The past few months have seen an unprecedented blow to the crypto industry: multi-billion dollar crypto banks face bankruptcy, largest hedge fund sells NFTs in response to liquidation, centralized crypto institutions face collapse… but surprising The thing is, after this storm, DeFi is still standing. I believe this also reflects the value proposition that the crypto community has been promoting to the outside world – creating an open, public, and accessible financial ecosystem for the world.
Because of this, DeFi will never die.
Why do you say DeFi will never die?
To design a strong economic system, we must first recognize this complex reality and accept the human instinct of greed and ignorance. Also, you have to understand that the resilience of the economic system has nothing to do with bull market performance, but the ability to adapt to market changes without the intervention of regulators or giants.
Second, to judge whether an economic system can be sufficiently resilient in financial markets, the following questions are also crucial:
1. Can the system effectively clear bad debts?
2. For unsustainable business models, does the system choose to eliminate or support?
3. Can the above two points be achieved before the systemic risk accumulates to a certain extent?
4. When systemic risk arises, can it be solved by minimizing active management and negative spillover?
In fact, the decentralized financial system is more closely related to these goals than the centralized financial system, because both from the perspective of the design of the protocol token economic system, and from the daily financial management and balance sheet. In terms of health status, everything in the DeFi system is on the blockchain, and it is open and transparent. Anyone can observe and monitor it in real time, and everyone can clearly understand the investment trends and potential risks of giant whales.
We often see mainstream media describe DeFi as the “Wild West of the financial sector”, but this metaphor is not appropriate, because DeFi’s self-regulation mechanism is actually very perfect –
Self-regulation in DeFi
Take Lido Finance and Solend as examples:
With Lido staking nearly a third of the total ETH supply, it could start to pose a centralization threat to Ethereum after the transition to proof-of-stake. As such, Lido initiated a governance proposal vote on whether to limit the amount of ETH deposited into the Liquid Staking Protocol. As a result, the self-limiting governance proposal failed, and 8 additional validators were subsequently added to further strengthen the decentralization of the Lido validator set.
Solend, the largest lending protocol on the Solana chain, faces a more pressing situation. It was found that liquidating a single whale’s margin position ($170 million) would have catastrophic consequences and have serious implications for the entire chain if the price of SOL continued to fall. To this end, Solend developers put forward a series of governance proposals to the community, such as taking over the whale account and performing safe liquidation, but the final solution was to introduce a new rule – limiting the amount of borrowing to 50 million US dollars (this giant Whale borrowed $108 million).
Of course, although Lido and Solend may not be able to get out of the predicament after taking relevant governance, the uniqueness of DeFi can already be felt by the governance process of these two platforms.
Thanks to the transparency of blockchain rules and on-chain activities, a community of internal and external stakeholders has aligned goals and works together to solve problems. The two cases mentioned above were all community members who followed up in a timely manner after discovering danger signals, and finally gave solutions after in-depth technical discussions to prevent problems before they occur.
Conversely, if people turn a blind eye to these risk choices, then the system is bound to be maliciously attacked, and the consequences will be disastrous. So is there a general solution to this kind of problem? In this regard, TradFi (traditional finance) responded like this: “The government will solve it through laws”, while DeFi’s answer is very cool: “Everything is decided by the code.”
The decline of centralized finance
Compared with DeFi’s active self-rescue, the encrypted banks that have fallen like dominoes in the past month have become much more passive. In fact, at the center of this storm is the most important hedge fund in the crypto space, Three Arrows Capital, whose liquidity problems were exposed as early as mid-June, when Three Arrows Capital had already been liquidated by an OTC platform with a total of up to $400 million.
Soon, the liquidation incident of Three Arrows Capital exposed other high-risk shadow trading problems of encrypted banks: misappropriation of depositor funds, such as BlockFi providing $1 billion in over-collateralized loans to Three Arrows Capital, and Voyager Digital providing it with about $670 million dollar loan. Although Voyager Digital’s capital ratio is relatively safe (the loan interest rate is only 4.3%), it was also caught in the wrong decision to provide three arrows with more than twice its capital in a concentrated loan. predicament.
Of course, risky transactions in the financial sector are everywhere, not just in crypto banks. The crux of the matter is how the system should govern and deal with risks when they come.
Unlike DeFi’s approach to risk, because crypto banks’ balance sheets are centralized, the community cannot conduct independent investigations, and these over-leveraged and risky transactions of crypto banks can only be done when the paper can’t cover it. It is known to the outside world, and at this stage, everything is too late. The biggest problem with such “centralized” crypto banks is that most transactions are bilateral over-the-counter transactions behind closed doors, only known to insiders, and they will only disclose information after a liquidity crisis, because this is in the The only condition for legally withdrawing funds.
The openness and transparency of DeFi can avoid the risks brought by “centralized players”
For an in-depth look at the comparative advantages of DeFi, take a look at how centralized players conduct decentralized exchanges.
Let’s look at three examples –
Example 1: Celsius
The Celsius problem was first exposed, in fact, because they had signs of insolvency in a series of on-chain loans. For example, there was a pledge transaction of 17,900 WBTC in the Maker vault that could not be repaid. Celsius hurriedly replenished the funds to avoid bitcoin prices. The drop led to the liquidation of the collateral (the loan was fully paid off on July 7), and soon other loan issues from Celsiu followed, including a 458,000 stETH pledge on the Avalanche chain, and a Lending collateral on Compound and Oasis.
At the beginning, Celsius CEO also swore that there would be no problems, but since Maker, Avalanche and Compound transactions on the blockchain are all open and transparent, crypto users quickly discovered potential risks and began to worry about the community. Make an early warning. Sure enough, Celsius soon announced the suspension of withdrawals. Although the alarm bell sounded a little late, without the public information of DeFi, more people may suffer losses and the problem will last longer.
Example 2: Terra
In fact, the Terra disaster was first discovered because of the transparency of DeFi, because Terra’s liquidity was rapidly drying up on the Curve protocol, “The UST exchange rate was under pressure for the first time on Sunday, May 7, mainly due to USTw – A $85 million UST-to-USDC exchange from the 3CRV Curve pool… This single block transaction shook the public’s confidence in the pool’s liquidity providers, and people rushed to withdraw their 3CRV, leading to May 8th Funding pool UST: 3CRV dropped to 77%: 23%.”
After the story, I believe everyone already knows.
Millions of Terra investors panicked, Do Know famously tweeted that “more UST will be deployed”, and Luna Foundation Guard, the centralized entity behind Terra, started changing hands with $1.5 billion worth of Bitcoin to stabilize Its algorithmic stablecoin. All of these operations, not based on smart contract rules, resulted in the collapse of Terra when the “flood” of Anchor poured out.
Example 3: Three Arrows Capital
In the case of Three Arrows, many analysts know their balance sheet is unhealthy, as on-chain data clearly proves that they lost $560 million in LUNA locks in May this year before delisting stETH in July. position. The mystery of 3AC’s bankruptcy is not complete, but a few pieces of information are enough to allow us to speculate on the problem.
In the end, you will see that these centralized players are quickly approaching bankruptcy. Why go to bankruptcy? Because the high-risk and leveraged closed-door bilateral transactions between CeFi platforms can only be resolved through legal channels, this is their only option, and maybe they can get a better outcome for themselves in court. In contrast, DeFi does not have similar problems, because you cannot argue with smart contracts under the premise of openness and transparency.
The above three examples all prove one point: Celsius, Terra and Three Arrows Capital are not true on-chain DeFi, and we only understand the risks before the night comes. It is indeed difficult to completely avoid and prevent such a crisis, but if they Is the real DeFi, perhaps the tragedy will not happen.
Greed and stupidity may be human nature. As the Scottish Enlightenment philosopher David Hume said, a truly resilient political and economic system should be based on the basic facts of human nature, he said:
“.Everyone should be considered a scoundrel who has no other purpose than personal gain in all his actions. We must govern him through this benefit, and though he remains insatiable and ambitious, he will be willing to serve cooperation in the public interest.”
The advantage of DeFi is actually to take advantage of human nature, and then design ruthless smart contracts around this nature. In DeFi, the code is the liquidator, and the code is the settlement engine. So you will find that Celsius, Terra, and Three Arrows Capital have fallen, while major DeFi protocols such as Aave, Compound, and Maker are working well. For example, in June 2022, Compound, Aave, and Maker successfully completed “9 figures” , of which Compound liquidation is about $9.9 million, Aave liquidation is about $2.6 million, and Maker liquidation is about $49 million.
In DeFi, there are no closed-door negotiations, no deferral of issues to the courts, no lobbying of regulators, just one thing: comply with smart contracts, and isn’t that what a resilient economy should be like?
This is DeFi.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/bankless-why-defi-will-never-die-2/
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