Many so-called innovations eventually turn into financial bubbles. But after the bubble burst, the real “gold” will also emerge.

As early as March 2000, the famous financial magazine “Babylon Weekly” published a cover article titled “Burning”, exposing the bad situation of Internet companies at that time.

Of the 207 internet companies surveyed, 71% have achieved negative profits, 51 companies will run out of cash within 12 months, and even mass internet icon Amazon’s cash flow will only last for 10 months .

At the time, Internet companies recognized by countless investors as potentially changing the world ended up being “Internet scams.”

Less than a month after the Babylon news, the Nasdaq fell 25%, and on April 14 alone, the Nasdaq fell more than 9%.

In the bubble movement, 52% of Internet companies listed on the US stock market went bankrupt, and the market value of the remaining 48% generally fell by 75%, of which Cisco fell by 90%, and there were rumors of delisting from Nasdaq.

20 years later, the Internet has become an essential element of human society. Advanced Internet technology has updated human life and production methods, and various Internet models have pushed business to an unprecedented peak in human business history.

It is rumored that Cisco’s delisted stock price rose from $6/share to $54/share, and Amazon rose from $1.3/share to $3,246/share, a rise of 2,500 times, making it the world’s largest e-commerce company.

Twenty years after the dot-com bubble burst, the yuan appears to have morphed into a global bubble. But what breakthrough technologies and achievements will truly change the world?

Defi (full name Decentralized Finance, also known as Decentralized Finance) may be worth noting.

Can DeFi reshape the financial world?

A few days ago, Dawn Fitzpatrick, CIO of Soros Fund Management Family Office, said, “We (Soros Fund Management Family Office) do have some cryptocurrencies, but not many. .These cryptocurrencies are not as interesting as use cases like DeFi.”.

Mr. Soros has spent his life in the financial markets, from shorting the Thai baht to shorting the Hong Kong dollar. He has a panoramic view of the storms of the capital market, and can be called an interesting financial product by his fund manager – very rare.

Many people may be confused. What is the definition that even Soros fund managers are interested in?

Defi is also a decentralized financial institution.

To understand what decentralized finance is, we must first understand centralized finance, that is, traditional finance.

In the traditional financial industry, we are most familiar with and inseparable from the three major institutions of banking, insurance and securities. The three institutions represent the three sectors of currency storage and settlement, risk hedging and asset flow, respectively.

In the existing financial system, financial services are mainly controlled and regulated by the central system, whether it is the most basic withdrawals, transfers, loans or derivative financial transactions.

DeFi wants to build a highly transparent financial system that anyone can access through the blockchain’s distributed system.

Because everyone can access and monitor, decentralized finance minimizes trust risks, even insiders cannot do evil.

In the infrastructure of cryptocurrencies, for example, the Ethereum browser has this transparent and open mechanism.

In the Ethereum browser, you only need to know the wallet address (account number) of the exchange. Everyone can check the recent transaction records of the exchange, and the transfer time, quantity, and transaction fee of each record are clearly visible.

 

At present, DeFi is not only favored by the Soros Fund, but also very popular in the entire cryptocurrency circle. Let’s start with a set of data.

In June 2017, the concept of DeFi was just proposed. The locked volume of DeFi capital pools in the entire cryptocurrency market is $682, ​​which is the data when the DeFi capital pools were created.

 

By May 2020, the locked position of DeFi capital pool has reached 1 billion US dollars, but we can see from the data chart that although it is 68.2 to 1 billion US dollars, it is still a horizontal line on the data chart.

In August 2020, the concept of DeFi broke out. The reason is that the impact of the popularity of US currency has made people in the traditional financial market begin to accept the new financial order in cryptocurrency – decentralized finance.

Since August 1, 2020, DeFi locked volume has skyrocketed from $4 billion. On September 6 this year, when the Biden big fund released water, the maximum locked volume of DeFi on the Ethereum chain was $80 billion.

This is just data in Ethereum tokens. If the data of an coin, Hoo coin and okex coin are added, the total locked amount is 200.4 billion US dollars.

 

In terms of the take-off volume of DeFi in August 2020, the locked volume of DeFi capital pools has increased by 20 times in one year and one month, and has reached 10 million times since 2017.

In just two years, the DeFi market has grown from a few hundred dollars to $200 billion, and the popularity of this market is self-evident.

Why can a seemingly conceptual DeFi attract the attention and favor of the Soros Fund and a large number of funds?

The emergence of DeFi is like building a new financial world and a new financial order on the network. In this financial order, there is no need to set up a separate financial management team, everyone is a financial supervisor, and all information is open and transparent.

Any nefarious information in DeFi will be fed back to the company’s credit, “a mouse warehouse, the entire company’s reputation has plummeted”.

The operation of the DeFi financial system is completely determined by the smart contract code without human intervention. (Smart contracts are automated blockchain programs that run on Ethereum)

For example, in traditional finance, I would like to borrow 10,000 yuan from Citibank. We all know that Citibank’s money belongs to depositors. We believe Citibank will not lend indiscriminately. Since Citibank has reserves and is regulated by the Federal Reserve, even if Citibank only has 5,000 yuan on hand, it can borrow 10,000 yuan for e-banking.

However, DEFI has no financial institutions. All financial systems operate according to smart contract code. Funds deposited by cryptocurrency players in DeFi capital pools are also coded to match lending transactions.

Suppose I borrow $5,000 online. As long as I have enough collateral, the smart contract will lend me 5,000 yuan. But suppose I borrowed 10,000 yuan from the DeFi capital pool, and the DeFi capital pool only had 5,000 yuan. Where will he exchange 10,000 yuan?

Even if the DeFi pool has 10,000 yuan and my collateral is not worth enough, DeFi will not believe that I can repay the 10,000 yuan, so the loan transaction will be automatically cancelled.

If my mortgage is enough for 10,000 yuan, and the DeFi smart contract also lends me 9,000 yuan, what if I can’t get it?

Defi smart contracts are the same as real life. If the collateral is not returned when it expires, the asset is directly auctioned and recovered. Only in the real world is the auction and recovery of collateral determined by humans, while everything in DeFi is determined by machine rules written in advance.

In DeFi’s financial system, everyone’s assets are strictly scrutinized by DeFi smart contracts. No one can tamper with the data. The data is open and transparent, and the smart contract code is responsible for everyone.

In the DeFi financial order, the loan problem in finance is solved, which also solves most of the problems in finance. Leverage, trading and derivatives are all derivatives of loans.

At present, in the Ethereum wallet, in addition to the financial products of the loan relationship, there are some financial products that subvert the three views of the financial world, and the automated market maker is one of them.

The exchange for each market maker?

In the stock market, the market maker system has existed for hundreds of years.

In English, market maker is translated as market maker. In other words, market makers create a market without a market.

The so-called “land without market” here does not mean that the market does not exist, but that the trading market is not active enough.

In traditional financial markets, only institutions with financial licenses and strong asset strength can become stock market makers; for example, Citigroup, JPMorgan, Morgan Stanley, etc.

Have you ever imagined that one day you could become a market maker in the trading market?

In cryptocurrency trading in 2017, due to the derivation of Ethereum smart contracts, there were two exchanges in the market, centralized exchanges and decentralized exchanges.

The so-called central exchange is an exchange led by local currency securities, fire currency and okex and controlled by different founders. They have control over the foreign exchange account and a veto power.

These exchanges are no different from Nasdaq and Dow Jones. The only difference is that one is stock speculation and the other is currency speculation.

In centralized trading of cryptocurrencies, order book matching transactions similar to stocks are generally used, that is, exchanges match buyers and sellers to trade, that is, you can sell bitcoins on exchanges because you are buying bitcoins on the exchange market at the same time. It’s a zero-sum game.

 

Decentralized exchanges are different from centralized exchanges. It has no founder or boss. All communication activities come from the “Volunteer Community”. Therefore, large orders can only use the market maker trading model to increase liquidity.

Since everything on DeFi is handed over to smart contracts, decentralized exchanges are more like a combination of exchanges + market makers. Here, we just need to accumulate a pool of funds on smart contracts, and everyone can become a market maker.

For example, the smart contract-based Uniswap exchange is one of the decentralized exchanges.

In the Uniswap exchange, unlike traditional centralized exchanges, it does not require registration. It only needs to connect its own cryptocurrency wallet to authorize transactions.

Uniswap exchange is still in its infancy. Its function is very simple. It has only three functions: exchange, sending and pooling.

The exchange and send functions correspond to the transaction and transfer functions in the centralized exchange, respectively. I won’t introduce them here.

The most interesting feature of the Uniswap exchange is the fund pool, which is also the exchange’s market maker system. In the interface of Uniswap exchange, as long as we have tokens in hand, we can participate in market making.

Furthermore, participating in market making is not complicated and does not require much operation. We just need to put the remaining funds into the exchange, and all transactions are done by the smart contract itself.

If we deposit Ethereum, officials will ask us to deposit an equal percentage of USDT. After depositing these two tokens, liquidity market making begins.

First, after you deposit your tokens, Uniswap exchange will provide you with a Liquidity Proof (LP). The liquidity certificate can participate in market making to obtain rewards after the locked capital expires, such as fee reduction, fee sharing, etc.

Secondly, Uniswap exchange will calculate your market making ratio in the capital pool based on your investment, and provide you with a commission for participating in market making.

On the officially launched Uniswap exchange, the fee per transaction is 0.3%, and the recent transaction volume has hovered around $500 million. Uniswap’s daily fee income is around $15 million.

For users who participate in Uniswap market making, the official will give 40% of users to participate in market making, and the remaining 60% will be used for research and development, volunteer community and event operations.

In my discussions with blockchain practitioners, “Junjun” told me, “She is very optimistic about the market maker model of Uniswap exchange. She believes that Uniswap exchange greatly mobilizes through capital pool rewards and free issuance The willingness of traders to participate in the liquidity capital pool.”

Because anyone can benefit from it, there is an incentive to provide mobility to Uniswap, which increases mobility and makes the user experience better.

Moreover, the operation mechanism of the exchange fully complies with the smart contract rules and market operation mechanism, which greatly reduces labor costs, and only the programmer team can complete most of the work.

However, “Junjun” also told me that Uniswap’s market-making business opportunity system is not yet mature. Decentralized exchanges are composed of code, and code loopholes are endless.

Defi is not a panacea

Any code-based program will have vulnerabilities. The key is how to patch the loopholes to prevent this phenomenon from happening again.

In April of this year, Uniswap discovered a smart contract vulnerability that allowed hackers to steal hundreds of thousands of dollars, and then Land platform’s lending platform (dforce is a lending platform on DeFi) also stole 2,500 due to the same vulnerability. Ten thousand U.S. dollars.

Remarkably, the hackers who stole the dforce platform returned $25 million untouched to the dforce platform a few days later, but it also awakened all investors in the DeFi capital pool. (dforce is a lending platform on DeFi)

According to the slow fog analysis of the blockchain security team, the hacker’s attack method is to exploit the lack of re-entrancy attack protection of smart contracts, causing the attacker to deposit bitcoins into decentralized exchanges and obtain other tokens that double in value currency. (equivalent to depositing one bitcoin and withdrawing two bitcoins)

After the theft of dforce, the founder of the decentralized platform compound tweeted that “if a project can’t build its own smart contract professionally enough, it just copies the source code and builds on the smart contract. Minor modifications, then they don’t actually have the ability to be a DeFi security review. I hope you can learn from this violence.”.

 

The cues from the Compound founders are very clear. The dforce project owner plagiarized our smart contract code, and their project owner is unprofessional.

After the incident, dforce’s decentralized lending was based on DeFi, and the amount of locked positions in the capital pool fell from a high of $250 million to $1.77 million. It took less than six months to go from peak to trough.

 

In addition to the risk of platform vulnerabilities, the risk of private keys has recently become prominent (private keys are equivalent to bank passwords), and since DeFi does not require any institutional supervision, the possibility of evil in DeFi projects has also greatly increased.

When some DeFi project parties issue their own decentralized exchange platform currency, they deliberately request authorization on the network side, allowing Xiaobai who does not understand cryptocurrency to enter the private key or mnemonic of their blockchain wallet. (The private key is equivalent to the bank card password, and the mnemonic is the combination of the bank card account + password)

After obtaining the mnemonic and other information of the blockchain Xiaobai, the project party can change the password and steal the cryptocurrency held by the user.

For example, Weibo user “Bingtang Orange Lunch” once granted approval rights to DeFi project parties, and he wrote on Weibo “the third day of airdrops, unauthorized theft and rework” (airdrops refer to cryptocurrency project parties “Wool” released to attract users)

 

Furthermore, the disadvantages of DeFi include high transaction fees, asset stability, and high currency premiums.

However, these two points are not evident in the popular decentralized exchange, and they can only be seen as a disadvantage, not a security risk.

Write at the end

People are reluctant to change because they are afraid of the unknown. But the only constant in history is that everything changes.

I once asked my crypto friends why Nakamoto had to create a decentralized token like Bitcoin?

“This is because Nakamoto is disappointed with the existing financial order in the US,” said the friend.

Looking back at the 2020 epidemic, Biden first discharged 1.9 trillion of water, and then discharged 5 trillion of water for large-scale infrastructure construction.

The dollar index fell from 101 to 89 in half a year. Wouldn’t such an order for abusive currency disappoint people?

Defi is an interesting concept that breaks the shackles of non-disclosure and transparency in traditional finance and creates an open financial market.

After all, as long as the decentralized financial code is safe enough, the financial assets we hold are safe enough.

However, despite this, DEFI is still in its early stages. Will DEFI surpass traditional financial models or even reshape traditional finance in the future? These remain the mysteries of the future of finance.

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