The Financial Structure of the Ethereum Ecosystem: How Does It Work?
Editor's Note: This article comes fromBlue Fox Notes (ID: lanhubiji)Editor's Note: This article comes from
Blue Fox Notes (ID: lanhubiji)
, the original title is "Ethereum: Digital Financial Stack", author: David Hoffman, translator: SIEN; Odaily reproduced with authorization.
overview
Preface: Despite the scalability problems of Ethereum, decentralized finance based on Ethereum has gradually grown. It provides a secure native currency, with ETH mortgage rate, stable currency DAI provided by MakerDAO, Compound lending, ETH and DAI-based applications, and a user interface that provides liquidity and transaction volume for the protocol, etc. The decentralized finance of Ethereum is composed of multiple stacks, which are built on each other, and finally form the market operation force inside the Ethereum economy, and initially form a network effect.
Ethereum is a platform that supports the construction of financial superstructures. User behavior in the financial superstructure creates a push-pull force that pushes and pulls the assets that run within it. The metrics found at each layer of the financial stack will illustrate the economics of Ethereum.
overview
Layer1——MakerDAO
Ethereum is a set of layers built on top of each other. Each layer provides the foundation and stability for the layer above to express itself effectively. Each layer also has its own metrics, which build and respond to market forces within the Ethereum economy.
Layer 0 - Ethereum
ETH Mortgage Rate
Stability Fee; DAI Savings Rate
Layer 2 - Loan + Borrowing
DAI volume - weighted average borrow/supply rate
Layer3 - application layer
ETH locked in DeFi
asset trading volume
The stability of each layer adds possibility to the layers above. This is why Ethereum development is so critical. Likewise, it also shows how important it is to get MakerDAO right, although not as important as building Ethereum.
If these two foundations of the Ethereum economy are sufficiently built, they will be able to support the construction of a vibrant ecosystem of financial applications that can be fully managed by code and interact with market participants.
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Layer 0: Global Bond Market
Metrics: ETH pledge rate
Ethereum 2.0 will support ETH staking. Users with 32 ETH can verify network transactions on their computers and earn income. The size of the reward depends on the size of the validator pool. (Blue Fox Note: According to the current design, according to the size of the mortgage pool, the annualized rate of return ranges from 1.56% to 18.1%, the smaller the pledge amount, the higher the return; the annual circulation ranges from 181,019 to 2,097,152 ETH; The inflation rate ranges from 0.17% to 1.56%. Considering the lending rate of ETH, it may be difficult for the annualized return of ETH to exceed 5%, and it may be around 3.3%. The probability of the pledge pool being 30 million ETH is higher. What will happen specifically, Let's see when ETH2.0 goes live.)
The PoS network is the beginning of a single digital bond market. With ETH as currency, individuals with capital can pledge and then obtain low-risk returns. Earnings are proportional to capital size and staking time. It is a stable investment strategy for those who want low-risk, low-maintenance exposure to the digital economy of ETH and Ethereum.
In the traditional bond market, you buy bonds and notes from the U.S. Treasury. Buyers typically receive a yield of 1-3% when bonds and notes are redeemed. However, these rates are variable, they trade freely in secondary markets as securities, and together generate the yield curve. In other words, when you buy bonds, you pledge your dollars in the US economic network, and you will receive a guaranteed return proportional to the size of your pledged assets and the maturity of the bond.
"I used to think, if there was a reincarnation, I wanted to be the president, the pope, or a 40-percent baseball player. But now, I just want to go back to the bond market. You can scare everybody."
The bond market controls everything. It is by far the largest market in global securities, with 18 trillion US dollars, and the bond market may be the most powerful guiding force for global capital.
Bond markets are powerful because they are the underlying layer of all markets. The cost of capital (or the interest rate on a bond) ultimately determines the value of stocks, real estate, or basically any asset class.
This is because the bond market and ETH staking rates are the bottom layer of their respective financial markets. They determine all market dynamics that exist upstream.
ETH2.0: rebuilding the bond market
In ETH2.0, the functions of the central government and its financial reserves are written into the protocol code. The fixed and predetermined pledge rate in ETH2.0 solves the problem of central authority printing money. Additionally, ETH staking rates incentivize capital inflows into the network and provide security to the blockchain.
In other words, the government issues bonds to grow the economy, and it supports the military that protects the government and the economy. In Ethereum, the blockchain issues rewards to those who stake to pay for the security of the digital economy.
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Layer 1: MakerDAO: Cornerstone
Metrics: DAI Savings Rate, Stability Fee
MakerDAO is where DAI is generated. In order for DAI to be generated, the generator of DAI, that is, the holder of the CDP, promises to pay a stability fee. The stability fee is the loan interest rate, and at the same time, it is also a tool for managing the price of DAI in the secondary market.
It also determines the cost of capital. The stabilization fee is a measure of projected return on the return that CDP holders can expect to receive in a given year on the debt they incur on their collateralized assets. If the stability fee is 20%, and CDP holders generate DAI, then they believe they can generate more than 20% of the income through these DAI. The stability fee represents the "pull" of the total market value of DAI (Blue Fox Note: The stability fee has a pull-down effect on the circulation of DAI). The higher the stability fee, the less DAI there will be in supply.
MakerDAO announced a DAI savings rate in 2018. The DSR is a tool that helps MakerDAO manage the price of DAI while also increasing its ability to grow its market cap. Before the introduction of DSR, all stability fees paid by CDP holders were used to burn MKR (or PETH). This is the risk management fee charged by MakerDAO. Not all assets are equally risky, and some assets have little risk (e.g. tokenized US treasury bonds).
The less risky an asset is, the more its stability fee will be geared towards DSR rather than burning MKR. The higher the DSR, the higher the supply of DAI, as those who lock up DAI in the DSR can earn more rewards.
Left: No risk, fee paid to DSR ||| Right: Risky, fee paid to MKR
DSR is the twin brother of ESR. (Blue Fox Note: ESR is the ETH pledge rate). DSR allows you to earn returns with no risk exposure, it is a currency of stable value and has a highly predictable return value. DSR lures DAI out of the gravitational pull of the secondary market as it allows permanent risk-free returns.
As long as DAI exists, there will be people paying stability fees. If someone pays the stability fee, then someone can capture the DAI paid to the DSR. More people pay the stability fee, and more people can capture the interest rate of DSR.
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Layer 2: Borrowing
Indicators: DAI Weighted Average Borrowing Rate (WABR) & Supply Rate (WASR)
DAI weighted average borrowing rate & supply rate originated from LIBOR, which is a financial tool to measure the average borrowing cost of borrowing from various banks.
Weighted Average Borrowing and Supply Rates
The DAI weighted average borrowing rate and weighted average supply rate use the average interest rate of all DAI lending/borrowing platforms. By weighting the average price and taking each platform's trading volume (Compound, DyDx), borrow rate, and supply rate to arrive at a number, it shows the rate at which DAI is supplied to the "market" or borrowed from. These two numbers will be useful metrics because money managers need data to support their decisions.
DAI market rate on June 29, 2019
Weighted average supply rate: 16.5%
(By lending DAI, the average annual rate of return is 16.5%)
(Borrowing DAI, paying an average of 19.5% annual interest)
(Blue Fox Note: At present, the borrowing rate and borrowing rate of DAI have both dropped. For example, Compound is about 12.9% and 8.1% recently.)
Since the current day price reflects the current day market conditions, these rates will change significantly in the future.
Layer 3: Application layer
Metric: ETH locked in DeFi
This is the high-level currency, the expression layer, and the middle layer of the algorithm.
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From: defipulse
The application layer of Ethereum is what makes Ethereum interesting.
What is the application layer of Ethereum?
The big innovation of Ethereum is the integration of "EVM" into the blockchain. A "virtual machine" is what programmers call a "computer". Ethereum's EVM is the way computation is handled natively on the Ethereum blockchain. In other words, the EVM allows Ethereum to run software and enable software to process digital assets (currency, property, tokens) on-chain. This is where the term "programmable money" comes from. Ethereum applications are basically computer software that programs the operation of a currency or other asset.
Ethereum Application Layer: "Internet of Value"
Programmable money is powerful. It's so powerful that ethereum researchers and developers are just scratching the surface of what it can be. Just like in the 1990s, when it was difficult to imagine the possibilities of the Internet, the Internet of Value is showing early signs of the same promise, with many possible applications and use cases. An important difference is that the Internet runs on data, while Ethereum runs on value.
Ethereum's first large-scale applications
MakerDAO: Digital Native Stablecoin, DAI
Compound: Digitally native automated asset lending
Kyber Network: An on-chain liquidity protocol that aggregates the liquidity of various parts of Ethereum
Uniswap: Digitally Native Automated Asset Swap
Augur: A Digitally Native Prediction Market
dYdX: Algorithmically Managed Derivatives Market
UMA (Universal Market Access) Agreement: Synthetic Asset Platform
0x: A Platform for Order Book-Based Exchanges
All of these apps represent some kind of financial primitive. Each adds key building blocks for growing financial applications. Many of these applications are also similar to traditional financial services of centralized companies. Tokens generated by the UMA protocol can track the value of other assets, such as stocks on the NYSE, thus giving global investors access to the stock market. dYdX is a platform to go long and short an asset, and it is an alternative to other margin trading platforms like TD Ameritrade or Robinhood. Augur is a platform for buying and selling probabilistic shares of future outcomes. Its products can theoretically be obtained in a centralized form, but are always subject to regulation. Uniswap is just an exchange, like NYSE, but it is managed by algorithms and can match buyers and sellers of any asset. Similarly, Compound supports people who pledge assets to borrow assets and just pay the lender.
The following is an illustration of transactions between various protocols:
This graph demonstrates the maturity of some crypto enthusiasts' early visions: the Internet of Money. The current Internet runs on data, and the new Internet runs on value. As more and more valuable assets enter Ethereum, and as more applications can program these assets, Ethereum's ability to create new financial products continues to grow.
This is also how Ethereum grows its compound network effect. Each financial primitive adds another dimension to the choice of things that can be built on top of Ethereum. Each primitive is an individual Lego, and there are more and more Legos within Ethereum.
financial stack
These platforms all utilize DAI and Ether to function. The transaction volume of DAI and Ether, as well as the daily transaction volume conducted on these platforms will be greatly affected by the Ether pledge rate (Layer 0) and stability fee/DSR (Layer 1), as well as DAI WABR & WASR. These three metrics represent the rates generated by the three markets that will determine capital availability for all applications above.
composite stack
Layer 0 is an algorithm-controlled commodity currency issuance layer. All new Ether issuance is at Layer 0, the layer responsible for the security of the Ethereum blockchain. When the security is low, Layer 0 issues more Ether, but when the security is high, it issues less Ether (Blue Fox Note: That is to say, when the ETH pledge is less, the security is low, and the Ethereum In order to motivate more people to pledge ETH and verify transactions, the network will reward more ETH. However, when sufficient security is achieved, the issuance of Ethereum will be reduced, and users will be encouraged to transfer ETH to other more profitable places, such as the application layer, etc.). This is enough to ensure the security of Ethereum, while supporting the transfer of Ether to higher financial stacks.
The ETH pledge rate determines the gravitational force of Layer 0 toward the bottom of the stack, that is, the gravitational force toward ETH.
Layer 1 is the stable layer. Layer 1 takes the Ether issued at Layer 0 and converts it into a stable form of DAI. Layer 1 enables individuals to make long-term calculations about how to manage their capital, as they can make informed economic decisions now, knowing that DAI will represent similar value in the future.
Layer 1 is also the capital generation layer. Layer 1 is the layer where individuals can mint coins directly, which adds money to the total money pool of the macro economy. The Stability Fee is the minting cost, which represents the cost of capital within Ethereum.
The stability fee generates a proportional DAI savings rate, and just like the ETH staking rate, it also exerts its gravitational effect on DAI in the financial stack. The DAI savings rate manages the scarcity of DAI, which is comparable to the ETH pledge rate manages the scarcity of ETH.
Layer 2 is the "capital availability" layer. Layer 2 determines the cost of borrowing, which is balanced by the interest paid to capital providers. Layer 2 is the "peer-to-peer credit window" layer.
Lending and borrowing assets has fewer restrictions compared to MakerDAO, but also creates less systemic risk. At this layer, you can borrow DAI, often with fewer fees and lower penalties in liquidation events.
Ether can be in one of three places.
1. Pledge
Ether, as a capital asset, provides regular dividend returns.
Ether acts as a store of value, acting as collateral for trustless/permissionless participation in its financial ecosystem.
3. Secondary market
The price that must be paid in the secondary market to access the above two services.
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This graph also applies to DAI. 1.DSR 2.SF 3.DAI price
The price of Ether depends on the common pull of 1+2 vs. 3
The application layer (1-ETH locked in the APP) reflects the market's demand for financing. Supply and demand conditions in the market. Overall, the supply side and the lenders are putting far more capital into the market than they are taking out, because borrowers can only borrow less than the value of their collateral. Mortgage $1,500 worth of ETH, can lend $1,000 worth of ETH: overall lock-in: 1/3 of the ETH loan value. (Blue Fox Note: In other words, due to over-collateralization, more than 1/3 of the assets are actually locked.)
Every action has a reaction of equal magnitude and opposite direction. Both System 1 and System 2 aim to attract ETH into their respective spheres of control. As App has more attractive features and services, it always draws ETH out of staking. The Ethereum protocol offers higher rates of return when there are fewer stakers. (Blue Fox Note: ETH’s pledge layer, DAI generation layer, and application layer will all be attractive to ETH, and the size of these attractions depends on their respective return rates, which results in the value flow of ETH.)
1 and 2 create a pull against 3, which is the price of Ethereum. To provide an equal but opposite pull on 1 and 2, the Ethereum price appreciates in the secondary market. Such are the fundamentals of the Ethereum bull market. The virtual machine of Ethereum produces enough meaningful applications. Through the scarcity of ETH, the pledge rate of ETH increases. At the same time, these two mechanisms have a strong joint force on the price of Ethereum in the secondary market.
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Layer 4: User Aggregation
final layer. Liquidity providing layer. middleware layer. interface layer. Efficient Market Hypothesis layer.
Layer 4 is the last layer to appear, because its structure and purpose are completely dependent on the application below it. The best Layer 4 example is InstaDapp's cross-protocol bridge.
InstaDapp built a service that automatically transfers one's debt from MakerDAO to Compound, from one lending platform to another, for a better interest rate. InstaDapp generates 13 internal transactions to complete a single transaction performed by a user.
Settle Finance offers a similar service: a decentralized exchange interface that aggregates market data and offers the best exchange rates of any exchange. Through a good interface and liquidity services, Settle can capture users and reduce the friction of their financial interaction with Ethereum. Settle can help provide the overall liquidity and efficiency of the Ethereum ecosystem.
TokenCard presents an interesting aggregation scenario. By connecting payment networks like Visa to crypto credit cards, TokenCard pools users and provides transaction volume to decentralized exchanges. Sufficient users of TokenCard debit cards can provide more transaction volume and liquidity for the application layer.
RealIT is a tokenized real estate platform. The investor buys a share in the property and receives a daily share rent. RealIT increases the daily transaction volume of DAI transactions because it aggregates users with services and spreads DAI throughout the Ethereum system. As more and more users use it, more real estate assets are sold, and more rental income is converted into DAI and sent to RealToken holders, thereby increasing the liquidity of the application layer.
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predictions and conclusions
These metrics are always critical to measuring the Ethereum economy.
