What will DeFi bring to the financial industry?
What will be the form of financial realization with smart contracts? Such as Libra or central bank digital currency, if smart contracts are added in the future, how should it be designed?
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As the imaginary boundaries of the combination of blockchain technology and finance continue to expand, the emergence of decentralized finance ("DeFi" for short) may bring some enlightenment.
"DeFi has already made its debut in 2019. 2019 can be defined as the first year of DeFi. The value of locked positions has doubled throughout the year, and this momentum will continue in 2020. At present, the overall locked positions have exceeded 2 billion US dollars." Xu Kun, chief strategy officer of OKEx, told The Paper.
According to the latest data from The Graph, a blockchain data indexing company, the number of DeFi monthly queries exceeded 1 billion in June. In the previous few months, the daily query volume on The Graph hosting service was 20 million to 30 million, but in June, the daily query volume reached 40 million to 60 million.
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What is DeFi?
What is DeFi?
The full name of DeFi is Decentralized Finance, that is, "decentralized finance", also known as "open finance". At present, almost all DeFi projects are carried out on the blockchain of Ethereum.
Ethereum is a global open-source platform for decentralized applications. On Ethereum, you can manage digital assets and run programs by writing codes without geographical restrictions. The cryptocurrency it produces is called Ether ("ETH" for short).
Xu Kun believes that DeFi is a series of financial applications developed based on an open decentralized platform, and the entire business process is an interactive action on the chain.
She said that compared with traditional finance, DeFi is more open and inclusive: first, DeFi does not need to rely on any centralized subject to provide credit intermediary or endorsement; second, there is no access restriction, that is, any Anyone who is connected to the Internet can enter; third, any third party cannot prevent any transaction, nor can it reverse any transaction.
However, Zou Chuanwei, chief economist of Wanxiang Blockchain and PlatOn, told The Paper that DeFi and traditional finance are two different tracks and cannot be compared. Traditional finance serves the real economy and is the financing of funds. The process is accompanied by the transfer of risks, the allocation of resources, and the discovery of prices, and deals with legal tender. DeFi has nothing to do with the real economy, and it has nothing to do with legal currency. It is more about the field of cryptocurrency.
He gave an example, for example, a bitcoin miner who produces bitcoins needs to use legal tender to buy mining machines or pay electricity bills to hire people. Usually he digs out bitcoins and sells them, but when the market conditions are good, he may not want to sell them. Miners In applications such as Compound, over-collateralization based on Bitcoin can be carried out, and stable currency can be lent for RMB to meet its payment needs. A stablecoin is a cryptocurrency that is pegged to another asset (such as gold, the U.S. dollar, another cryptocurrency, etc.).
"Although some financial engineering product design methods may be used, financial risks are also involved, and traditional financial risk analysis methods can also be used, but the service scenarios, objects and goals are completely different, so it is different from traditional financial Than is a completely different concept." Zou Chuanwei said.
Some people believe that DeFi based on distributed ledger technology not only solves the problem of capital income being earned by intermediaries in traditional finance, but also eliminates credit barriers between countries.
"From the perspective of resource allocation efficiency, it is difficult to say that it is an advanced financial resource allocation method." Zou Chuanwei said.
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"Open Finance" is not "Open Finance"
Although DeFi is also called "open finance", Zou Chuanwei believes that it is necessary to distinguish it from the concept of "open finance" from the perspective of traditional finance.
"This is another concept of open finance that extends from the mainstream financial field and from the open banking API (Application Programming Interface). It can be seen that it is not the same in essence." Zou Chuanwei said, "I prefer I am optimistic about this open mechanism in the traditional financial field, because it has a profound evolutionary logic in it, and the scene itself is bigger.”
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Current DeFi Application Direction
Zou Chuanwei believes that DeFi is similar to Lego building blocks, and some basic financial modules are realized by different smart contracts. Then call each other between these smart contracts, and put together some financial functions, "some provide loans like Compound, some provide decentralized exchanges, and some provide mechanisms for monitoring the adequacy of collateral."
Take MakerDAO, an automated mortgage loan platform among lending platforms, as an example. Founded in 2014, MakerDAO pledges users' digital assets through smart contracts, and then lends users the same amount of stable currency Dai. And it adopts a dual-currency model. On the one hand, it produces the stable currency Dai, which is the form in which users eventually borrow assets. On the other hand, it also provides equity tokens and management tokens MKR, which are used to pay interest when redeeming staking cryptocurrencies.
Zou Chuanwei said that Dai is a debt contract at the level of mortgage debt warehouses. A uniform overcollateralization ratio requirement applies to all collateralized debt positions. If the market value of the collateral falls, the issuer needs to supplement the collateral or return some Dai to maintain the collateralization ratio. If the mortgage rate is lower than the liquidation rate, it will trigger the liquidation of mortgage debt positions, similar to the liquidation mechanism in equity pledge financing. If the collateral disposal is not enough to cover the debt gap, MKR will be issued and auctioned to obtain Dai, which is equivalent to MKR holders as the last loss bearer.
Similar to lending in traditional finance, lending in the cryptocurrency field also has the problem of term mismatch, that is, the contradiction between "the lender hopes to repay the funds for a short period of time" and "the borrower hopes to borrow for a longer period of time". In traditional finance, maturity mismatches are regulated by banks, but in the field of cryptocurrencies, it is difficult to solve them through algorithms.
Zou Chuanwei believes that there are currently two solutions. One is to move towards a peer-to-peer lending model, so that deposits and borrowing periods match, such as the early ETHLend. But this will limit the scale of lending activities, and the matching cost between depositors and borrowers is high. The second is to dynamically manage the deposit and loan period through algorithms. However, the effect remains to be seen.
Compound is a decentralized lending platform. Depositors can transfer their own Tokens to the Compound smart contract (deposit), and transfer the deposited Token from the Compound smart contract back to their address (withdrawal) at a future moment. Borrowers can use the deposited Token as collateral to borrow from Compound. The Token borrowed by the borrower can be inconsistent with the Token deposited by the borrower in terms of quantity and type, but it must meet the requirements of the over-collateralization ratio. If the collateral of the borrower is not enough, the Compound protocol will force the liquidation of the collateral.
Zou Chuanwei believes that the risks of the Compound platform are also obvious, because based on the overcollateralization, the collateral price fluctuates greatly, and if it falls sharply, there may be insufficient collateral. According to the agreement, there are two processing methods, one is to supplement the collateral, and the second is that the smart contract will liquidate the collateral. Therefore, once the price drops sharply, whether it is the addition of collateral or the disposal of collateral, it will be traded on the Ethereum blockchain, and there will be transaction congestion, and it will be difficult to clear market asset risks.
Xu Kun mentioned Uniswap, a decentralized exchange (DEX) that provides an automated market-making mechanism.
She said that Uniswap is now the leader in DEX, accounting for nearly 40% of the transaction volume. It automates market makers and replaces manual quotations with established algorithms, thereby removing centralized matching, clearing and settlement, and "eliminating" market makers in transactions.
But she also pointed out that this feature of Uniswap is suitable for small traders, especially for small traders who do not want to set limit orders. It is not friendly to large orders, and the price is prone to drastic changes when its trading depth is limited.
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Problems Existing in Defi and Its Enlightenment
Under the frantic pursuit of capital, it is necessary to think coldly about Defi.
Xu Kun believes that at present, DeFi is still in its initial stage and faces three major challenges: first, code loopholes. Programmable finance represents the power of technology, but loopholes after code stacking are always inevitable; second, systemic risks, Whether it is traditional finance or programmable finance, systemic risks must be taken into account, such as whether the DeFi ecosystem can carry it in the face of extreme market fluctuations; the third is asset on-chain, the complexity and uncertainty of asset on-chain are of great importance to the entire For the DeFi industry, it is a very big challenge, which requires pioneers to try.
DeFi apps are at risk of hacking. According to media reports, in the February-March period of 2020 alone, there were 6 security incidents in the DeFi field, with a loss of more than 1.5 million US dollars.
Zou Chuanwei said that there are actually many security issues in DeFi, including the security of smart contracts, the fluctuation of the value of collateral that is highly dependent on over-collateralization, and the efficiency of risk clearance.
He added that DeFi has liquidity risks, and it is impossible to solve the problem of term mismatch through algorithms, and it uses building blocks without unified planning, and there is no way for different modules to communicate with each other.
"Assuming that there is a link that is not designed well, some loopholes will actually amplify the effect of this risk," he said.
However, Zou Chuanwei also believes that DeFi may have some inspiration for mainstream finance.
