Blockchain in 2022 and beyond
A Primer
 

Presenter:           Andreas Park
 

 

Agenda

  1. Background:
    • Vocabulary & Evolution
    • What's DeFi and what's different to TradFi?
    • What do we know about tokens?
       
  2. What happened with FTX & Terra?
     
  3. Outlook

The Premise of the
Internet & Blockchain

Peer to Peer Communication

Peer to Peer Value

!

?

?

Sidebar: What is digitize-able value?

  • money
  • digitally native assets
  • claims on resources and property
  • identity, personal data

The challenge: how do you ensure digital scarcity?

  • traditional approach: unique record-keeper
  • problem:
    • intermediary necessary for record keeping
    • tight supervision of custodian
    • no peer-to-peer
  • What is the equivalent of TCP/IP for value?

What is a Blockchain?

What is a Cryptocurrency?

  • a blockchain is not a thing, it is a protocol \(=\) an idea and an approach
  • it is not going to be uninvented

Why is this idea powerful?

blockchain = a protocol that creates a common resource for value management

payments

stocks, bonds, and options

swaps, CDS, MBS, CDOs

insurance contracts

  • create & manage assets
  • transfer value
  • contingent contracts
  • guaranteed execution of sets of commands
  • applications

What makes DeFi different from TradFi

decentralized finance =
provision of financial service functionality without the necessary involvement of a traditional financial intermediary like a bank or broker-dealer

digital media =
provision of information service functionality without the necessary involvement of a traditional information intermediary like a publisher, library, or newagency

trading Infrastructure

payments network

Stock Exchange

Clearing House

custodian

custodian

 beneficial ownership record

seller

buyer

Broker

Broker

Blockchain Infrastructure

seller

buyer

Application: decentralized trading with automated market makers

New institutions!

  • passive "shared" liquidity provision
  • new pricing function

Dapp composability & Flash loans

1. flash-borrow DAI

5. repay DAI

3. receive ETH

4. convert ETH to DAI

2. liquidate ETH loan with DAI

Loan liquidation opportunity

Examples of research questions in the literature

  • system risk from liquidations
  • contagion risk
  • price impact from liquidations

Securities Creation: Tokensets

idea: create new mutual fund like asset 

Philosophy of Peer-to-peer

Traditional Market 
two-sided with fixed roles

  • consumers \(\leftrightarrow\) producers
  • consumers \(\leftrightarrow\) intermediaries \(\leftrightarrow\) producers

Decentralized Market?
value management protocol \(\not=\) market

  • blockchain \(=\) application execution \(=\) intermediary
  • blockchain-native \(\Rightarrow\) requires platform thinking
  • consumers \(=\) producers

Peer-to-peer \(\Rightarrow\) Platforms

liquidity \(\nearrow\)

volume \(\nearrow\)

protocol fees \(\nearrow\)

token value \(\nearrow\)

Platform economics is tricky:

  • What's the product?
  • How do you get it started?
  • How do you get people to contribute?
  • How do you earn money?

Who controls the Projects? Decentralized Autonomous organizations

UniSwap Lab supports development

a website app accesses the code

token holders control contact features

don't own the code

operation = decentral

control = decentral

anyone can use the baseline code

core code runs on the blockchain

tokens used as rewards

A Taxonomy of Tokens

  • tokens are a re-imagination of value, ownership, use, rewards
     
  • tokens live on a single infrastructure and can interact with other tokens
     
  • tokens are immediately transferable  & immediately usable in DeFi
     
  • token can be programmed to have many features and have many different uses

  • tokens can assign ownership to "things" that could not be owned before

What's a crypto-token and what's special about it?

  • a blockchain is a protocol in which
    • users have direct control and responsibility over their assets
    • users can create codes at will
    • \(\rightarrow\) any user can create tokens and applications

Tokens by use

payments:

  • you use them strictly to pay for something
  • example: native cryptocurrencies


     

utility

  • you use them to access a specific service of function
  • example: filecoin


     

stablecoins

  • digital representation of fiat money
  • centralized/ decentralized
  • examples: DAI, USDC, USDT
     

governance

  • voting rights to determine parameters of a project
  • example: UNI, Compound etc

     

asset

  • representation of ownership
  • pool claims, digital items
  • example: receipts from UniSwap, Compound, NFTs

derivatives

  • tokens based on other tokens & functions
  • Example: tokensets



     

Disclaimer: this list in non-exhaustive, new ideas and concepts come up every day!

- End of Theory - 

An ugly 9 months

From a slow slide to a thorough crash

-75%

-75%

!

The Terra Implosion

UST Stablecoin

LUNA (cryptocurrency of the TERRA network)

A timeline

 May 7: selling pressure on UST from Curve withdrawals

May 12: LUNA and UST at $0.01

June 27: Three Arrows Capital ordered to liquidate

June 12: Celsius Network suspends withdrawals

July 13: Celsius files for Chapter 11

July 6: Voyager Digital files for Chapter 11

July 4: Vault suspends withdrawals

Three Arrows Capital lost >60% of value and faces numerous margin calls that they did not react to

\}

partially "saved" by \(\ldots\) FTX

The FTX Implosion

A timeline

Nov 8

Recurring Core problem QuadrigaCX:

  • QuadrigaCX:
    • Gerry Cotton sold people crypto he did not have
  • FTX:
    • auto-execution of margin calls for all except Alameda
    • SBF used customer funds to hide "short" market maker Alameda

Fundamental Problems: Solution sans Regulators?

IN FINANCE TERMS

  • hedge = off-setting position
  • here: unhedged/"leverage"
     

Solution

  • prove aggregate positions
  • prove assets & liabilities
  • asset = liabilities \(\Rightarrow\) solvency

New trend: data providers check assets

  • Assets: cash in bank accounts and crypto assets in exchange wallets

  • Liabilities:  customers' crypto and cash deposits

  • Proof of crypto assets

    • publish all exchange wallets

    • proof of control: shift assets from one address to another at a pre-determined time
       

  • Proof of crypto liabilities

    • public customer balances - customer can check

      • own holding

      • sum of all

  • Problem: privacy (adequate solutions exist)

Proof of Assets & Liabilities

A timeline

 May 7: selling pressure on UST from Curve withdrawals

May 12: LUNA and UST at $0.01

June 27: Three Arrows Capital ordered to liquidate

June 12: Celsius Network suspends withdrawals

July 13: Celsius files for Chapter 11

July 6: Voyager Digital files for Chapter 11

July 4: Vault suspends withdrawals

Three Arrows Capital lost >60% of value and faces numerous margin calls that they did not react to

\}

partially "saved" by \(\ldots\) FTX

all centralized!

Centralized vs Decentralized?

Path forward

  • blockchain as an idea will not become uninvented
  • there is continuous research & development, including by universities
  • when another hype starts, people will want to get their hands on the assets
  • blockchains are borderless by design
  • "tough" regulation pushes firms outside of jurisdictions
  • no regulation can prevent the bankruptcy of an offshore entity
  • jurisdictional battles among regulators have to end
  • willing issuers need clear guidance 

Summary and Outlook

Three Scenarios for the Next Five Years

borderless digital economy \(\to\) blockchain-integrated

blockchains \(\to\) stay niche (gaming)

mass tokenizations \(\to\) likely originates from non-Western world

@financeUTM

andreas.park@rotman.utoronto.ca

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