Editor's Note: This article comes fromBlue Fox Notes (ID: lanhubiji), reprinted by Odaily with authorization.

Editor's Note: This article comes from

Blue Fox Notes (ID: lanhubiji)

Blue Fox Notes (ID: lanhubiji)

, reprinted by Odaily with authorization.

Foreword: In the ecosystem of the public chain, the development of DeFi is the most eye-catching at present. So, how defensible is the DeFi protocol itself? Can they be forked? What impact does the composability and interoperability of DeFi protocols have on the defensibility of Ethereum itself? Based on the analysis of the main current DeFi projects, this article proposes the defensibility ranking of the current DeFi protocols. It is believed that USDT and Maker are the most defensible, one shows the strongest liquidity in actual combat, and the other is due to the liquidity and external availability of the synthetic stablecoin DAI. Tornado and Synthetix are in the middle of defensibility, one is because of the network effect of their privacy pool itself, and the other is because of the threshold of the bridge between real assets and synthetic assets. The defensibility of the lending market and the trading market is relatively not so strong, mainly through the mutual use of capital subsidies and capital pools, which can lead to a certain amount of liquidity, and cannot achieve absolute advantages, which also leads to these two fields Competitors emerge in endlessly. The original title of this article is "Talking about Forked DeFi Protocol", the author is Kyle Samani, translated by "JT" of the "Blue Fox Notes" community.

A bunch of new layer 1 blockchains have been launched one after another, and I have been thinking about the network effects of Ethereum and the defensibility of DeFi protocols built on Ethereum.

A few years ago, I wrote about the network effects of non-sovereign layer 1 currencies such as Bitcoin and Ethereum. Since then, the Ethereum-based DeFi ecosystem has flourished: by leveraging a set of DeFi protocols, users can withdraw hundreds of millions of dollars in debt, which is collateralized by a larger pool of capital.

In this article, I will consider:

1) Effort to fork

2) The funds to be paid for the fork

Afterwards, I rank the relative strength of these network effects. Finally, discuss the level at which the Ethereum ecosystem is defensible.

secondary title

About a year ago, I wrote about how Layer 2 assets like MKR (the equity token of the MakerDAO system) can capture value in a permissionless and open context. In particular, it is pointed out in the article that the existence of "unforkable state" is the key to its value capture. In the case of Maker, it is obvious that its unforkable state is the collateral supporting DAI lending (mainly ETH). (Blue Fox Note: Is this the main part of Maker’s defensibility? Can’t other protocols use ETH as collateral? Is the wide use of DAI in different external protocols the real source of network effects? Here welcome to discuss)

However, it is also now clear that this framework is not complete. To understand this, let's assume that the only source of Maker's network effect is collateral. Wealthy third parties could fork all Maker contracts, create fake Maker ecosystems, and deposit tens of millions of dollars in collateral to bootstrap liquidity. so what? Copycat Maker's system is useless if no one wants to buy or interact with copycat DAI.

The strongest source of Maker's defensibility is not MKR, or the collateral backing DAI loans, but the liquidity and availability of DAI. DAI must be liquid in order to be usable. If someone withdraws DAI debt (with ETH as collateral), DAI is useless if there is no liquidity. However, availability is a superset of liquidity. The usability of DAI comes from obvious adoption by merchants, from other protocols (like Augur), and from being used as collateral in lending protocols (Compound, Lendf.me). DAI has been plugged into various third-party applications, services, and infrastructure, making it more useful and usable.

The combination of DAI's liquidity and usability is its strong moat. Well-funded Maker knockoffs could offer higher DSRs and pay third parties to enable knockoff DAI integration, but it's unclear if this will gain meaningful traction.

secondary title

Fiat-collateralized stablecoin——USDT

The defensibility of USDT is very clear: in the encryption ecosystem, it is the most liquid asset, comparable to BTC. It is used by all major non-US exchanges, is used as collateral on many derivatives exchanges, and accounts for a large percentage of OTC trade settlements.

Despite fierce competition from USDC, PAX, TUSD, GUSD, and DAI, USDT still accounts for more than 80% of the stablecoin market (measured by market capitalization). This is the ultimate proof of USDT's defensibility.

Several teams are working on stablecoin clearing houses, including DeFi protocols (such as StableCoinSwap, Shell); and central clearing houses like Stablehouse. If they succeed and thereby reduce the friction of trading stablecoins, then this has a negative impact on USDT.

For example, if these protocols/companies provide strong guarantees that large amounts of stablecoins can be swapped with minimal slippage, then derivatives exchanges might start to use other stablecoins as collateral. Today, FTX provides this service natively; however, the existence of liquid stablecoin clearinghouses may accelerate this trend, which may work against USDT.

secondary title

• Collateral Money Market - Compound/Lendf.me

• The unforkable state in Compound is its collateral. Compound’s defensibility can thus be understood as: as the value of the collateral pool increases, borrowers can lend more, which attracts more lenders, and so on.

• How difficult is it to fork Compound and induce liquidity in fake Compound?

• There are several ways to do this. Teams that copy Compound can:

Support assets that Compound does not support (such as USDT)

Introducing more favorable collateralization rates and liquidation penalties

Deposit your own assets in the asset pool and lend them to users, which can provide more competitive or even lower interest rates

Subsidize third-party lenders to lower interest rates.

Today, Compound has less than $100 million in collateral. If the knockoff Compound team competes with Compound by subsidizing users, for example, on the order of 100 basis points per year, then its annualized opportunity cost of inducing liquidity will be less than $1 million. Risks of this magnitude are investable.

However, in addition to Compound's internal liquidity (in the form of borrowing rates), Compound is also subject to several unique forms of external liquidity, which may provide additional defensibility.

First, there are third-party aggregators such as Instadapp, Zerion, RAY, idle.finance, Aave, etc. These systems route deposits to Compound, which in turn reduces borrowing rates, thereby attracting more borrowers. While natural capital flow is certainly nice, it's not clear that it matters at the margin (since the team at alt-compound can subsidize interest rates to channel liquidity). (Blue Fox Note: There is not only the issue of interest rate subsidy, but also the issue of balance. For lenders and borrowers, what is the most suitable interest rate? Strong defensibility, and the copycat Compound project also faces the same problem. From this perspective, the market can accommodate at least several copycat Compound loan agreement projects, and each one cannot be dominant)

Interestingly, the presence of aggregators can be counterproductive, as aggregators have an incentive to send user assets to the highest yielding lending pools. Assuming that contracts, governance, and oracle mechanisms have similar trustworthiness, aggregators will not be loyal to Compound at the expense of user interests, so Compound copycats can easily win the support of aggregators through subsidies. Also, a sufficiently large aggregator can siphon liquidity from Compound into its own pool or a Compound knockoff. Although this didn't happen, I expect it to happen in the next few years.

Overall, it is unclear whether third-party aggregators would be a significant source of defensibility.

Second, let's consider cTokens. cTokens are somewhat similar to DAI. If a third-party application integrates cToken

(e.g., as collateral), which would make cTokens more usable outside of the Compound core protocol. This makes it difficult for lenders (cToken holders) to transfer from Compound to other projects that copy Compound.

While the Maker/DAI and Compound/cToken analogy can be made, it is not a perfect analogy: the only reason to create DAI is to sell it and buy something else (e.g. more ETH). Therefore, copycat Maker is useless unless there is a market for copycat DAI. (Blue Fox Note: This means that no matter how good it can be, it cannot provide more functions, which is determined by its traction outside the agreement. However, if other collaterals can be mortgaged, things will be different For example, Kava can be mortgaged to btc, ATOM, BNB, etc., which brings other possibilities. In a sense, this is similar to the relationship between Compound and Lendf.me)

However, this is not the case for Compound. Even if third-party applications do not use cTokens, Compound is still useful. (Blue Fox Notes: cToken does not rely on external scenarios to survive. DAI needs external scenarios to survive.)

Empirically, this is exactly what one would expect. The dForce community from China forked the Compound codebase and launched lendf.me, a collateralized money market protocol, and in just a few months, they have introduced $20 million in collateral to their system.

*Provide products not supported by Compound (such as USDT, imBTC, HBTC)

*Integrate with local third parties for Chinese users

From this point of view, the dForce community does not necessarily have to subsidize the lendf.me product to achieve this. (Lendf.me, which is a fork of Compound, was attacked just today. Safety is the first in the DeFi world, and there is a long way to go.)

Maker is more defensible than Compound. With a subsidy budget, anyone can fork Compound and channel the internal liquidity of the lending market. However, successfully forking Maker requires more than a subsidy budget: it also requires DAI liquidity, and the availability of DAI outside the protocol.

secondary title

Universal Synthetic Asset Protocol - Synthetix

Synthetix is ​​a specific type of exchange focused on trading synthetic assets. The defensibility of an exchange is usually its liquidity. However, Synthetix is ​​not a traditional exchange because it does not offer a centralized limit order book (CLOB), which is offered by almost all exchanges in the market and crypto markets.

One of the most important features of Synthetix is ​​that Taker will not cause any slippage when trading synthetic assets to the mortgage pool. However, liquidity is also limited, which is subject to the amount of mortgage assets in the system. This implies liquidity, with defensibility, which is primarily a function of available collateral assets.

Interestingly, the growth of the Synthetix exchange is actually constrained by the need for takers to enter the Synthetix ecosystem by trading their real assets (such as ETH) for synthetic assets (such as sETH). Today, most users enter the Synthetix ecosystem through Uniswap, and the largest liquidity pool on Uniswap is sETH/ETH. So while the need for a liquidity bridge limits growth, it is in turn a moat: if someone tries to fork the Synthetix system, a similar liquidity bridge needs to be bootstrapped first. (Blue Fox Note: That is to say, first of all, there must be a liquidity pool similar to the larger real assets/synthetic assets on Uniswap, which has a certain threshold)<-->How does Synthetix's network effects compare to Maker and Compound?<-->Second, let’s consider exotic assets: DAI, cTokens, and synthetic assets. Unlike Maker's DAI, synthetic assets do not require liquidity outside the protocol... Instead, synthetic assets are more comparable to Compound's cTokens: like cTokens, synthetic assets can be used in third-party applications As collateral, but not necessary for the protocol to work. While this could be a source of defensibility, it's not there yet.

The most dominant form of defensibility is real assets

A bridge for synthetic assets. Although Synthetix is ​​using Uniswap to achieve this today, teams copycat Synthetix can easily provide their own real assets through Uniswap, Kyber or other free DeFi tools

A bridge for synthetic assets. (Blue Fox Notes: Essentially, it is also achievable through assets)

secondary title

Automated Market Makers (AMMs) - Uniswap, StableCoinSwap, Shell, Bancor, FutureSwap, and Kyber

Compound is an automated market maker, although it is for borrowing/lending rather than trading. In this way, the defensibility of most transaction-centric AMMs can be understood as comparable to Compound, except for cToken.

Empirically, this is indeed the case. While not all of these AMMs are directly competitive due to different product focuses (e.g. StableCoinSwap and Shell focus on stablecoin trading, while FutureSwap focuses on futures), the defensibility of each project basically depends on the flow of each protocol sexual size.

While larger liquidity pools in Compound allow for tighter lending rates, in transaction-centric AMMs, larger liquidity pools provide takers with lower slippage.

Kyber became the most liquid AMM in the past 12 months, mainly due to:

1) Enter other AMM liquidity pools, such as Uniswap

2) Since the third-party integration will route the taker order flow

Obviously, over time, all AMMs will leverage each other's liquidity pools.

Non-custodial centralized limit order book exchanges - dYdx, IDEX, NUO, 0x

Mixer——Tornado.cash

The defensibility of these protocols is comparable to that of centralized exchanges, albeit with some drawbacks.

First, all of these protocols are constrained by the constraints of their underlying blockchains on which they need to settle transactions, including non-deterministic order execution, high latency, and miner front-running. All these limitations hinder liquidity providers and therefore increase slippage.

Second, in general, all decentralized exchanges do not support cross margining or position netting. While I hope to eventually see this kind of development in the DeFi ecosystem, it's clearly still years away. Meanwhile, centralized exchanges FTX and Binance now offer cross-margin services and are rapidly expanding their offerings to maximize capital efficiency for traders.

secondary title

Tornado Cash is unique among the aforementioned DeFi protocols. While other companies focus on lending/lending and trading, Tornado focuses on mixing funds to maximize user privacy.

Also, beyond a certain point, larger anonymity pools don't matter from a marginal perspective. For example, as the anonymity set grows from 500 addresses to 1000 addresses, it's not clear that the next marginal user will care about this. Who would think that 1/500 is not good enough and 1/1000 is good enough? So, in its current form, Tornado Cash isn't all that defensible.

However, in a future version of the service, Tornado Cash aims to support private asset transfers in private pools (rather than just anonymizing funds, which is a currently available feature). In this model, capital is more sticky because it doesn't leave the system as quickly. This will allow anonymous pools to grow even larger, making them more useful for large-scale capital.

The idea that large-scale capital will only go to large private pools is unique relative to the other services mentioned above. For example, if the entire privacy pool has only 1000ETH, then, for someone who wants to anonymize 9000ETH, this pool is not available, and it is actually not good for the original 1000ETH in the pool, because the owners of the original 1000ETH may not I hope that 90% of the possibilities are related to another 9000ETH.

For a user who wants to anonymize 10000ETH, they might need a pool with 90000ETH. This model, while not yet usable, is clearly more defensible than the current situation because it makes the service available to the wealthiest people, who have the greatest incentive to hide their wealth.

secondary title

3.Mixers——Tornado.cash

Defensive ranking

Considering the hypothetical difficulty of forking these protocols, and our observable experience to date, I rank these protocols from strong to weak in defensibility. Note that ranking is only speculation as it cannot be quantified:

6.AMM——Uniswap、StablecoinSwap、Shell、Banco、Futureswap

1. Fiat-collateralized stablecoin——USDT

2. Synthetic Stablecoin——Maker

4. Universal Synthetic Asset Protocol - Synthetix

5. Collateral money market - Compound/Lendf.me

7. Non-custodial centralized order book exchanges - dYdX, IDEX, NUO, 0x

Based on the above, it should be clear why Maker is in second place. If DAI is not liquid and usable outside of the core protocol, then the Maker Protocol cannot function. These two characteristics are not easy to be forked, and it is difficult to replace them through subsidies.

I would rank Tornado third, above lending protocols, because wealthy users, who provide the vast majority of funds in these protocols, require the participation of other wealthy users. Also, because wealth is not evenly distributed (wealthy users are relatively few), I expect the market may only support 1-2 privacy markets, instead of 10+ markets like lending and trading markets.

Despite the similarities between Synthetix and Compound, I rank Synthetix above Compound due to the bridge between real and synthetic assets.

One of the common features of the second half of the agreements is increased competition. Empirically, this is clear: Entrepreneurs and venture capitalists are betting that these markets are less defensible. Furthermore, as mentioned above, competitors can relatively easily induce liquidity comparable to most current markets by subsidizing liquidity. (Blue Fox Note: In addition to the fact that the moat is not strong enough, the potential of the market size is also an important reason for their entry. Essentially, they are still in the early stage, and there is no possibility of one company dominating the market.)

secondary title

Network effects at the ecological network level

Before concluding, consider the implications of what was mentioned above for the defensibility of Ethereum.