DeFi solves the five shortcomings of traditional finance, book review

DeFi solves the five shortcomings of traditional finance, book review


Writing a book on decentralized finance is a bit like describing a riddle. It is wrapped in a mystery and borrowed from Winston Churchill. First, we must summarize the origin of modern decentralized finance, and then provide the mechanism of blockchain technology that is the backbone of the industry, and then we can understand the DeFi infrastructure. All this should also be done in 191 pages, including glossaries, notes and indexes. This is not the business of the faint-hearted.

Fortunately, the author DeFi and the future of finance — Campbell Harvey, professor of finance at Duke University, Ashwin Ramachandran, general partner of Dragonfly Capital, and Joey Santoro, founder of Fei Labs — are up to this task. After summarizing the “five flaws of traditional finance”-inefficiency, restricted access, opacity, centralized control, and lack of interoperability-they went on to explain how DeFi can improve the status quo.

Take the problem of centralized control as an example. The author writes that the government and large institutions have “virtual monopolies” over money supply, inflation rates, and “obtain the best investment opportunities.” DeFi “subverts this centralized control” with its open protocol and immutable properties.

As for how DeFi solves the shortcomings of traditional financial opacity: “All [DeFi] The transaction party understands the capitalization of its counterparty and understands how the funds will be deployed to the extent needed, thereby reducing counterparty risk. Due to inefficiency, for example, in decentralized applications, by exercising put options, “users It can be self-service to a large extent within the parameters of the smart contract”.

What if traditional finance fails in restricted access? The author writes that DeFi provides direct access to financial services for underserved groups such as the unbanked population in the world. Taking yield agriculture as an example, this is a DeFi process in which users receive capital rewards in the form of governance tokens. As a matter of fact, part of the owners of the platform, “rarely seen in traditional finance.”

The author also describes the ways in which DeFi protocols can be superimposed on each other (that is, the composability of DeFi, sometimes referred to as “DeFi Lego”), which helps solve interoperability deficiencies. Once the infrastructure has been established (such as the creation of synthetic assets), “any new agreement that allows lending can be applied. Higher levels will allow leverage over borrowed assets.”

Deep dive

Chapter 6 delves into eight leading DeFi protocols: MakerDAO, Compound, Aave, Uniswap, Yield, dYdX, Synthetic, and Set Protocol. Each section is accompanied by a very useful table. The first column describes how traditional finance solves a specific problem, and the second column describes how a specific DeFi protocol handles the problem.

For example, in Table 6.3 “Problems Solved by Aave”, the first line deals with “centralized control”.In the existing financial system, the “borrowing rate [are] Controlled by the agency”, while in the DeFi method, column 2, “Aave interest rate is controlled by algorithm. ”

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Traditional finance only provides “limited access” in its legacy system. In other words, “only selected groups can obtain large amounts of funds for arbitrage or refinancing” (line 2, column 1), and in the Aave agreement, “flash loans democratize the opportunity for liquidity for immediately profitable companies “.

The third line focuses on “inefficiency”, especially the “suboptimal lending rate due to cost inflation” in traditional finance, while Aave’s solution (row 3, column 2) is “algorithmic aggregation and optimization of interest rates”.

New risk

The author carefully reminds readers that “all innovative technologies will bring a series of new risks.” As far as DeFi is concerned, these are very rich, including smart contracts, governance, oracles, capacity expansion, DEX custody, environmental and regulatory risks.

“Software is particularly vulnerable to hacker attacks and developer misconduct,” the author wrote, and recent hacks on bZx and DForce “prove the vulnerability of smart contract programming.”

Among these new threats, the “oracle risk” is particularly prominent. The DeFi protocol requires access to accurate and secure price information to ensure the smooth progress of actions such as liquidation and prediction market resolutions. “Fundamentally speaking, the oracle aims to answer a simple question: how to safely report off-chain data on the chain?” However, all online oracles currently constituted are “susceptible to preemptive transactions, and arbitrageurs have already lost Millions of dollars,” they wrote, adding:

“Before oracles became native to blockchain, enhanced and proven to be resilient, they represented the greatest systemic threat to DeFi today.”

Cultivate “marginalized groups”

“This book is basically about financial democracy,” co-author Harvey told Cointelegraph. The foreword of this book is written by a person who is also the creator of Ethereum, Vitalik Buterin. It reminds readers that “financial review is still a problem for marginalized groups”, especially in developing countries-this is why DeFi is so important. .

However, ordinary readers may find this book a bit heavy in terms of technology. For example, graphs include super-linear and logical/sigmoid bond curves, which may be beyond some people’s imagination. However, those who want to understand how fast loans actually work will find it useful. The vocabulary in this book is comprehensive and useful.

related: DeFi: A Comprehensive Guide to Decentralized Finance

However, it would be instructive to learn more about how DeFi started to truly change the world, such as providing banking services for people without bank accounts, or providing insurance for people without insurance—although this may be beyond the scope of this book.

One might ask, what percentage of the “unbanked population” in the world is actually using “yield agriculture”, which is a DeFi process that is still esoteric, and the author still refers to it as DeFi for “many people in need of financial services” “An example of a way to provide access is those left behind by traditional finance. “Not too much, some people guess.

Unfortunately, most of the focus in today’s DeFi world still seems to be how to obtain leverage or arbitrage between markets, rather than solving the problems of the global poor.This book does not use too much ink to defend DeFi from criticism from general commercial media such as the Wall Street Journal., Which famous In September, DeFi was “bringing casino capitalism to the cryptocurrency public”.

This is not the author’s vision for the future. Instead, they saw the “scaffolding of a shiny new city” in DeFi. […] Everyone can use finance. No matter who you are, high-quality ideas will be funded. A $10 transaction is treated the same as a $100 million transaction. As the wasteful middle layer is eliminated, the savings rate rises and the cost of borrowing falls. Ultimately, we see DeFi as the greatest opportunity in the next decade and look forward to the reshaping of the financial industry as we know it. “

These are valuable goals, although they are unlikely to be achieved in the near future. Until then, anyone who wants to understand the inner workings of DeFi will be interested in this book.