Can DeFi's "currency Lego" attribute continue to drive innovation?

Editor's Note: This article comes fromGolden Finance, reprinted by Odaily with authorization.

Editor's Note: This article comes from

Golden Finance

, reprinted by Odaily with authorization.

We know that the traditional financial system is characterized by permissibility, high barriers to entry, and additional legal costs, so it is relatively limited in terms of composability. All financial services built on top of traditional centralized financial services require legally binding financial contracts between two parties, which not only increases market entry barriers, but also makes it difficult for developers to create fully automated or impartial financial applications , as ongoing access may be revoked at any time. Additionally, third-party developers do not get the assurance of certainty that they expect, since a centralized entity can control critical parts of the application.

Secondly, we found that traditional financial services are often affected by opacity or information asymmetry, because the public has very little understanding of the back-end infrastructure, which in turn creates unknown risks and increases the risk management costs of a small number of regulatory agencies. For example, financial composability can create “mortgage-backed securities” by combining the collateral of existing consumers. This diversified business model seems to be good, especially internationally renowned ratings such as Moody’s, S&P and Fitch. The agency gave a AAA rating, but when the time came to 2008, many securities actually relied on the "toxic" subprime debt endorsement, and the crisis broke out and led to the global financial crisis. Therefore, providing high levels of transparency and visibility to a wider audience could prevent such “implosion” events from occurring.

Then, we can also see that if traditional financial entities wish to provide their financial services or products to the citizens of a certain country or region, these entities are usually required to meet the regulatory compliance of that country or region, such as "know you customers” and “anti-money laundering” and other laws and regulations. While regulatory standards may improve the market in some cases, achieving them can also lead to high compliance costs, such as expensive legal advice, and increase the difficulty of market entry, which means that in the end it is likely that only a few It takes a few well-connected and well-capitalized companies to compete and survive in the market, especially when operating in many different jurisdictions. Additionally, compliance often involves more human involvement in the process, hindering the development of multi-party process automation.

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The unique advantages of DeFi

Very different from what we have seen in the traditional financial industry, decentralized finance can essentially change the status quo in a permissionless way, which in turn supports the creation of a more open financial foundation from which any developer can gain Real-time access to highly tamper-proof and reliable financial infrastructure. In this case, a truly impartial and deterministic application can run according to the coded rules, and no one person or centralized entity can shut it down. Using a decentralized financial infrastructure also requires no original developer approval, allowing for seamless innovation without any centralized bottlenecks.

Secondly, in terms of transparency, decentralized finance is also different from traditional finance. Its transparency is quite high, because many projects are not only built on the basis of open source technology, but every transaction and interaction between users and DApps is recorded in an open and non-tamperable ledger distributed around the world. Once a centralized cryptocurrency exchange goes bankrupt, it often takes months or even years to complete debt settlement, but the solvency and operational health of decentralized finance have always been collectively "monitored" and analyzed by the open source community. Potential fraud and systemic risks can be pointed out.

In terms of regulatory and legal obstacles, decentralized finance adopts a different compliance approach than traditional finance, which can make it compatible with the laws and regulations of jurisdictions without sacrificing innovation. The blockchain infrastructure is open-source and decentralized in nature, meaning it is not owned by any for-profit company, and every transaction can be verified and audited on the blockchain. More importantly, the composability of decentralized financial agreements means that each agreement does not need to have built-in compliance tools. As long as the terms of the agreement are followed, any user or enterprise using the agreement is fully compliant. When a public ledger is combined with pluggable and modular compliance support, it can effectively ensure that end users meet regulatory standards without stifling innovation.

Through the above comparison, we can see that the traditional financial industry always tries to improve efficiency and solve problems such as poor operation through stricter control of the infrastructure, while DeFi hopes to improve market efficiency through an open source code framework. Under this framework, license-free innovation can naturally solve the problem of inefficiency.

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'Currency Lego' is actually powerful

Since developers know very well that the core business logic they develop can access key infrastructure without any permission, the modular composability of the DeFi ecosystem allows them to focus on building core business logic. When developers use the decentralized financial infrastructure to create new tokens, they don't need to build their own exchanges, and they don't have to pay expensive listing fees to be listed on some proprietary platforms. They only need to focus on creating transactions and providing liquidity. support. Not only that, they can list their tokens on a decentralized exchange (DEX) that is thoroughly vetted and includes an existing user base, which in turn gives token holders instant access to liquidity and different financial use cases, greatly Extended token utility.

If this structure can be extended by connecting new decentralized financial applications to existing decentralized financial applications, it will feel like building Lego bricks, which is why DeFi composability is also called " Currency LEGO” reason. Now, some "currency Lego" scenarios in the decentralized finance industry include: decentralized exchanges, automated market makers, DeFi aggregators, stablecoins, etc., all of which support various combined connections to create services larger than their own Some of the many building blocks of functionality.

Under interoperability, anyone can build products and provide a new user experience by combining two protocols (such as Aave and Synthetix). If this product is good, then liquidity will also benefit from interoperability, and then can quickly gain network effects, which is obviously much stronger than the traditional financial system. In addition, another key feature of the composability of decentralized finance is the ability to "chain" together a chain of decentralized applications, which can reduce the friction cost to almost Zero and no permits required, resulting in increased capital efficiency. Not only that, decentralized financial composability can also promote accelerated growth of network effects, and each decentralized financial application in the "combination" can make other decentralized financial applications in the "combination" stronger, more usable.

All of the above operations already exist in the field of decentralized finance, and the “combinations” involved include Ethereum, MakerDAO, Compound, Chainlink, and PoolTogether. Create entirely new decentralized applications through tokens without having to mint stablecoins yourself, or figure out how to bootstrap a money market protocol, or figure out how to get a verifiable on-chain source of randomness. Users can also “merge” their own interest-bearing stablecoins together, thus creating a permission-free and loss-free savings portfolio, further extending this composability.

Use Cases for DeFi ComposabilityEthereum2. Flash loan: Flash loan is similar to a temporary, unsecured loan, but the repayment must be completed in the same transaction. If the flash loan borrower is unable or unable to repay his loan immediately, the entire transaction will be revoked. This protects the agreement and its lenders from any default. At the same time, flash loans can also be used to arbitrage between decentralized exchanges, conduct seamless lending, switch collateral or debt in loan transactions, and many other use cases, all of which can be completed in a single transaction .

3. Aggregation service providers, another decentralized financial application that makes heavy use of composability is 1inch.exchange. It can bring a better experience to DeFi users, because users do not need to check or compare token exchange rates of different decentralized exchanges every time, and can navigate all information, access

Ethereum

All liquidity on the Internet, avoiding cumbersome processing operations. Among them, 1inch plays the role of a decentralized exchange aggregation provider, which can obtain liquidity from all decentralized exchanges on Ethereum and help users avoid slippage as much as possible when exchanging tokens. Not only that, 1inch can also split large-scale transactions into multiple orders, and even realize cross-exchange settlement in one transaction, so as to provide users with decentralized financial products with the best yield.

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Be wary of the risk of "currency Lego"

The first is that when multiple smart contracts are combined, the attack surface will expand, increasing the scope of the "attack surface", which in turn will bring more extreme situations, and even require extreme measures to ensure the smooth operation of the combined application. This composability risk could exploit vulnerabilities in potentially lower-standard DeFi applications, meaning that collateral tokens in combined applications are only as safe as the weakest collateral tokens.

Second, some users may not know much about decentralized finance and the applications they use, and this risk may be more serious than we realize. Therefore, we need to educate users that risk transparency is critical to ensuring the healthy functioning of the decentralized financial ecosystem. DeFi composability can get very complex very quickly, so each step in the composition process needs to be broken down to a level of security so that users can always know where their funds are invested.

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Summarize

How to deal with risk?