Opinion: DeFi growth, innovation and risk

Editor's Note: This article comes fromCrypto Valley Live (ID: cryptovalley)Crypto Valley Live (ID: cryptovalley)

, author: ndustry, translation: Liam, reprinted with authorization by Odaily.

"secondary title"The development and innovation of DeFi

Show me the motivation, I'll show you the results

--Charlie Munger.

DeFi protocols have seen significant growth in adoption, token prices, and total value locked. Although websites and social media platforms that rely on third-party advertising require a large number of daily (monthly) active users to obtain value, decentralized protocols generally do not need to rely on frequent use of users to create value. Instead, the dollar amounts held by smart contracts that power decentralized financial services are more reflective of the value created by these dapps. Therefore, the total value locked has become a barometer of widespread concern in the DeFi field, because most of these protocols need to lock collateral before using their services."black thursday"black thursday

During the entire market slump, the total value locked in DeFi continued to grow throughout the second quarter of 2020, surpassing $2 billion in just six months after breaking through the ten-digit mark for the first time.

As of July 8, 2020 at 10:00 a.m. ET. Source: DeFi Pulse

In the graph above, readers may have noticed a recent inflection point in total value locked. By zooming in, we can confirm that this happened in mid-June, which coincided with the launch of Compound’s COMP token on June 15. In less than a month, the total value locked in DeFi protocols has doubled. This is mainly because users are rewarded through what is known as liquidity mining.

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As of July 8, 2020 at 10:00 a.m. ET. Source: DeFi Pulse

In short, liquidity mining is the process of earning rewards in the form of tokens and/or interest by providing liquidity to DeFi protocols. The concept has been around since last summer, when Synthetix (a decentralized derivatives exchange) first attempted to reward users for providing liquidity to its derivatives sETH on Uniswap, by paying users with their native SNX tokens. However, it wasn’t until the launch of Compound’s native token, COMP, that liquidity mining became a common practice and buzzword in the crypto space."Some people in the industry praised this approach as a "growth hacking method" of DeFi.

. Analyzing key on-chain data, we can assess the effectiveness of liquidity mining in increasing COMP adoption. For example, let's observe how the number of holders has changed since the token was launched.

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As of July 8, 2020 at 10:00 AM EST, using IntoTheBlock's newly added COMP analysis method

As can be seen from the figure above, in less than a month, the number of COMP addresses with a balance has risen rapidly from almost zero to more than 10,000, effectively acquiring a sizable community from the very beginning, and will delegate Coin ownership is decentralized. To put it bluntly, BitFinex’s token LEO has less than 2,000 cumulative holders throughout the year, while MakerDAO’s MKR has 22,000 holders even though it was only launched in November 2017."In addition to yield farming, DeFi protocols have been utilizing other strategies to foster growth and community adoption. A common method that many projects have implemented or are looking to implement is staking. For example, popular decentralized exchange Kyber launched an upgraded version of Katalyst on July 7, enabling holders of Kyber’s native KNC token to stake their tokens to vote on improvement proposals .

At the same time, it also

Additionally, as an exchange, Kyber also realizes that incentivizing liquidity is critical in order to build a robust trading infrastructure. So as part of the Katalyst upgrade, now 30% of Kyber network fees will be used to provide rebates to liquidity providers, this part is called the reserve within the Kyber ecosystem. Through these, Kyber can effectively reduce the cost of market-making activities on exchanges, encourage the creation of more and higher-quality reserves, and enhance the liquidity of the platform.

In anticipation of the Katalyst upgrade, the crypto market is optimistic about the KNC token. Year-to-date, the price of KNC has risen by more than 700%, leading a wave of DeFi token rebound. However, analyzing the activities on the chain, we can ensure that the transaction volume of KNC tokens has indeed increased in real terms. Throughout 2020, the transaction volume of KNC tokens has increased by about 9 times. While staking and other updates in the Katalyst upgrade clearly assisted on-chain growth in the context of the anticipated release, the long-term impact of the Katalyst upgrade on the overall health of the Kyber ecosystem will determine whether these additional incentives are effective.

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All of these innovations benefit from the permissionless nature of DeFi. Given the transparency and open source dynamics of Ethereum, DeFi projects built on it can obtain information quickly and freely. In a message from Compound founder Robert Leshner, he highlighted how COMP’s governance was built on the previous MakerDAO and how COMP’s liquidity mining was inspired by Synthetix’s previous incentive design experiments. Being open source, Compound and other DeFi protocols are able to freely copy and improve existing solutions, speeding up the build and deployment process.

While DeFi’s ability to incentivize rapid adoption and decentralized tokens has led to DeFi’s recent growth, it’s not without risks. In general, some of the risks to consider with liquidity mining and DeFi include potential hacks, loan liquidation, unlinking of stablecoins (often used as collateral), and devaluation of tokens received as rewards.

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Readers may have heard of recent hacking incidents in the DeFi field, such as the attack on dForce, where hackers used smart contract vulnerabilities to steal $25 million and then returned most of the stolen assets. Recently, a hacker attacked the automated market maker platform Balancer, using flash loans to drain the liquidity of a small token, STA, manipulating its price and exchanging it for $500,000 worth of other tokens. While these hacks are not unique to the DeFi space, they are certainly an important risk to consider given that over $2 billion is locked in smart contracts held by major protocols. Offering a silver lining in this threat is the rise of decentralized insurance protocols, such as Nexus Mutual, that protect users from the risk of smart contract failure."black thursday"In addition to the obvious risk of hackers stealing funds, DeFi users may also face liquidation risks. In order to borrow funds from a lending protocol like Aave, users must deposit collateral greater than the amount they wish to borrow. This overcollateralization creates a buffer in the event that volatility devalues ​​the collateral provided. However, over-collateralization is also not enough to protect borrowers and lenders during times of extreme volatility, such as Black Thursday. exist

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During the period, more than $8 million in MakerDAO was liquidated at 0DAI. It ended up causing many users to lose significant amounts of money, prompting lawsuits against the protocol."Finally, just like agriculture, DeFi also has the risk of bad harvests. As liquidity mining kickstarts this new era of crypto "mining and farming," "miners (farmers)

Rely on quality products to profit from their efforts. In other words, if the value of tokens earned through these incentive systems drops significantly, users may start to opt out of providing liquidity to the protocol. Additionally, if the prices of these tokens suddenly and sharply drop, it could cause a liquidity shock, which would further exacerbate protocol issues.

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final thoughts

Overall, there is no lack of innovation or risk in the DeFi space. Leading DeFi protocols have successfully managed to create incentive systems for multiple stakeholder participation, perhaps something we have never seen before. Leveraging the transparency of the blockchain, these projects have been able to improve each other permissionlessly and accelerate the pace of innovation.