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Summary

Today's article is divided into 2 parts:

Key Take Away:

If we really want to find the secrets of getting rich in the DeFi industry, we must have an understanding of lending. People will never make money beyond what they know. We need to look up and see the road.

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The digital currency industry has developed for about ten years since the birth of Bitcoin. In the past ten years, it has experienced a series of processes such as scams-surge-bust-consensus establishment. Until today, many traditional financial institutions, Musk, Top entrepreneurs in traditional industries such as Wang Xing have also begun to pay attention and enter the market. It is necessary for us to make a complete review of the development trend of the digital currency industry to help us better understand historical trends.

1. Characteristics of DeFi

DeFi, Decentralized Finance, also known as decentralized finance, is a financial revolution native to the blockchain industry. Compared with traditional finance (centralized finance, such as central banks of various countries, they have a unified settlement, currency issuance system and financial systems subject to the financial policies of governments of various countries), DeFi uses smart contracts to formulate rules and strictly enforce the rules through codes , is essentially a financial method that replaces human governance with machine governance. At the same time, all smart contracts are open source. In this way, it is realized:

Transparency: Once the code is deployed online, no centralized organization or subject can make rule changes without notifying users;

Availability: All DeFi applications are deployed on the blockchain, and only a mobile phone or a computer is needed to obtain the service. Compared with offline financial services, the availability is greatly enhanced;

Privacy protection: Traditional financial services require customers to do KYC (real-name authentication), and traditional financial institutions have all the financial information of customers, but DeFi only requires users to set up a wallet, and no one knows who the wallet user is. Users can also set up multiple wallets to decentralize their assets;

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2. The structure of DeFi

Any system is like a building with a foundation and a subject, just like the traditional financial system, where the central bank is responsible for final settlement and monetary policy, commercial banks are responsible for investment and financing, and so is DeFi. We can abstract the entire DeFi world into five levels, As shown in Figure 1, it includes: settlement layer, asset layer, protocol layer, application layer and aggregation layer.

Settlement Layer (Layer 1): Consists of the blockchain and its native protocol assets (e.g., BTC on the Bitcoin blockchain and ETH on the Ethereum blockchain). It allows the network to securely store ownership information and ensure that any state changes comply with its ruleset. Blockchain can be seen as the basis for trustless execution, which acts as a settlement and dispute resolution layer.

Asset Layer (Layer 2): Consists of all assets issued on top of the settlement layer. This includes native protocol assets as well as any other assets (often referred to as tokens) issued on this blockchain.

Protocol Layer (Layer 3): Provides standards for specific use cases, such as decentralized exchanges, debt markets, derivatives, and on-chain asset management. These standards are usually implemented as a set of smart contracts that can be accessed by any user (or DeFi application). Therefore, these protocols are highly interoperable.

Aggregation layer (layer 5): is an extension of the application layer. Aggregators create user-centric platforms that connect to multiple applications and protocols. They typically provide tools to compare and rate services, allow users to perform otherwise complex tasks by connecting to multiple protocols simultaneously, and combine related information in a clear and concise manner. Now that we understand the conceptual model, let's take a closer look at the tokenization and protocol layers. After a brief introduction to asset tokenization, we will examine decentralized exchange protocols, decentralized lending platforms, decentralized derivatives, and on-chain asset management protocols. This allows us to provide the necessary basis for our analysis of the potential risks of DEFI.

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3. The cornerstone of the DeFi protocol layer - lending

Lending is the cornerstone of the entire DeFi world. Before understanding this logic, we need to have an understanding of stablecoins.

The native tokens of the digital currency industry, such as Bitcoin and ETH, are very volatile, which brings huge risks to settlement and payment. Therefore, the digital currency industry needs a relatively stable currency like the US dollar for settlement. This is the reason for the emergence of stablecoins.

There are many types of stablecoins, which can be mainly divided into three categories: off-chain collateral, on-chain collateral, and unsecured. Unsecured stablecoins currently have no large-scale applications, so I won’t introduce them here for the time being. The off-chain mortgage is represented by TEDA’s USDT. TEDA will issue 1 USDT for every 1 dollar received by TEDA. The problem with this kind of token is that it needs to regularly audit the issuer to ensure that it has enough collateral. Chain mortgage is represented by DAI issued by MakerDao, and DAI is obtained by pledging ETH in the smart contract set by MakerDao.

The biggest problem with USDT is the problem of centralization. First, the so-called 1:1 peg to the US dollar has not published an audit report, and this problem has been criticized for a long time. Second, the SEC is still reviewing USDT. If it is true If a problem is found, there will definitely be a wave of flash crashes in USDT. USDC is similar to USDT. Although there are compliance audits, the problem of centralization cannot be avoided;

Currently, the three lending projects with the most usage scenarios in the DeFi field are MakerDao, Compound, and AAVE:

1) MakerDao: Its core function is to generate stable currency DAI through its Collateralized Debt Position Protocol (CDP). There is a very important parameter here, which is the mortgage rate. MakerDao’s mortgage rate is set to 150%, which is ETH worth 150DAI Mortgage can only lend 100DAI in MakerDao. When the mortgage rate is lower than this rate, the system will start to liquidate the CDP. If the customer voluntarily terminates the CDP, the customer needs to pay a fee. This fee is paid through MakerDao’s native token MKR. The paid MKR will be destroyed by the smart contract, which realizes the deflation of MKR in disguise and pushes up the price of MKR. . Therefore, we can see that when USDT was exposed to be investigated by the SEC, the supply of DAI was increasing, which meant that more CDPs were created, and more CDP creations also meant that more customers would end CDPs (here Everyone should understand that the creation and termination of CDP is a dynamic balancing process), so more and more MKR is being destroyed, so the price is being pushed higher and higher. From an essential logical understanding, as long as the demand for DAI increases and the operation of MakerDao remains benign, the price of MKR will definitely increase.

Maker official website Dai data release

2) Compound: The simple understanding is that Compound has established a lot of fund pools, and each fund pool corresponds to a token. You can either deposit assets to earn interest or pay interest to lend assets. The interest is calculated in real time by the algorithm Adjustment is also a manifestation of interest rate liberalization. There is a detail here that the value of the deposited assets determines the value of the assets that can be loaned out. At the same time, different assets deposited will have different loan coefficients. The higher the coefficient, the more assets that can be loaned out. The real explosion of Compound is that it was the first to start liquidity mining in DeFi, which made its TVL explode, and the explosive growth of TVL will make its deposit and loan interest rates closer to a reasonable level. Therefore, users with capital needs will come to Compound to make transactions, further promoting the development of the entire ecology;

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Compound official website homepage

3) AAVE: The general logic is similar to Compound. Its original name is ETHLend, which is also an early lending project on Ethereum. The most noteworthy thing is its flash loan function. Regarding flash loans, this is also an extremely geeky and subversive creation that only exists on the blockchain. To understand flash loans, one must have an understanding of blocks. We know that transactions on the blockchain are made through The block is packaged, and the flash loan is the process of realizing both loan and repayment in one block (if there is only a loan but no repayment, the entire transaction will not be packaged into this block, so naturally the transaction fails ), at this time there is no need to provide any collateral. Theoretically, flash loan is to get rid of the dependence on funds and release the powerful nature of the strategy. In principle, as long as the strategy is good enough, there will be no need to consider the source of funds, and the blockchain will be full of unlimited free funds. There are 17 tokens available on Aave for flash loans with a fee of 0.09%.

The lending platform has the following modes of play:

The third is short-selling. Users can deposit DAI to lend ETH, then sell ETH, wait until the price of ETH falls, and then buy back ETH and return it to the lending platform to complete the arbitrage.

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epilogue

https://docs.aave.com/developers/tutorials/performing-a-flash-loan/...-in-your-project

https://money-legos.studydefi.com/#/aave?id=flashloans