Opinion: Ethereum 2.0 will elevate DeFi, accessibility will make it mainstream

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Ethereum 2.0 has been promised to last forever. The reported delay has users struggling to keep their faith, especially in decentralized finance (DeFi). For those who mostly reside on Ethereum and try to collateralize, borrow and lend crypto assets through DeFi, the crowded, stagnant blockchain and high transaction fees make DeFi unusable for some less experienced users. users because they have less cash.

Now, it’s important to note that Ethereum 2.0 will not change the way DeFi works. This very complex and often risky field is not known for being particularly welcoming to new users. However, it will make the overall network faster by splitting the chain into 64 individual "shards," which will increase the transaction rate per second from the current 15 per second to 100,000.

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Ethereum 2.0 is a very important development for DeFi, and without it, some would argue that it would not develop at its current pace. DeFi growth has been exponential of late, with the total value locked (i.e. the amount of money floating in DeFi) now growing from $662 million in January to $13 billion, a 1,786% increase.

As a result, Ethereum usage in terms of total GAS transaction volume has increased by 113% in 2020, from 37.3 billion transactions on January 1st to 79.6 billion transactions on Tuesday, November 3rd. This has led to network congestion and high fees, with the average gas fee for DeFi transactions reaching an incredible 0.03 ETH in September, peaking at over 500 GWEI, or about $14.40 as the blockchain’s native token ether (ETH ) also surged by $480 per coin.

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Reduced DeFi interest or due to technical problems?

The full picture of DeFi is notoriously difficult to map, but withdrawals and reduced activity are understandable in the face of slow transaction times and huge fees. For example, at September’s GAS price level, DeFi transactions below $1,400 were severely cost-effective, and delayed transaction times led to increased slippage. Losses due to changes in the price of goods being sold and bought. This reduces the accessibility of DeFi, which is the opposite of what most founders and users hope to achieve: namely, open finance to everyone, everywhere.

In fact, it's become such a problem that Ethereum's challengers have been running the challenge. Competitors like Polkadot and Tron have been making claims of their own at lightning speed, while Polkadot is also developing DeFi projects like Polkastarter, a decentralized exchange that allows users to create tokens across blockchains. Coin pools (currently outside the scope of Ethereum). So, in the face of these threats, it should come as no surprise that Ethereum 2.0 is coming to market faster than last expected.

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Long live Ethereum!

In addition, what Ethereum 2.0 cannot solve is the inherent complexity of DeFi, users need to roam between different wallets and dApps, and manually enter gas fees to complete transactions. This can lead to serious mistakes even by experienced users, as one Uniswap user recently made a $120 trade with a gas fee of $9,000. This type of bug can only be fixed with a next-gen DeFi iteration like YIELD, which brings all DeFi products together without the need to connect various disparate wallets and applications, and without tinkering.

Accessibility for individual users has to be the focus of DeFi because increasing it is the only thing that will push DeFi to the mainstream. With massive increases in transaction speed and the expectation of consistently low fees, Ethereum 2.0 will provide some way to achieve this. However, the next phase requires products like YIELD that can make DeFi as easy as mobile banking or using PayPal; products that remove the need to hold crypto assets in numerous applications that require constant monitoring. Ultimately, this will free savers out of money-losing cash accounts and into the new world of digital currencies.

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Integration of DeFi and Stacking

Compared with the PoW (Proof of Work) mechanism that requires "hardware" to generate computing power, the PoS (Proof of Stake) mechanism requires locked "capital" to reach consensus. Theoretically, the certificates of PoS projects can be 100% pledged into their network, but while achieving network security, liquidity will inevitably be reduced, which will hinder the development of the DeFi ecosystem based on token mortgages.

For example, according to MINTSCAN data, the equity ratio of Cosmos is as high as 64%, which means that its liquid tokens only account for 36%, and the liquidity of tokens is greatly reduced. Additionally, Cosmos takes 21 days to redeem tokens from the network. Volatility in the secondary market may directly cause many risk takers to lose their fiat currency standards, and they cannot obtain funds from the market for a long time.

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The Solution: "Shadow" Tokens

How to release the liquidity of collateralized tokens? The main development community has formed a solution to issue collateral certificates similar to bonds and return them to the stakers as soon as possible. In order to solve the "unlock period" and income, we can use "shadow tokens".

Polkadot is currently the largest PoS blockchain by market capitalization with a valuation close to +$3 billion. According to data from StakingRewards, as of Sept. 25, 60% of the DOT on the network had been staked. If Polkadot’s validators were allowed to lend out 75% of their staked assets in the form of synthetic assets. We tentatively call it sDOT, and sDOT is equal to its initial market price for short-term liquidity of validators. Then, in order to balance the income and expenditure, the verifier needs to withdraw its accumulated rewards + block rewards, and he needs sDOT to buy back DOT. This "synthetic asset" is called a "collateralized derivative".

Synthetic sDOTs are so-called “lien tokens” that represent certificates to hold currency and earn interest for a specified date in the future, and can be efficiently integrated into various DeFi applications. This design can greatly improve mobility.

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Advantages and disadvantages of Staking + DeFi derivative design

If there are more mature derivative products in the mortgage process, similar to the interest-bearing token model, for validators, funds can be used to pay fees. For the average user, there is no need to mess with complicated promises and delegates. The process of directly acquiring synthetic interest-bearing digital assets in the secondary market is a meaningful attempt to revive the PoS public chain.

With the rapid development of various DeFi protocols in 2020, it becomes possible for complex derivatives on the chain to be gradually recognized by the market. The article “What PoS and DeFi Can Learn from Mortgage-Backed Securities” from economic modeling research firm Gauntlet models PoS networks using a similar model to mortgage-backed securities.

Currently, a commonly used design in DeFi lending protocols is to create stable tokens by staking digital assets. If the mortgagor cannot repay the mortgage, it will be liquidated. Similarly, collateralized derivatives allow nodes to acquire collateralized assets. Assuming many validators are lending their staked assets at the same time, the security of the entire PoS network will be the same as the default probability of each validator staking and borrowing them.

In short, if PoS public chains conduct large-scale derivatives of collateralized assets for liquidity, they will also inject collateralized loans into the entire system. The benefit is that validators increase capital utilization, but if the network's lending standards are low, breaching the agreement will trigger liquidation, which greatly reduces the security of the PoS network.

Therefore, when designing such protocols, it is necessary to carefully design the derivatives pricing function to strike a balance between liquidity and network security.

Currently, active projects in this field are located in China, the United States, and South Korea. Many design suggestions on collateralized derivatives come from PoS node institutions, such as Wetez, Liebi Pool, Chorus One, etc. They have accumulated a lot of experience in the PoS field. Innovation is needed to balance the security and ecological activities of competing chains.

These institutions grew up in the last round of "staking economy" in 2019 and accumulated relevant technical experience. In the new round of decentralized financial cycle governance engineering, professional validators in the industry seem to have reached a consensus. Solved the "liquidity of mortgage assets" problem.

According to the classification of the well-known PoS base layer service organization Chorus. “Collateralized Derivatives” are designed into four categories:

1. Native classes (credential concept proposed by Sunny of Cosmos);

2. Non-native languages ​​(more mainstream, including Stafi / Bifrost / Acala / Everett, etc.);

3. Synthetic (derivative design, a pledge interest swap contract synthesized by both parties);

4. Escrow (a securitization product in which a central authority controls the issuance of mortgage assets through private keys).

From the perspective of protocol design, in addition to the central custodian, the design of decentralized pledge liquidity protocols falls into two categories:

1. Pursuing the original design that is easy to use and still retains the management rights of token holders;

2. Pursue a cross-PoS network, but may require a non-local design with stricter security risk control.

Authorization credentials are based on the original chain design. Sunny, a developer and researcher for the Cosmos community and node Chorus. There is a lot of research and advice in this area. Many new development teams focus more on the design of "non-native" staking derivatives with incentive models.

For example, based on the underlying pledged derivatives protocol, the teams performing this direction are the teams of Stafi and Bifrost. Stafi has launched its governance token and will release a series of rTokens in Q4. Bifrost also recently released the Asgard CC3 incentivized testnet, which is now live. The number of nodes per hour exceeded one hundred.

This year, Stafi designed StakingDrop. In StakingDrop as of August 31, more than 1,700 addresses have bound $200 million in mortgage assets to the network.

The Stafi Protocol recently released its roadmap for the fourth quarter. It will launch an ERC20 bridge that will cross assets with Ethereum, the bridge can convert FIS or rToken into Ethereum tokens, and circulate in Ethereum's decentralized exchanges such as Uniswap . Its rToken will be connected to Polkadot/Cosmos and other mainstream PoS chain ecosystems. rToken will first be implemented on FIS, and rFIS is scheduled to go live at the end of November. After stable operation, rDOT and rKSM will be developed. The rFIS solution will also be opened on Ethereum, which will focus on the Dex decentralized exchange business and is another DeFi application solution.

Unlike the Stafi team, which focuses on DeFi finance and multi-chain diversification, Bifrost focuses on the construction of the Polkadot ecosystem. Its founder, Lupris, won the third prize in the 2019 Polkadot Shanghai Hackathon. Before connecting Bifrost to the substrate, Bifrost has issued PoS mining rights, similar to staking derivatives based on smart contracts. In the Bifrost Asgard CC2 incentive test network that ended in August, the cross-chain exchange between EOS and vEOS exceeded 8 million.