of DAML smart contracts in Medici:

• Pure verification: invariants like P + N = 1 are mathematically proven, not runtime checks
• Causality: settlement depends on oracle observation, which depends on maturity — the model enforces proper ordering
• Privacy: only parties to a contract can see its details (Canton sub-transaction privacy)
• No mempool: Canton has no public mempool, so there is no front-running, no sandwich attacks, and no MEV (Miner Extractable Value)

Custodial vs Non-Custodial

In cryptocurrency, "custody" refers to who holds the private keys that control assets.

Custodial

Like a traditional bank. The service holds your keys, executes transactions on your behalf, and you authenticate with a username/password or API token. The Medici Ledger Service supports custodial operation — the service submits Canton commands as the user's party.

Pros: simpler UX, no key management, easier recovery
Cons: trust required, counterparty risk

Non-Custodial (Path C)

You hold your own keys in a wallet (like a CIP-103 wallet). The Ledger Service prepares transactions and sends the hash to your wallet for signing. The service never sees your private key. Your signature authorizes on-chain actions.

Pros: full control, no counterparty risk, the service cannot move your funds
Cons: you are responsible for key security, recovery phrases, signing every action

The Medici Protocol supports both paths. The custodial path is the default for simplicity; the non-custodial Path C activates when a CIP-103 wallet is detected.

The Canton Difference

Canton is not a typical blockchain. It was built by Digital Asset for institutional finance, and it makes different design choices than public chains like Ethereum:

How the Protocol Works — Step by Step

A user wanting USD-stable exposure backed by ETH:

1. Split: Deposit ETH as collateral. The protocol issues P (Protected) and N (Speculative) tokens. P tracks the BTC/USDC index; N provides leveraged exposure.
2. Hold P: You are now an option seller. Theta accrues to you over time. Your position drifts slowly — at 50% strike with 30-day maturity, the embedded put costs ~0.1 bps/year.
3. Sell N: Sell the N token to speculators on the swap marketplace. They get ~2x leverage with no liquidation risk and no funding rate.
4. Monitor: Track your vault's delta (deviation from the index). If ETH price approaches 1.5x your strike, consider a roll.
5. Roll (optional): Before maturity, swap your P tokens for new ones with updated parameters (strike, maturity). Execution quality matters — 10 bps slippage per roll = ~1.2%/year drift.
6. Settle: At maturity, the oracle publishes a price (or use physical settlement for on-chain pairs). P and N holders claim their share of the vault.

Glossary