Blockchain Technolgy & Decentralized Finance Part 1

Instructors:          Andreas Park & Zissis Poulos
 

 


Rotman – MBA

A tumultuous 12 months

The NFT Boom

  • "what is the real value proposition here? [...] probably nothing.”
  • "[...] a lot of people have grown weary of cash-grab tactics.”

The NFT Boom & Crash

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

The Aftermath:
is crypto dead or dying?

Cryptomarket Crash

bitcoin

ETH

-70%

-60%

Consequences of the Crash?

Some Questions

  1. Are blockchains no longer used?
  2. Is crypto investing dead?
  3. What other effects does the crash have?

Are blockchains no longer used?

transactions on Ethereum flat

Is crypto-investing dead?

crypto market follows traditional market

Is crypto trading dead?

trading volume on exchanges lower but steady

Are markets dead?

no meaningful net outflows from exchanges

Other consequences?

  • less hype will
    • attract less new capital
    • separate grain from chuff for projects
    • lower distractions
  • lower token prices
    • make working in crypto less attractive
    • make it harder for projects to pay people

Challenges

Proof of Work uses unsustainable amounts of energy

Source: Cambridge Bitcoin Energy Consumption Index https://cbeci.org/

Usage

Network DApps Dollarvolume
Ethereum 3,500 $40-50B
Solana 100 $2.5B
Binance Smart Chain 250 $3B
Avalanche 400 <$.5B
EOS 300 <$100M
Algorand 12 <$20M

Ethereum Challenge 1: Environment

  • Carbon footprint of Switzerland
  • Power consumption of Austria
transactions per second T per 12 hours (business day)
Bitcoin 7 302,400
Ethereum 30 1,296,000
Algorand 2000 86,400,000
Conflux 4000 172,800,000
Athereum 5000 216,000,000
Payments Canada ACSS 648 28,000,000
US retail 7639 330,000,000
Canada number of equity trades 46 2,000,000
Orders on Canadian equity markets 3588 155,000,000
  • Tweaks: lighting network (BTC) or side chains, SegWit, blocksize possible, but there are limits

  • microtransactions, IoT, and other smart contract use cases place very high demands

Ethereum Challenge 2: Throughput

Ethereum Challenge 2: Throughput

Source: Etherscan w re-scaling

Ethereum Challenge 3: State Size

Source: Ycharts

Major Ethereum Tech Upgrade: The Merge

scheduled date: September 13

Hacks, Thefts, and Exploits

Common Reasons: hacks, faulty code, tricking a protocol

Miner extractable value and High Priority Gas Auctions

5-minute version:
What is a blockchain?

blockchain=

an infrastructure for digital resource transfers

5-minute version:
What is a cryptocurrency?

cryptocurrency = 

internal payment mechanism to pay for operation of a blockchain

5-minute version:
What is Decentralized Finance?

decentralized finance =
provision of financial services without the necessary involvement of a traditional financial intermediary based on blockchain technology

Why should you care?

Verbal Overview: Origins of Financial Institutions

  1. Money
     
  2. Safekeeping
     
  3. Deposit certificates and lending
     
  4. Trade facilitation & finance
     

in practice: new financial infrastructure that will be a common resource

payments

stocks, bonds, and options

swaps, CDS, MBS, CDOs

insurance contracts

Application: decentralized trading

Application: Decentralized Lending

\(\vdots\)

dapp-linking, Defi-Legos and flash loans

Source: Harvey, Ramachandran, and Santoro (2020)

quick comparison

FinTech vs. Defi

FinTech

DeFi

  • more user-friendly UX
  • more customer-oriented
  • less squeezing/rent-extraction
  • more competive services
  • more innovative services
  • currently: horribly user-unfriendly
  • "blowing up the banks"
  • fundamental re-thinking of financial services
  • lots of scams, cowboy-attitude towards laws

innovation vs. salesmanship

main focus

Silos vs Common Infrastructures

Illustration of Infrastructure Frictions: money transfers

Version 1: They use the same bank

Change ledger entry locally

Version 2: They use different banks but the banks have a direct relationship

Sue's bank transfers from Sue's account to Bob's bank's account

Bob's bank transfers from its account to Bob's account

Version 3: They use different banks that have no direct relationship

Sue's bank transfers from Sue's account to its own account

Bob's bank transfers from its account to Bob's account

Central Bank

Central bank transfers from Sue's bank's account to Bob's bank's account

International transfers

Sue's bank transfers from Sue's account to its own account

Bob's bank transfers from its account to Bob's account

use the Swift network of correspondent banks

Bottom Line

very complex

many parties

lots of frictions and points of failure

very expensive

Crazy thought: Wouldn't it be nice if there was a single ledger?

Existing solutions

Problem:
power concentration/Monopoly

Distributed Ledger/Blockchain Technology

  • A "joint, single system"
  • Features:
    • secure storage of information and transfer of value
    • guaranteed execution of code
  • Promise
    • open platform
    • global reach
    • frictionless finance

How does it all work and why?

How do we establish trust in commerce?

trustworthy People

long-term Relationships

reputation

contract law

institutions

What's needed for trust in  anonymous deals?

Authority

Execution

Continuity

Authority

Do you have the item?

Do you have power over it?

Tool: "key" cryptography

Execution

Can we agree that it happened?

Tool:
consensus algorithm

Security and Continuity

Are the records immutable?

restricted permissions

really difficult to hack

premise of blockchain

no trusted parties needed

everything
in code

open to
anyone

platform or network

commerce thrives

How?

Future of Crypto: Regulators

  1. Presidential Executive Order
    • instructs several branches of government to develop rules around crypto assets
    • comments still open
  2. Regulatory competition
    • SEC and CFTC quibble over who gets to regulate crypto-assets
    • Gensler: "bringing regulation into the political fold"
  3. SEC regulation by enforcement
    • charged Coinbase executives with insider trading of unregistered securities
    • \(\to\) makes these crypto-assets securities
    • goes around the usual process (e.g., no comments)

United States

  • Treasury’s Office of Foreign Assets Control (OFAC) action against Tornado Cash = a mixer:
    • inbound crypto assets into pool
    • outbound to different address
  • used by Lazarus Group, fraudsters and thieves
  • Not gone, only website off \(\to\) many regulatory compliance questions

Most relevant case for FIs: Tornado Cash

  • Raises many questions
    • Privacy?
    • Culpability for code?
    • OFAC sanctions for miners or validators for processing TC transactions?
    • Compliance guidance/obligations for apps?
    • Rules for FIs that offer blockchain services?
    • Note: there are third-party risk mitigation providers (e.g., Chainalysis)
  • Stablecoins
    • create certainty and safeguard for the redemption process and disclosure for fiat-backed stablecoins to avoid spillovers
  • NFTs
    • create legal framework to link ownership of items to NFTs
  • Capital raising
    • create certainty for capital raising activities for items that are available to public by default
  • Decentralized Autonomous Organizations
    • define rules around DAOs
  • ​Tokenization
    • ​develop a framework that allows issuers to tokenize their existing securities​

Need for Regulation

  • Tax regime
    • ​create a reasonable tax regime for crypto-asset users (as opposed to investors)
  • ​Digital economy
    • ​adapt regulatory processes to the digital economy
  • Privacy rights and limitations​
    • create a framework to provide users with certainty on their rights to protect their privacy

 

@financeUTM

andreas.park@rotman.utoronto.ca

slides.com/ap248

sites.google.com/site/parkandreas/

youtube.com/user/andreaspark2812/

DeFi Intro Part 1

By Andreas Park

DeFi Intro Part 1

This is the slide deck that I use for a quick introduction to the Decentralized Finance class.

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