DeFi and the cryptographic world of economic crisis
Text title: DeFi and the economic crisis in the encrypted world
Blue fox notes
DeFi opens the way to open finance, and its permission-free composability demonstrates a completely different nature from traditional finance, making it a rare bright spot on the blockchain over the past year, holding the promise of the cryptographic world. DeFi isn't perfect, though. It also has weaknesses that, if mishandled, could trigger economic crises in the encrypted world.
DeFi is very early on, and in addition to potential vulnerability risks, there are risks such as governance attacks. At the same time, as more and more protocols emerge, composability creates potential systemic risks. This systemic risk could test the weak DeFi.
There is a possibility of price manipulation in DeFi
During the Christmas holiday, westerners are immersed in the joy of the festival. And for some, it's a good time to price. One DeFi user has profited from Uniswap and Synthetix pricing multiple times. The basic formula is to first buy a long MKR on Synthetix and then buy a roughly equal amount of MKR, about 12 or 15 MKRS, on Uniswap in 10-12 passes, driving up the price by buying and taking advantage of its long MKR position. The show is not over yet. The user then buys MKR shorts on Synthetix and sells the MKR he bought before on Uniswap, knocking the price down and profiting from Synthetix's MKR shorts.
Carefully prepared
This user was previously primarily a Maker user, using Maker to generate Dai, etc. But 10 days ago, the user suddenly started paying attention to the Synthetix platform, familiarizing himself with its mechanics by using it heavily before launching an attack.
Before committing a large amount of money, he discreetly did some testing with a small amount of money (mainly 0.1mkr per transaction), at least ten times over, and judging by his trading time, the user spent more than a day testing without interruption before launching a formal operation.
After finish repeat test, the user opened big money for operation, the user first buy 370.78 synthetic sMKR assets, then in MKR Uniswap buy 11.9 or so every time, buying 11 times in a row, took a total of about 132 MKR (worth more than $60000) at the time, and then sell 370.78 sMKR, buy 263.9 iMKR; Then he sold 12 MKRS at Uniswap for 10 times, 120 MKRS, followed by 263.9 imkrs. From then until five days ago a total of nine operations were initiated, with the next few MKRS raised from 12 to 15, while long and short positions were also increased, with sMKR up to 723 and iMKR up to 505. The whole operation process is very compact, without any delay.
After all the back-and-forth, the MKR price volatility still got the community's attention, with Synthetix founder Kain responding by suspending the price streams for iMKR and sMKR.
As can be seen from the above operations, price manipulation through Uniswap offers opportunities for arbitrage through Synthetix. DeFi's unpermissibility and interconnectedness bring benefits and innovation, as well as operational space. The operation was more of a mini-exercise, with no big shock and no big price collapse, but it was not good for MKR's assets per se. What happens if the magnitude of the attack increases?
Systemic risk and cryptographic economic crisis
When it comes to DeFi, people often talk about the concept of "currency lego." it does bring a lot of innovation and possibilities, but it also increases systemic risk.
Although DeFi's lending services often use excessive collateral to secure assets, with the development of DeFi, there has been a growing focus on improving the efficiency of assets, and low-mortgage solutions have been explored by more people (see the previous blue fox notes article, "DeFi's path to low-mortgage"). Dan Elitzer proposed "superfluid mortgage theory", its essence is the same assets can be used in multiple protocols at the same time, it will be the development trend of DeFi (refer to article blue fox notes before the DETH of etheric fang). So, this produces a problem, if the same assets have been used for many times, at the same time will have systemic risk? After all, we have experienced the subprime mortgage crisis in 2008.
This is already starting to happen. Attempts are being made to improve liquidity by scriscribing locked-up assets, while multiple collateral issues are being considered.
DAI, which earns DSR interest on MakerDAO, became the first concern. MakerDAO now allows users to deposit DAI into smart contracts and earn interest on the DSR. The DSR fee is derived from MakerDAO's stabilization fee, which is paid when the Dai generator closes its Vault.
Since Dai in DSR is storage locked, getting this part of the asset flowing is also of concern. For example, dAppHub can create Chai tokens, which are tokens of Dai that earn DSR interest and represent Dai and Dai accrued interest. That is, users can use Dai, which earns DSR interest, to generate Chai. Chai, on the other hand, can be circulated and used to earn more interest without being locked into the DSR.
The creation of Chai has generated interest from lending platforms such as Fulcrum. Fulcrum is an encrypted lending platform that has Dai's lending business and USES unused Dai to generate Chai. In other words, some of the Dai on its lending platform was loaned out, while the rest was replaced with Chai. That is to say, Dai of this part change to Chai also can gain profit. In this way, Dai's lending users on the lending platform can get more revenue. This example illustrates the innovative possibilities of DeFi composability for efficient use of assets.
Once a lending platform offers this service, other platforms are likely to follow, as users are driven by profit. Compound cDai tokens, for example, may also earn DSR proceeds in the future. If so, the cDai could earn both Dai's borrowing income from the Compound and some of Dai's unlent DSR income. CDai could also be used as collateral to borrow other assets in the future. So there's a second mortgage. CDai's value is supported by Dai and Dai's interest, while other assets are borrowed against cDai, meaning that the assets it generates are also exposed to cDai risk. There are layers of nested risk exposure, as we'll see later.
From the above, it can be seen that people can earn interest on lending Dai in the lending agreement, or they can earn more interest through other agreements (Chai and Maker), and obtain higher returns by providing liquidity for the locked assets through tokens. In summary, with the permission-free composability of DeFi, it is possible to maximize the return on the same asset under different agreements. That is, the superfluid mortgage theory.
Dai in DeFi can earn more revenue, which is also related to Maker's DSR revenue mechanism. The revenue of DSR is different from the interest charged by the lending platform from the lender. The revenue of DSR comes from the stabilization fee of MakerDAO, which can ensure the relatively stable revenue for users. That's the benefit, but at the same time, the benefit exposes the risk of the collateral itself, which is the risk of the benefit being exposed to the Maker system itself.
For future ETH2.0 liquidity of mortgage assets, there have been a lot of people are beginning to try to provide this part of asset liquidity, because this part of the assets mortgage on the etheric lane, some fear it with lending platforms such as at a disadvantage in competition, and thus lead to PoS chain security problem, while others think this kind of unnecessary worry. Because this part of the assets will have to be scribbled sooner or later, and achieve liquidity, there will not be the problem of insufficient mortgage power.
From the above, it can be seen that in DeFi, there is no need to license the combination, the convenience of asset token, the possibility of multiple mortgages, etc. All these bring infinite possibilities for innovation, but also lay the groundwork for the potential economic crisis in the encrypted world.
Currently DeFi mainly includes lending, DEX, derivatives, etc. At present, the DeFi mortgage assets are mainly ETH (with some ERC20 assets or stable currency supported by us dollars, etc.). Currently, the most basic projects in DeFi building are ethereum and MakerDAO. One is the underlying assets and protocol infrastructure of DeFi building, and one is the stable currency assets for DeFi building. These two are the cornerstones of stability for the entire encrypted DeFi world.
In this DeFi system, the asset supporting MakerDAO system is ETH, which generates Dai through excess mortgage. Although it is multi-mortgage Dai, ETH is still the main asset at present. That is, for now, Dai is essentially a derivative of ETH, a stable currency based on ETH. Thus, all dai-related products or services in DeFi world are inherently exposed to ETH's underlying risks.
If the ETH bottom is solid, all is well. And if ETH goes wrong, there's a cascade of effects. If ETH plummets sharply, causing Maker's Vault to be liquidated, or causing Dai to become unstable, for example at prices well below $1. This will spill over into Dai's various lending agreements and derivatives. Compound Dai loans, for example, can cause problems, as can assets created using cDai collateral. Chai mined on Fulcrum, for example, can also be problematic. In this case, there may be a rush to withdraw Dai from the lending platform and then exit as soon as possible. Similarly, Chai will be converted to Dai to exit. In margin contracts backed by Dai, traders' positions may also be liquidated.
In a composable system like DeFi, the more basic the component, the more widely used the component, the more the whole system will be implicated if something goes wrong. Since DeFi does not require a license, anyone can build a new product or service out of these legos, but if the derivatives are collateralized multiple times, it could lead to a financial crisis within the cryptography world.
conclusion
The non-licensing and composability of DeFi leads to more innovation and possibilities in open finance, which leads to increased asset utilization and greater financial freedom. However, everything has two sides. While DeFi thrives, there are also hidden risks. If its underlying assets are attacked, it could spread across DeFi world, causing a series of asset collapses that could trigger a financial crisis in the encrypted world.
The financial crisis in 2008 was caused by the subprime crisis, and the encryption world's multiple mortgages plus the feature of no license, which makes it hidden corresponding risks. How to avoid the financial crisis in the encryption world? This is a problem that DeFi must face on the way forward.
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