AN INTRODUCTION TO BLOCKCHAIN,
CRYPTOCURRENCY, AND
DECENTRALIZED FINANCE

Andreas Park

MFIN 2021

Agenda for the presentation

Answers and quick explainers to some questions - what is $\ldots$
- a cryptocurrency
- a blockchain
- Decentralized Finance
An Outlook:
- Some risks and what's coming over the next years.

What is a blockchain?

What is a cryptocurrency?

What is Decentralized Finance?

decentralized finance =
provision of financial services without the necessary involvement of a traditional financial intermediary

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

$\vdots$

borrowing and lending rates compounded per block

Smart Contract Derivatives with Synthetix

creations of Synths
- tokens linked to underlying price feed provided by a Chainlink Oracle
- long asset: sToken (sETH, sBTC)
- short asset: iToken (iMKR iAAV)

How does it work?

single collateral asset SNX $=$ utility token
you mint sTokens against SNX
you incur debt as proportion of total debt of system

Securities Creation: Tokensets

idea: create new mutual fund like asset

dapp-linking, Defi-Legos and flash loans

Source: Harvey, Ramachandran, and Santoro (2020)

Does it matter economically?

Coinbase (Centralized Crypto Venue) Financials

Application: decentralized trading

Daily volume of decentralized trading commonly exceeds that of Coinbase (mcap: $52B)
Fees earned on DEX per day exceed several millions

Risks and open problems

many apps are still experimental, many kinks need ironing, and tech progress is needed
smart contract risk:
- detecting problems with code
- detecting problems with economic incentives
- foreseeing unforeseen contract contingencies
- contract contagion risks
governance of decentralized organizations
role of regulators

Where is the regulator?

Crypto Wash Trading, Lin William Cong, Xi Li, Ke Tang, Yang Yang

unregulated exchanges: rampant manipulations
70% of reported volume fake & temporarily distort prices

Volume Manipulation

Cryptocurrency Pump-and-Dump Schemes
Tao Li, Donghwa Shin, and Baolian Wang, 2020

What is pump and dump?

arranged via Telegram Channels

Pump-and-dump

Text

IS BITCOIN REALLY UN-TETHERED?
JOHN M. GRIFFIN and AMIN SHAMS
Journal of Finance 2020

Flow of events

Tether is authorized
moved to Bitfinex
then slowly distributed to other Tether-based exchanges (Poloniex and Bittrex)
$\to$ almost no Tether returns to the Tether issuer to be redeemed
Kraken (major exchange for Tether$\to$ USD) accounts for only a small proportion of transactions

Figure 1. Aggregate Flow of Tether between Major Addresses

Price Manipulations with Fake Money

the 1% of hours with the strongest lagged Tether flow are associated with 58.8% of the Bitcoin buy-and-hold return over the period.

Is the Price Effect Economically Important?

the "normal-times" returns

August 2016

Centralized exchanges are a security risk

https://www.osc.ca/en/news-events/news/osc-working-ensure-crypto-asset-trading-platforms-comply-securities-law

Centralized exchanges are a security risk: regulatory action

Regulatory predictions

Centralized exchanges regulation (OSC has started harassing them)
Stablecoins
Ontario's new Capital Markets Act draft proposes that Chief Regulator can designate any crypto asset a security

What lies ahead?

Evolution