What have we learned from this round of DeFi ups and downs?

Source: Planet Daily

Author: Twenty-three Painting Students

JPMorgan Chase once called Bitcoin a fraud in 2017, worse than the tulip bubble; but now it says Bitcoin will compete with gold and has huge room for growth in the long run. From pyramid schemes to important innovations that have the opportunity to shake up traditional finance, the blockchain industry represented by Bitcoin has developed rapidly, and some outlets will appear every once in a while.

The market has calmed down recently after the DeFi boom, and new hot spots are still in the making. This article will sort out and reflect on the DeFi wave triggered by liquidity mining this year, and explore the next possible trend and investment opportunities.

DeFi is booming, whose cheese is being moved?

DeFi is not a new concept. The current DeFi leader MakerDAO was founded in 2017, and the DeFi pioneer BTS has existed since 2014, but DeFi became popular in 2020.

In mid-April, the decentralized lending platform Compound launched its governance token COMP. In less than two months, it surpassed Maker to become the largest DeFi by market value, officially opening the curtain of the DeFi 2.0 era. At the same time, the decentralized trading platform Uniswap emerged as a dark horse, impacting centralized exchanges by not requiring listing fees. At the same time, the biggest dark horse of the year, Yearn.finance, emerged, completing the 8-year market of Bitcoin in 30 days, and skyrocketing more than 10,000 times in 43 days. The total locked amount of DeFi has also increased by about 20 times compared with the beginning of the year. When it was at its peak, DeFi successfully triggered FOMO among investors in the currency circle, and even attracted the attention of regulators such as the US SEC.

However, since mid-September, major DeFi leading projects have led the decline, with COMP, UNI, YFI and other high points falling by about 70%, and DeFi instantly burst like a bubble. At the same time, fake coins are rampant, founders cash out and dump stocks, projects lack code security audits, and smart contracts have backdoors... Various strange phenomena have emerged one after another, and DeFi has been criticized and shorted by the currency community in an instant.

DeFi has been booming for a long time, but what caused the rapid decline of this wave of enthusiasm? Whose cheese was moved and hit? In fact, there are many reasons, but if we sort out the market trends and news, we will find that the most direct counterattack starts with the entry of centralized exchanges. In order to avoid capital outflow and miss the hot spots, CEX first launched DeFi tokens frantically in mid-to-late August, and then opened a special DeFi section, and even lowered the listing conditions in the face of the popularity, which helped push the DeFi craze to its peak, but also accelerated the decline of the DeFi craze.

Since September, many CEXs have entered the market of liquidity mining and conducted DeFi financial management on behalf of users. This move has greatly reduced the threshold and risk for traders to participate, making the originally risky and profitable DeFi projects gradually return to the normal range of returns, and the original "28 effect" has become "participation is the key".

In addition, with the stagnation of the coin price, liquidity mining has entered a vicious cycle: in the "dig-sell-withdraw" mode, large investors earn tokens by providing liquidity, and then withdraw and sell them, which once again creates selling pressure on the coin price. Secondary market buyers are locked in, and with the continuous outbreak of negative news, market confidence has been greatly lost, and the DeFi craze has already declined and is difficult to reverse.

Is it just a bubble? Face up to the financial innovation behind DeFi

Why didn’t Maker and the earlier BTS create a DeFi craze that led the moment? Is DeFi just another financial bubble with no value?

In fact, the rise of this round of DeFi is by no means accidental, but a financial innovation driven by technology and products. The temporary retreat of the DeFi craze is due to excessive speculation in the past, but it does not mean that there is no support.

Let’s start with financial innovation. Compound, the leading lending platform, innovatively introduced governance tokens. Lenders and borrowers can obtain governance tokens by providing lending assets and borrowing assets. The introduction of governance tokens has stimulated market participation. The number of assets provided and the number of assets borrowed in the Compound application have increased significantly.

In fact, the essence of Compound's business is margin trading. The activeness of Compound applications has made digital asset trading more active. Users can borrow digital currency from Compound applications at low interest rates, and then apply it to digital asset transactions that can obtain higher returns. Data shows that the trading volume of DEX leader Uniswap has increased significantly during the same period.

The [Constant Product] model adopted by Uniswap allows users to exchange tokens directly in the exchange pool, which not only changes the previous order book trading model, but also lowers the threshold for market making, allowing every user to become a market maker for a certain trading pair and share the commission income. This is very attractive to borrowers who have successfully raised funds and raised coins in Compound. Uniswap's innovative mechanism has, to a certain extent, seized some of the users and traffic of traditional centralized exchanges, which is also why Uniswap is more successful than previous DeFi projects.

yearn.finance is also financially innovative. As a decentralized financial platform, it covers complex functions such as aggregated liquidity pools, leveraged trading platforms, and automatic market making. It can automatically allocate and transfer tokens borrowed by investors to dYdX, Aave, and Compound to achieve maximum returns.

This series of financial innovations have jointly contributed to the DeFi boom. These innovations have important value. They have successfully migrated the original centralized financial facilities to the blockchain. This is the most important significance of this round of DeFi boom for the development of blockchain.

The future of DeFi driven by technology and products

Let’s answer the previous question again: Why did DeFi’s financial innovations emerge in 2020?

In fact, if there is only financial innovation without the corresponding blockchain technology and ecological development, it is not enough. Taking Compound, which we mentioned first, as an example, the oracle is indispensable. The oracle provides on-chain prices that can be referenced by smart contracts for various DeFi applications such as decentralized lending. Users of decentralized lending can lend or borrow based on the oracle price to avoid the loan price deviating from the market price and incurring losses. It can be said that the maturity of general tools such as oracles has provided important support for the large-scale emergence of DeFi applications.

The role of oracles is actually more powerful than imagined. Currently, the locked assets in DeFi applications are still mainly on-chain assets. However, in the future, more off-chain assets will be on-chain. Oracles can realize on-chain and off-chain data interaction, which will expand the application scenarios of DeFi more widely.

With the issuance of governance tokens in DeFi projects gradually completed, decentralized autonomy (DAO) is also an important technical support for the future development of DeFi. DAO is not a new concept. In 2016, The Dao, a DAO organization based on the Ethereum blockchain platform, was born, but due to loopholes in the smart contract, huge amounts of funds were transferred by hackers. DAO can realize the equity structure table, token conversion mechanism, voting, job appointments, financing and accounting required for the establishment of an online version of the company on the blockchain. When the DeFi project enters the community governance model, DAO needs to provide more mature and more complete governance functions, only in this way can DeFi be guaranteed to develop more vigorously.

In addition, the interconnection of all things and the interconnection of all chains are not only the theme of the times, but also the bottleneck that the blockchain industry urgently needs to solve. DeFi projects are still mainly concentrated on the Ethereum chain. In the future, the development of cross-chain technology is important and urgent. Cross-chain technology can enable more private chains, public chains, etc. to interconnect, break the island effect, support more assets on the chain, meet more real transaction needs, and promote the prosperity of on-chain finance.

It can be seen that under the bubble, infrastructure such as oracle services, DAO architecture, and cross-chain technology are quietly evolving and maturing deep in the soil, waiting for the arrival of the next wave of DeFi craze.