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Taihe Observation丨A Brief History of Defi

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The price fluctuates around the value and the value is in everyone's heart. To quote a saying that people often say: Don't Trust, Verify

Original source: Ti Capital

"Trusted third parties are security holes", since Nick Szabo proposed smart contracts in the 1990s. For more than 20 years, however, based on the situation at the time, it has not been put into practice until the Ethereum white paper mentioned in 2013: Ethereum was designed as a (Bitcoin) replacement protocol to cater to the many decentralizations that were born during the rapid development period. Its built-in Turing-complete programming language allows anyone to write smart contracts and decentralized applications. The Ethereum protocol realizes applications far beyond currency functions, and the concept of DeFi, which has been flourishing in the past two years, has also begun to take shape at this time.

This article will describe a DeFi from scratch based on the above timeline Some history:

1.2017-2018 many old projects emerged

; 1.1 2017.12 MakerDao launched - Defi's own stable currency

1.2 2018.9 Compound launched - the former king

; 1.3 2018.11 UniSwap launched - a powerful tool for AMM to subvert the trading model

1.4 2018.11 Synthetix launched - a bridge linking the traditional world

2.2019-2020 A Hundred Flowers of New Ways to Play

2.1 2019.1 WBTC Launched—BTC Opens the Door

2.2 2019.7 Chainlink launched - a bridge connecting real data

2.3 2020.1 AAVE launched - the flash loan is not over Not started

2.4 2020.312——systematic "stress test"

2.5 2020.6 Liquidity mining—— Unsustainable hot spots

3. Looking forward to the future of Defi

3.1 Liquidity staking— —Release the liquidity of pledged assets

3.2 Derivatives—maybe the next tipping point

3.3 New species ——On-chain processing methods that meet actual needs

4. Conclusion

1. In 2017-2018, many old-fashioned projects emerged

The DeFi ecology is also known as decentralized finance. Although the scale of traditional finance is small, all directions of traditional finance have been gradually mapped to DeFi to form a blockchain financial Lego. It has been five years since the concept of DeFi first took shape in 2013 to when DharmaLabs founder Brendan Forster first proposed the concept of decentralized finance or open finance Decentralized Finance in 2018. This period is also the embryonic stage of the entire blockchain ecosystem.

1.1 2017.12 MakerDao launched - Defi's own stable currency

In November 2014, the stable currency USDT issued by the centralized entity Tether was launched, and users can exchange 1:1 for US dollars. "The 100% credit endorsement and the "completely transparent" approach make it the anchor currency of the most mainstream exchanges, but Tether has not published an audit report since 2018.

Then the first DeFi project, MakerDao, was launched on the mainnet in December 2017, and its stable currency is of great significance. In addition to the function of the centralized stable currency, the decentralized stable currency Dai also has the following characteristics:

Resistant to hyperinflation: Argentina's inflation rate is as high as 37.2%. The dollar-pegged nature of the stablecoin Dai has made it a tool for many Argentines to store their wealth.

Alternative financial channel: Based on the decentralized characteristics of DeFi, users do not even need to hold a bank account to complete functions such as transfer, transaction and even payment .

In addition, Dai also has features such as no censorship, a 7*24-hour market, and tax avoidance. In other words, Dai can do what USDT can do, but USDT can’t do what Dai can do. Decentralization, public auditing, complete transparency, and checkability on the chain are all things that USDT can do. At present, Dai is not only the pricing currency on many exchanges, but also the stable payment method used by default on many Dapps. Maker, as the first project in the entire ecology, issued stable coins to lay the foundation for the future of the entire Defi ecology. It does not need to rely on bank accounts, credit ratings, or even USDT. Our Defi has its own stable currency, which is The reason why Dai has always ranked first in Defi TVL.

The opacity of USDT can provide better liquidity in many cases:

The current circulation of USDT and Dai is shown in the figure below, and the circulation of Dai and USDT also has a gap of a hundred times. So why can USDT still be "too big to fail" despite many problems? Swedish economist Bengt Holmstrom (Bengt) made a comparison in his paper "Understanding the role of debt in the financial system": "The stock market (token Market) is to provide risk sharing, while the currency market (stablecoin market) is to provide liquidity. The important point is that currency markets are inherently opaque, and opacity can in many cases provide better liquidity. 』For example, the blockchain’s features such as on-chain checkability and quasi-anonymity expose every step of the operation of the address on the chain to all players in it to a certain extent, which can be said to increase potential risks. Opacity is like the existence of a black box. Knowing nothing about the existence of a black box guarantees security to a certain extent. Tether has not released an audit report for several years, and this move seems to be one of the reasons why it is still going strong. Maker, known as a decentralized central bank, relies on the development of DeFi to a certain extent, but the future of DeFi may not be so dependent on Dai.

1.2 2018.9 Compound launched - Once King

In September 2018, Compound, known as a decentralized commercial bank, was launched. At first glance, users will know its name This lending platform is compound interest rather than simple interest, but what users don’t know is that it completes one interest calculation in one block time of Ethereum, which is about 13 seconds. I believe that the issue that users are most concerned about is the interest rate of the bank. Compared with the traditional deposit interest rate, there is a large difference between countries, as shown in the figure below, while the deposit interest rate on Compound is significantly higher than the deposit interest rate of countries in the traditional field.

Due to the popularity of Compound, we can temporarily conclude that a qualified DeFi project needs to have the following qualities:

No access permission Permissionless

Is there Counter-Party Risk

Is the fund trusted by a trusted third party Trusted Third Party

By applying the above points to Compound, it can be used by anyone without (Know Your Customer) KYC. Compared to 1.7 billion people without bank accounts, this may be a very big problem. Good choice. Secondly, Compound has no counterparty risk. The counterparty of the user's transaction is a smart contract. Since the smart contract is open and transparent on the chain, every step of the operation can be checked. In the end, user funds are on the chain rather than in the hands of the project party, so they are relatively more credible. Although it has only been 3 years since 2018, in that emerging era, Compound’s status as the first commercial bank was enough to attract well-known investment institutions such as Coinbase, and this is also the case. Compound has been firmly seated as the leading lending platform until this year Aave Comparing it online, you will feel that Compound is actually completely crushed.

1.3 2018.11 UniSwap launched - AMM's weapon to subvert the trading model

Exchanges in the traditional market act as the medium for investors, and financial products in the secondary market such as stocks, futures, and options have always been the underlying assets of investment. In view of the tamping of the underlying technology of the blockchain and the improvement of Ethereum, the entire ecology is in a preliminary state of rapid development, and the digital currency exchange assumes the role of releasing investors' enthusiasm.

A Defi trading system that does not require an oracle

In November 2018, UniSwap was launched. In Q3 of 2020, UniSwap has already surpassed other DEXs to become the leader of the track. Abandoning the order book model, there is no problem of difficulty in matching buy and sell orders due to insufficient liquidity, and there is no deep problem that limited price orders have not been traded. AMM brings together liquidity and realizes market making based on algorithms. According to its CFMM formula, even pricing is not at all. An oracle is required. The counterparty of the user is the fund pool, and the user’s money is 100% safe on the chain, so there is no need to worry about problems such as running away from the exchange. This is a problem that centralized exchanges will never be able to solve.

Extremely simple virtual monopoly

UniSwap still provides an open and transparent platform that does not require an issuance license to meet the trading needs of the long-tail market. It does not require matching order books and has no threshold for listing coins. Increased transaction breadth. Uniswap can be regarded as the first person to eat crabs in Defi, thus forming a virtual monopoly, and there is a positive cycle in which a single company has always been dominant if there is liquidity. In other words, once these liquidity goes elsewhere, it will be the time of Uniswap's decline. This sentence is obviously nonsense, but why should I say it? Because the problems of Ethereum are well known, and it is this problem that makes Uni stand out. Uni is extremely simple and has a low surface area for hacking, so low gas fees are extremely important.

The uncertainty of UniSwap is the certainty of Sushiswap

With the expiration of UniSwap mining and the uncertainty of the community voting to restart mining, a large amount of funds have poured in According to reports, Sushiswap rose by 30 points on November 15. The reason: the uncertainty of UniSwap is the certainty of Sushiswap. Sushi also increased the rewards of USDT/ETH, WBTC/ETH and other pools accordingly to attract UniSwap's recent outflow of funds. It is obvious that according to Defi Pulse statistics, the daily change of UniSwap’s total locked-up TVL is -43.99%, and the corresponding daily change of SushiSwapTVL is +69.14%, but the DeFi TVL has not decreased significantly. It is inferred that funds have not flowed out of the DeFi ecosystem significantly (as of 11.25) .

1.4 2018.11 Synthetix launched - a bridge linking the traditional world

With the improvement of the entire DeFi ecosystem, from stablecoins to lending platforms to DEX, users can almost see another traditional financial world, but in this world, there is a lack of traditional financial fields such as stocks , bulk commodities and other derivatives investment targets. If users want to participate in investment in traditional fields, they must return to traditional exchanges and there are restrictions such as regional supervision. With the launch of Synthetix, it is almost a channel to open up traditional financial assets. Similarly, the entire project is decentralized without barriers to entry.

Adding Portfolio Diversity

As For top derivatives projects, its synthetic assets can be simply understood as a "parallel world" of real assets, moving real investment targets to the chain. The diversification of available portfolios is unquestionable. Users can hold iBTC to hedge the risk of BTC decline while retaining their BTC positions. Similarly, users can also hold Apple stock to increase the diversity of cryptocurrency portfolios , based on the low correlation between cryptocurrency and many investment targets in the traditional market, as shown in the figure below, and the low correlation of each asset in the portfolio will ensure the effectiveness of the portfolio. It is of great significance to reduce the correlation and diversify risks.

2.2019-2020 new ways to play let a hundred flowers bloom

In fact, it is not difficult to see that 2017-2018 is the period when various projects drive the ecology, and traditional finance is mapped to the blockchain, accompanied by Establish a complete bottom layer for projects such as lending, exchanges, derivatives, stable coins and anchor coins. 2019-2020 is the period when innovative applications help the ecological development. It is the period when imitation disk challengers are born. Such as lightning attack, liquidity mining, and liquidity attack are all new methods derived from the previous basis. These new methods The traditional world never existed, nor could it exist.

2.1 2019.1 WBTC is online - BTC opens the door

Now it seems that DeFi is one of the hottest ecosystems. Since the end of 2017, DApps have shown a blowout growth as shown in the figure below, among which high-quality projects emerge in an endless stream. But most of the current DeFi projects are built on Ethereum. The reason can be found as early as 2013 when the Ethereum white paper came out. In January 2019, WBTC was launched. WBTC is the first Ethereum to anchor BTC , the exchange ratio is 1:1 ERC-20 pass. Bitcoin has always been the cryptocurrency with the highest market value and the highest circulation. However, since the Bitcoin and Ethereum networks are not in circulation, the purpose of the birth of WBTC is to bring BTC liquidity to the Ethereum ecosystem.

2.2 2019.7 Chainlink launched - a bridge connecting real data

At that time, the smart contract could only retrieve the data on the chain, and the growth of scale was naturally accompanied by a reality world interaction needs. Interaction means connecting with the real world. In July 2019, the first project of the oracle track was launched on the Ethereum mainnet Chainlink.

As the current Defi project with the largest market value, Chainlink is not only a partner of many traditional companies such as Google and Oracle, but also an oracle machine for most Defi projects such as Aave , Synthetix, Yearn Finance. Presumably many people know that 90 million assets of Compound were liquidated on November 26. Since it has no oracle machine, it anchors the price of Coinbase and OKEx. On the other hand, because Aave uses the Chainlink oracle machine, its liquidation assets decreased on a large scale under extreme market conditions.

Challenger Nest directly forms data on the chain

The quotation of miners’ real gold and silver forms the off-chain facts directly on the chain. Since the quotation scale of the miners’ chain game is an integer multiple of the transaction scale, the cost of doing evil has increased exponentially, and the incentive mechanism rewards high-quality data The provider ensures the reliability of the data and the stability of the system to form a perfect closed loop. Just as V God emphasized that the oracle should focus on obtaining real data, Nest's quotation model caters to this very well.

2.3 2020.1 AAVE is online - the flash loan has not ended, it has not begun

In the blink of an eye, in 2020, the DeFi ecology has begun to take shape, the track projects are emerging one after another, and the competition in the industry is intensifying. Many challengers are trying to carve up market share. For example, Aave, formerly known as EthLend, was launched in January 2020. As a challenger on the lending track, many people will compare Maker, Compound and Aave. I personally think that Maker can be classified as a lending track, but it is not suitable for comparison with other lending projects. Its role as a stable currency is beyond deposits and loans, although Dai is essentially an over-collateralized loan.

The code says: no end is equal to never beginning

The revolutionary financial instrument of flash loan originated from Aave, and it is called a financial instrument because it is related to future Derivatives such as options are not a complete set of profit strategies. It never ends, it never starts: users only need to complete the repayment and interest within about 13 seconds of an Ethereum block time, and it will be considered a successful flash loan. If the code logic is incomplete or cannot be returned on schedule, the flash loan will be never started. The flash loan launched by Aave can be said to subvert the traditional cognition. Logically speaking, there will be results only after the beginning, but the end of the flash loan can only see the beginning. Defi has mapped from the passive traditional financial industry one by one to relying on the advantages of the blockchain to innovate something that is not and impossible in the traditional field, which is interesting.

The law of the jungle is cruel but also the normal state of ecological development

I have to mention the two thresholds of flash loans for ordinary users:

Users need to understand programming and use Solidity to operate

The key to a successful flash loan is to find feasible arbitrage opportunities

As shown below The core of the success of the whole process attack is that bZx's smart contract error allows the under-collateralized state to exist. In addition, most of the current applications of flash loans are used for arbitrage. Arbitrage opportunities can be large or small almost everywhere. Flash loans are used as arbitrage tools to smooth price differences, which may be a big step in promoting the positive development of the ecology. Even though lightning attacks occur frequently, the tool itself is not wrong, but it can just eliminate those agreements with loopholes in smart contracts for the entire ecology. The law of the jungle is cruel but it is also the norm of ecological development.

Looking at Aave today, it can almost be said that he is a relatively successful challenger , no matter its stable lending interest rate allows users to have multiple choices, or it is an innovative financial tool such as flash loan that cannot be replicated by traditional finance. As a lending platform, interest rates are obviously the most concerned issue for users, and the deposit and loan interest rates of most currencies provided by Aave are better than those of Compound. The Aave protocol provides more functions than Compound, and the more complex things are more likely to go wrong, this is probably the only thing that can defend Compound.

2.4 2020.312——systematic "stress test"

Since the 2008 financial crisis, the Federal Reserve has continued to implement quantitative easing policies, and such policies will cause the yield curve to shift to the right, which means that investors need to take more risks with the same return, and the market has become extreme During the market, investors will turn to hedging and safe-haven assets, causing liquidity to dry up. In the week of March 12, affected by the epidemic, U.S. stocks triggered circuit breakers twice, the Federal Reserve cut interest rates and the Bank of England cut interest rates, and global economic panic spread to the entire market.

ETH, the second largest in market capitalization, plummeted 40% overnight. The selling pressure of Ethereum caused Maker leveraged mortgages to generate stablecoins into a death spiral, and the redemption of ETH further caused liquidity Sexual exhaustion, large-scale liquidation of mortgage debt warehouses led to a series of operations of Maker, including debt auctions, and the reduction of the Dai deposit rate (DSR) to 0%. I believe that any extreme market will expose the shortcomings of the system and trigger thinking to make corresponding adjustments. Although the Defi ecosystem is still in its early stages, it seems that the performance after the "stress test" is not bad. In just 3 months, BTC And ETH has recovered to the level before the plunge. Bitcoin is an investment-grade target, digital gold, and a safe-haven asset, but the extreme market conditions in the global market triggered by the epidemic obviously did not play its safe-haven nature. The figure below shows the performance of gold in previous events, and against gold, with the gradual increase in the acceptance of digital assets, Bitcoin obviously still has a long way to go.

2.5 2020.6 Liquidity Mining——a hot spot that is difficult to sustain

In June 2020, Compound launched liquidity mining, which ignited the entire Defi economy. The two steps of staking and liquidation can be said to bring qualitative changes to Compound, as shown in the figure below.

A dying project suddenly experienced explosive growth in lending in June, Compound is not the first project to launch liquidity mining, but the reason why it can bring about fission is that users discovered the BAT arbitrage model at that time, and the Compound token distribution reward is set to the number of COMP tokens received by each market. The accrued interest in the market is directly proportional, that is, the higher the interest paid, the more COMP you get. At that time, the deposit and loan interest rate of BAT on Compound was as high as 23.77% & 31.88%. Compared with BAT’s listing on Compound on May 23-June 18, the deposit and loan interest rate of BAT has been only 0.06% & 2.75% about.

Distort the real interest rate and squeeze the original loyal users

There is no real value support

The value is long-term, but mining Not for long

Liquidity mining is just a way, and it is also one of the tools chosen by major projects during their start-up or development period. The key lies in whether the project itself has the value of retaining users after mining. In other words, the super high interest rate of BAT at that time may drive out the users of the original platform in exchange for many speculators, and the rate of return increases with speculators. After the influx is diluted, people can completely switch to other mining pools. Speculators attracted by destroying the ecological balance and distorting the real interest rate of the market are unsustainable. Each lending project has a synonym: Maker—stable currency, Aave—flash loan, Compound—mining, except liquidity mining Besides, Compound seems to be lackluster. In other words, anyone can do mining, and projects without real real value support are destined to not go far.

3. Looking forward to the future of Defi

3.1 Liquidity staking - releasing the liquidity of pledged assets

The current Defi is a guarantee platform Security, all adopt the over-collateralization mechanism, that is, deposit 150% of the assets as a margin before lending out 100% of the assets. The pledged assets have begun to take shape as the Defi lock-up volume has reached the 10 billion mark, but the pledged assets will be lost. Liquidity in turn loses value, although over-collateralizers lend assets for specific purposes such as mining. For PoS issues, Kira aims to release liquidity for pledged assets, Kira supports all tokens, and each node has equal voting rights.

Derivatives staking to regain liquidity

DEX that supports any token

The lock-up period and payback period for different purposes of different projects are as long as tens of days, and some as long as several months. Liquidity staking, a traditional market that has never had a concept, has a promising prospect. Although the current DEX is more transparent and simpler than centralized exchanges, DEX can only provide ERC20 Token transactions, which greatly limits the breadth of transactions. Kira's derivatives trading system supports all tokens, and on-chain transactions greatly improve the liquidity and utilization of assets.

3.2 Derivatives—maybe the next tipping point

The preconceived concept of this industry is very strong. The derivatives track is small in scale but growing fast. It is an important track in Defi but has not seen significant growth. At present, derivatives transactions in the cryptocurrency industry are mainly concentrated in mainstream currencies such as BTC and ETH, while thousands of other currencies have derivatives transactions such as option futures contracts, but problems such as lack of liquidity due to difficulty in matching buy and sell orders still exist Just stay at the stage of existence.

Friendly interface

Setting of time limit, price and other parameters

Whether market liquidity is sufficient and matching efficiency

At present, there are some derivatives market projects in the market, covering such as futures and options swaps, underlying assets such as interest rate foreign exchange, etc. There are many bottlenecks in these projects. Can Defi use the blockchain to gather option sellers into the fund pool to smooth potential losses? Secondly, the primary consideration for any exchange is whether the trading depth and sufficient liquidity can be provided to the options trading platform, how to price it, whether oracle machines are needed, and how to prevent oracle machine attacks. Whether the trillion-dollar market in the traditional world can shine in the way of Defi is worth looking forward to.

3.3 New Species—On-chain processing methods that meet actual needs

I believe that many investors can see the rapid development of DeFi in the past two years, and it can also be seen that most projects are based on the pain points of the industry, the needs of users and the whims of developers Brilliant idea to build. The underlying laying has gradually been completed. It is conceivable that the future development of Defi may be a new way of playing in any aspect, but there must be sufficient market demand and enthusiasm. Solving blockchain problems in the form of blockchain is bound to be the future development direction of Defi. .

4. Conclusion

Looking at the development of the Defi ecosystem in recent years, truly valuable projects have emerged one after another. It can also be seen that Defi is not a hype like the ICO in 2017 but a long-term return of value. On this composable Lego building block, people can assemble what the market needs according to the pain points, and meet people's needs for financial services without relying on third parties and without permission. Ecological expansion accompanied by more eyes also means issues such as regulation, compliance, and anti-money laundering. With the recent skyrocketing of BTC, Uniswap and Aave, as the leaders of their respective tracks, are Defi’s oversold rebound or a reflection of value, and whether 312 is coming again is worth pondering.

The price fluctuates around the value and the value is in everyone's heart. 't Trust, Verify'.

Quoting

1.2020 DeFi Industry Research Report Part1. (November 2020). Search source: TokenInsight: https:// image.tokeninsight.com/levelPdf/TI-2020_DeFi Industry Research Report Part1.pdf

2.CapitalHillChain.(October 2020). Retrieved from: ChainNews: https://www.chainnews. com/articles/050191411445.htm

3.EthereumGroup.(2013).ethereum whitepaper. Retrieved from: https://ethereum.org/en/whitepaper/: https://ethereum .org/en/whitepaper/

Gains in Financial Inclusion, Gains for a Sustainable World. (May 18, 2018). Retrieved from: The World Bank: https://www .worldbank.org/en/news/immersive-story/2018/05/18/gains-in-financial-inclusion-gains-for-a-sustainable-world?cid=ECR_TT_worldbank_EN_EXT

4. tradingeconomics .(2020). Retrieved from: tradingeconomics: https://tradingeconomics.com/

5. Pan Chao. (May 2018). Dry goods| About USDT and stable currency, big Most people are wrong. Search source: Encryption Economic Research Institute: https://mp.weixin.qq.com/s?__biz=MzU3MDQ1NDU1Nw==&mid=2247483762&idx=1&sn=9ddaa95a837db1cbc21e0156903ebf98&chksm=fcee6600cb9 9ef1678d2d85e16c196d19a14a02e718a88c61856c4f71a52dd25c916c2d33dad& ;scene=21#wechat_redirect