The original sin of DeFi: understanding the limitations of DeFi from the actual banking business
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Original compilation: TechFlow Intern
From banks to central banks
The use case of cryptocurrencies as an alternative to hard money has drawn society's attention to central banks and currencies.History tells us that the arc of financial development is to be a bank first, and then a central bank.
Before the Federal Reserve was established in 1913 (about 140 years after independence), the US successfully financed railroads, real estate, wartime weapons, ships through banking channels without a central bank. During the American Civil War, banks operated as private businesses distributing funds to society.
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DeFi today
Currently, real-world adoption of any crypto stablecoin is limited. The vast majority of DeFi protocols are self-digestion of leverage. (The general idea is that stablecoins have no other use except in DeFi, and DeFi will use revolving loans to digest high leverage-because real finance does not allow high leverage for assets without high volatility). We can see the clues from the increase rate of ETH circulation in the table below. As time goes by, the increase rate of ETH will become faster and faster.
DeFi yield comes from arbitrage spread/speculative demand.DeFi is a major beneficiary of the central bank's liquidity lottery, but in a bear market with reduced volatility, borrowing utilization will decline. We can see that the TVL of USDC/USDT is shrinking significantly.
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banking framework
Banks borrow short term and lend long term, this time transition is a key use case for obtaining a fair liquidity premium.Most of the DeFi community talks about overcollateralization/undercollateralization/algorithmic models, but very few people seriously discuss actual banking.
Let's take DAI as an example:
I have $100 million in deposits and I have a $100 million loan. If my liquidity cost is 4% and my loan rate is 8%, I will have a 4% profit. In the first year, we took in $4 million. In the second year, we took in $8 million.
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implicit debt ceiling
The biggest obstacle to creating an on-chain bank is the implicit debt ceiling brought about by liquidity pool drainage. Suppose MakerDAO lends Walmart $100 million in DAI, and Walmart has no use for DAI because its payroll/purchase orders are denominated in USD, so Walmart will exchange DAI for USDC and transfer to Coinbase and exchange USDC for USD. Walmart may just be borrowing DAI because it has a lower interest rate than the USD alternative and has implied vulnerability options.
Therefore, the loan book of the bank on the chain can only expand with its liquidity pool. If there is only 50 million "exchange" liquidity, no one will lend 100 million DAI.
The debt ceiling problem can be solved by:
Create use cases to facilitate the holding of DAI;
Issue a DAI that is not convertible for a period of time;
Locking in a fixed amount of liquidity for a period of time;
Confidence/resilience growth, equivalent to savings in DAI.
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savings as a service
Unless you live in a non-OECD (Organization for Economic Co-operation and Development) country, you wouldn't consider using a stablecoin.Many non-OECD countries experienced a decline in saving in local currency terms. The reason for this is the political failure of the respective countries to reduce fiscal/existing account deficits. Countries use inflation as a coordinating game to devalue savings and lower borrowing costs, and the biggest borrower in any country is the government itself.
This is why we can see strong dollarization in emerging markets.
In Turkey, if you have the ability to save in dollars, you are protected from inflation and bank failures. But obtaining dollars there is not easy and frictionally costly, and the official dollar exchange rate is manipulated by the government.
If viewed from this point of view,A use case for DeFi is a global savings account that can exist in countries without branches or institutions. There is no JPMorgan Chase in Libya.
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Some thoughts on on-chain banking
Building an on-chain bank requires strong liquidity, which I believe can be tapped from the demand for hard currency in non-OECD countries.But there are other areas in DeFi that need significant improvement:
DeFi needs a yield curve — almost all activity is spot;
On-chain banking may mean locking up a lot of liquidity/irredeemable primitives;
Borrowing/loaning tools need to be facilitated through lending services and on-chain contracts;
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On-Chain Banking Ends the Game
Ending the game with on-chain banking is simple:
On-chain banking is cheaper given the cost structure;
Instant payment/settlement;
Tokenization allows for borrowing and lending incentives that are not possible today.
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