the what, why, and how of Decentralized finance
Zissis Poulos
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
- Are blockchains no longer used?
- Is crypto investing dead?
- 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
- Money
- Safekeeping
- Deposit certificates and lending
- 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
- Presidential Executive Order
- instructs several branches of government to develop rules around crypto assets
- comments still open
- Regulatory competition
- SEC and CFTC quibble over who gets to regulate crypto-assets
- Gensler: "bringing regulation into the political fold"
- 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/
Copy of Topic 1: Introduction to Decentralized Finance
By zpoulos
Copy of Topic 1: Introduction to Decentralized Finance
This is the slide deck that I use for a quick introduction to the Decentralized Finance class.
- 237