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Element: a Placeholder in the next generation of DeFi agreement | project is introduced

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Nothing, it seems, is impossible in DEFI, a large experimental facility for open finance.

Liquidity and capital utilisation have been two of the biggest concerns in the financial world. In traditional markets, the liquidity of many assets has been greatly reduced due to the limitations of infrastructure, technology, laws and regulations, and investors have also suffered a fearless loss of negative liquidity premium. And capital utilization is also affected by these factors. This is where the advantage of DEFI comes into play. In a permission-free environment, one can assign a medium of value to any valuable unit, fragmenting the whole value that would otherwise be difficult to break down. Nothing, it seems, is impossible in DEFI, a large experimental facility for open finance.

Element is part of this financial innovation drama, backed by a number of top institutions including A16Z, Placeholder, and Scalar Capital. So, let's take a look at how Placeholder interprets this new cryptofinancial protocol.

Rhythm Blockbeats has translated the original:

One of the most important fundamental primitives in financial markets is "yield", which, unlike capital gains, is another form of investment profit. But capital gains come from changes in the price of an asset and are realised only when the asset is sold, while yield is the cash flow generated by the asset and paid out to its holders. Although they are independent patterns, yields determine asset prices and vice versa. Element is a protocol that allows developers and investors to take advantage of profitability in applications and strategies.

For example, you could make a capital gain by selling your stock at a higher price, or the company could distribute you excess profits in the form of dividends. You can then value the stock based on its cash flow, which is common in securities analysis. Similarly, the interest rate a borrower pays on a loan contract is the yield earned by the lender, while the market price of that contract is a function of its expected yield. The yield is calculated as a percentage: that is, the total cash flow divided by the corresponding investment (for example, 5% on a $100,000 investment that generates $5,000 in cash flow per year).

Yields are also the way most DEFI agreements reward active participants. Decentalized trading platforms such as 0x, Uniswap and Balancer, for example, compensate users who participate in market-making and liquidity provision in these agreements with a portion of their trading fee income. In the credit market, borrowers like AVE and Compound pay interest rates to lenders, and "smart advisers" like Yearn use different strategies to maximize yields. You can also pledge money to POS networks such as ETH2 or Decred.

When you pledge in most DEFI protocols, you get a second token that redeems your original token, along with the proceeds generated at the time of the pledge. In Aave, these tokens are called a-tokens, in Compound they are called c-tokens, and in most amms they are called LP tokens. But all of these tokens have capital efficiency problems. First, yields are usually market-based, and therefore constantly changing, and often volatile, so you cannot be sure of their ultimate value until you redeem them. Second, during the period of your pledge, your asset is locked up, and while it's still your asset, you use it somewhere else during the period of the pledge.

For example, if you pledge 10,000 USDCs at AVE, the current annual return (at the time of writing) is about 8.92% -- but you can't know what the return will be in three or six months 'time. When your principal ($10,000 USDC deposit) is pledged, you can't use it, which means you can't use it elsewhere.

Element solves both of these problems by building on various mining protocols. It works by separating principal and interest into two separate, tradable tokens: principal token and interest token. At the end of a fixed period (say 3 or 6 months), each of your principal tokens will be convertible into a percentage of the initial funds, while your interest tokens will be convertible into interest income generated during the same period.

For example, if you use the AVE strategy with the same 10,000 USDCs through Element during the 12-month cycle, you will receive 10,000 principal tokens convertible for 10,000 USDCs and 10,000 interest tokens convertible for interest. If the average interest rate is 10%, then the final value of the interest token is approximately 1,000 USDC (or 0.1 USDC per interest token).

This gameplay is very powerful. Once you've separated the yield from the principal, here are some things you can do:

First, your principal and interest are now liquid. Using the example we just had, your 10,000 USDC is still pledged to AVE for one year, but you now have an equivalent principal token that you can sell at a discount (due to the pledge lock). There may be someone in the market who will be willing to buy your USD10,000 principal token for USD9,400 for a fixed rate of 6%. This can solve the problem of yield uncertainty.

Principal tokens trade at a discount in the market like zero coupon bonds, opening up a whole new asset class to the DEFI market. Many investors will be very interested in fixed income products, which creates a lot of demand for principal tokens, and users who sell principal tokens can get most of the principal funds. These are naturally appreciating assets that offer exposure to stable interest rates and can be used as an alternative to the mortgage lending market. If you are long the underlying asset (the pledged asset), buying the asset from the market at a discount can further improve your expected return.

A liquid interest token would also give users a lot of flexibility. You can sell your principal token and keep your interest token, or you can sell your interest token and keep your principal token to advance tomorrow's interest income. Or you can sell both! New market and compound return strategies will surely emerge (for example, you can repledge your principal to earn leverage interest).

Element also makes it easier to switch strategies. For example, if you want to transfer your 10,000 USDC deposit from AAVE to Curve, instead of first unlocking it from AVE and then pledging it on Curve, you can directly convert your principal or interest tokens from one strategy token to another through a decentralized exchange platform. This saves time and money.

What's most interesting to me is how the market will change with these DeFi primitives. Just as every investor in the world pays attention to the national bond market and interest rates, DEFI investors can also gather valuable market information from changes in principal tokens and interest tokens. The higher or lower principal token solidates provide some information, as do interest tokens at different prices.

The discount rate of the principal token may indicate that the investor expects a higher risk-adjusted return in the market, but it may also indicate that there is a high principal risk (for example, contract risk or liquidation risk) under the strategy. In a lending agreement such as AVE or Compound, the rising price of USDC deposit interest tokens may indicate the market's expectation of rising interest rates, while the falling price of LP interest tokens in a decentralized trading platform may indicate the expectation of declining transaction volume in the future, i.e. lower fee income.

In principle, improving capital utilisation is the key to allowing the DEFI market to grow exponentially as it attracts more capital into the market. Today, we've only discussed the shallow possibilities of Element. We are excited to see these ideas come to fruition and look forward to this agreement as a catalyst for many more possibilities.