Author: Zheng Jialiang, Research Director of Blockchain Investment Fund HashKey Capital
After more than 2 years of development, the Decentralized Finance (DeFi) industry has gradually demonstrated a strong ecology. Although this ecology is based on Ethereum, the ecology of DeFi is not completely equal to Ethereum. Last year we think DeFi will move closer to the traditional financial and learn a lot of standard design. But to rely on the center, no review of the properties, DeFi has developed a different appearance.
This article summarizes the brief points of the DeFi track as follows:
DeFi’s AMM is a new way that can make up for the deficiencies of centralized exchanges (CEX) and has great potential for development. In the past, present, and for some time in the future, transactions will still be the number one demand in the blockchain world;
Borrowing from the rising demand for mobility mining, and nested lever, which plays a role in amplifying gains;
Decentralized derivatives are more complicated, and mature platforms have not been seen in decentralized exchanges. Derivatives and synthetic products combined with contracts will develop;
Participants to the center of the insurance is still very small, industry demand is very rigid, the track was pulling effect. The return on risk investment will be great.
We also made a brief quantitative analysis to study the return characteristics DeFi class tokens, and found a few interesting phenomenon:
According to the current data, price-earnings DeFi tokens and short-term benefits mining has little (a little counter-intuitive, as explained later);
Surprisingly, the income of DeFi tokens has little to do with ETH ;
DeFi tokens and returns two largest relationship, a token bit is, a significant negative correlation characteristics, and the other is non-small-cap altcoin DeFi class exhibit significantly in the same direction, it indicated that more DeFi exhibits characteristics of altcoin;
Our statistics show that there are still about 33% of the changes that cannot be explained, which may be attributed to factors such as valuation, fair launch and long-term mining revenue, and project fundamentals.
We judge the prospects of this liquidity mining as follows:
Mining is a good flowability use onboarding profit of a user, as the Uber, drops and Internet products early subsidies;
Reflects a certain amount of fairness, so that the community fully positive contribution, hard work;
But still can not help being controlled predators, large predators like mine pool miners, who benefit the most capitalized;
The hastily launched community projects are more dangerous. The actual value of the project has not received tokens of inspection, economic models of many projects has not straightened out, only token management functions, it is difficult to capture the value, overshadowed by FOMO atmosphere;
The later the project is more difficult to go online, the taste of the community is getting higher and higher, and there will be a situation of “picking eyes”. Refer to the later stage of the IEO (this is now the case) ;
Sure to leave some truly valuable products and economic model, but not the majority;
Congestion costs Ethernet Square, but rather against the backdrop of other public chain, the next generation of male chain competition increases the uncertainty.
Transaction: AMM mechanism organic solution
Coin listing, cold start, slippage, liquidity issues
We believe that the most important DeFi is a big breakthrough here in the decentralized exchange.
The idea of DEX in the past was to directly move CEX’s order book model to the chain. Although it can realize the self-managed assets of the blockchain and the absence of KYC/AML, it ignores three problems:
This mechanism and CEX compared to no advantage, because orders can not catch up with the speed of the center of the thin trading center of the order, there is no way of timely price discovery;
The current structure of Ethereum has extremely slow transaction speed;
Create Order also need to pay the gas fee (not traded and will not be returned). So basically DEX can only appear as the role of CEX’s copycat.
AMM, liquidity mining and project startup mechanism are closely integrated
In fact, however, DEX advantage lies in quick to get the open market liquidity, but if you want to listing on the CEX, you need to go through lengthy procedures and greatly overhead (at least used to be so). It can be said that the CEX model determines that it is impossible for the project party to operate in a decentralized small team or community model. A complete set of financing, issuance, currency listing, and market making processes is very difficult to complete without a team to do a cold start.
DEX can just send money and community corresponding to the pattern (now slowly standardization), a project of DeFi token, there is no strong team to operate, it is difficult to get through CEX, but quickly realized transactions on DEX, which CEX can’t help it.
In addition, the cold start of the DEX order book model is very complicated, requiring the market making team to understand not only market making, but also blockchain, smart contracts, wallet interaction, etc. But AMM solves this cold start problem. It only needs to provide LP token , and ordinary people can participate in market making, which greatly reduces the threshold. Plus incentives layer (liquidity mining), then a way to solve the currency, cold start, a series of problems such as slippage transaction (at least a partial solution), obtained an unexpected effect.
AMM’s price discovery mechanism is still weaker than centralized exchanges
Of course, there are many problems with AMM. Here we put the comparison between common AMM and order book mode:
AMM biggest problem is the loss of impermanence, because AMM does not take the initiative to provide order, but only to provide a pool. Centralized order book maker and taker is based on a market price to provide liquidity, spontaneous done oracle to do things, the exchange is essentially the center of the order book is a sorting and matching pool, the price of the order The initiator decides for himself.
The AMM and popular product maker CPMM constant, between the price determined by the number of tokens, i.e. the product X * Y constant determined ΔX can exchange Delta] Y, then change back to know that the transaction on behalf of the corresponding price is How much. So AMM offer price before the transaction price estimate is based on the ratio of conversion out of ΔX and ΔY.
So AMM true price discovery is certainly needed after the transaction before they can see, rather than centralized order book to spontaneous formation of market prices by maker and taker. So take advantage of this arbitrage to be profitable, so he caused a loss of impermanence. But now some have begun to introduce AMM oracle mechanism to provide a price quote only oracle frequency trading frequency and mechanisms need to match. The price cannot be adjusted automatically like an order.
Borrowing: Provides liquidity, leverage and income amplifier
Lending is the earliest DeFi, represented by MakerDao . Compound, Aave, bZx, etc. were launched later. Compound ‘s liquidity mining ignited the entire community and became a pioneer in the DeFi industry.
The minimum amount of borrowing is actually related to trading and liquidity mining:
You can mine on your own lending platform, such as Compound, bZx, etc.;
Lending platform provides a tool for adding leverage. One type of asset can be exchanged for another type of mineable asset, or continuous borrowing for liquid mining, because the mining revenue is higher and the borrowing cost can be fully covered. The lending platform has become a revenue amplifier;
If you can credit such as loans Aave, adding that greater leverage.
However, since the amount above has a premise that the end of the game the whole mining – mining rate of return of liquidity to be relatively stable. The current industry is constantly extending the game forward (renewing life) . Although I don’t know where it can be extended, including centralized exchanges that have begun to carry the banner, it has been a bit difficult.
But through mining flow, the ability of the product to activate the loan agreement: to increase the currency and increase lending function (credit), liquidity mining user subsidies, access to a number of real users, user education and were left The available products.
There are also some loan agreements attempt to introduce centralized method, which use real identity information (such as banks, telecommunications) credit and other loans, such as Teller. This can also be seen as the traditional centralized lending to change the product into a digital currency.
Insurance: great potential but rough product
Decentralized insurance is the most innovative mechanism of DeFi. Compared with other types, it is still at an early stage and has a greater opportunity. We discussed the topic of insurance mechanisms in the last report. This form of traditional insurance which is based on the shares of insurance companies for the mainstream (50% -70%), mutual assistance and mutual insurance as a secondary form, but not the lowest proportion, accounting for about 27% of the global market in the United States And Europe is particularly developed, both exceeding 30%, Japan exceeding 40%, and China’s share is very small.
Mutual insurance company and joint-stock insurance company comparison of advantages: joint-stock insurance company involving the interests of three parties, namely managers, policyholders and shareholders, policyholders and shareholders in the interests of the opposite sense, that is more than compensation to For policyholders of 1 yuan, the shareholders’ benefits will be reduced by 1 yuan. But to get through the checks and balances ease: that is, if the insurance company has a clear bias shareholders, the insured amount will be greatly reduced, affecting long-term interests.
Mutual insurance only managers and policy holders two parties, policyholders into a pond, all compensation out of the pond, does not involve the shareholders, greatly simplified. Therefore, the nature of mutual insurance and blockchain is similar in some cases. For example, the owners of blockchain projects are only divided into two types: teams and general token holders.
Centralized insurance can effectively use the mutual insurance model
Although the number of interested parties involved is reduced, it is not easy to coordinate the interests, because the risks of different forms of insurance vary greatly. Taking Nexus Mutual as an example, insurance is provided for different contracts, but the situation of unintended use in different contracts is definitely very different. Therefore, between cover holders, they must try to claim more compensation for themselves and less accompany others. (The nature of people seeking advantages and avoiding disadvantages) . At present, only bXz is the only example of claim settlement on Nexus Mutual. So Nexus Mutual really want large-scale promotion, need to be very careful discretion claims mechanism. The current prosperity can hardly be said to be the success of a mechanism or product (after all, it is rough and not very effective, and the loss determination of traditional insurance is more standardized) , but it is a success in opportunity.
Nexus Mutual also hopes to push insurance products into the wider real world. For example, the amount of insurance is not linked to actual losses. For example, compensation can be partially processed instead of simply yes/no. All this requires more efforts in the direction of products and pricing, which is a very test. The team has deep experience in insurance and actuarial, and therefore the level of intensive products still have great hope.
Of course, another idea is to use financial products such as options for certain protection, but this is more of a type of derivatives than insurance.
Derivatives: The synthetic product track has many advantages
Synthetic products have more advantages than traditional finance
We feel DeFi derivatives, can make a difference and CeFi of synthetic products. Synthetic products are a special kind of products (of course they will be considered derivative products) , but synthetic products have been realized in traditional finance. A large number of transactions have been conducted in the open market through CFD (spread platform) , and in the non-open market through investment banks. A lot of customized services have been carried out, and they are not completely new.
Risk traditional CFD platform primarily was trading counterparty risk. In fact, the corresponding assets cannot be actually held through the CFD platform. The CFD platform does hedging in the middle, resulting in the actual counterparty between the user and the platform.
If it is done with DeFi, the counterparty risk is actually reduced. This is determined by DeFi and blockchain mechanisms. To Synthetix example, because all the products are based on mortgage platform native user tokens to complete, so that the combined assets to risk control, require over-collateralisation (750%), synthetic assets casting who will receive the asset deal transaction costs and to Only by maintaining this mortgage ratio can you claim the cost share, and more synthetic products and transactions are the key to the success of the platform, so the platform’s motivation for evil is reduced. In addition, the current CFD platform still requires a traditional KYC process, and the participation process of the DeFi synthetic asset platform is smoother.
Perpetual contracts have the largest profit margins, and new designs and structures are needed
Another trend DeFi derivatives market started to target sustainable futures contracts. Previously, Chain News summarized the decentralized perpetual contract products launched by the six major DEX platforms. In fact, those who do perpetual contracts see that in CEX, the development of contract transactions is very fast, and it has surpassed spot transactions. On March 12, the BitMEX server was down. It was also seen that some DeFi could only have contract liquidation problems. The DEX of perpetual contracts has not yet received such a test. So based on the current Ethereum architecture, the performance may not be good enough.
DEX also see other high-performance public chains are slowly involved, this is a very interesting point, like Cosmos, Polkadot, products such as the Solana, is a very strong competitor. It will also stimulate the cross-chain trading track.
Derivatives are definitely the most profitable piece of CEX. CEX will not relax its pursuit of products, market share, and mechanism design. DEX derivatives are equivalent to encountering the most difficult competitors. But it is also possible to design a “similar” liquidity mining mechanism, which requires more whims and opportunities, otherwise it may move to a similar pattern of DEX with a thin order to compete with the spot exchange CEX.
Analysis of DeFi token income characteristics
We will do a very preliminary analysis here and try to find out what factors come from the fluctuations in the price of DeFi tokens. Here we use the method used by Zayn Khamisa in the article “An analysis of the factors driving performance in the cryptocurrency market”.
Here, as the dependent variable, DeFi tokens do not use any single token to prevent the large fluctuation of a single token from being too large. We choose the DeFi index on the exchange FTX as the dependent variable, which contains 11 DeFi tokens. (DeFi Pulse also launched a similar DeFi index, but with too few data points)
We select several types of independent variables: one is the DeFi mining yield , the second is the BTC price, the third is the ETH price, the fourth is the large altcoin index Alt, the fifth is the medium altcoin index Mid, and the sixth is the small altcoin index Small. (Among them, four, five, and six are also taken from FTX, and there are five constituent currencies in the six that overlap with the DeFi index and have been eliminated) .
Independent and dependent variables to choose all day yield (rate of change today), has been a smooth process, therefore OLS regression methods can be used, modeled on Zayn Khamisa article in practice. The following are the simulation results:
We found that only a small cottage BTC and currency index has explanatory power (P-Value significant), and BTC is negative, yield model can be simplified as follows:
Our understanding of this rate of return model is as follows:
BTC and DeFi earnings are negatively correlated, you can be seen from the phenomenon, when the cottage currency dancing, BTC market slightly dull;
Changes or rises in BTC will generally cause the so-called DeFi tokens to suck blood . It may also come from the demand for hedging/profitability, that is, the hedging/profitability of DeFi rushes towards BTC;
Earnings and small cottage currency coins DeFi very similar, so the current can be classified as a class of high-risk cottage currency;
The dependent variable in the model set also has some disadvantages, because there is no data mining yields, we use the gradient descent be substituted, if there is a real rate of return can do a little more sophisticated. At present, we can’t see any strong connection, and it may also be related to the variety and the diversified yield. Theoretically, the mining yield will be a plane opened according to the date* variety;
The explanatory power of the model reached 0.677, which means that 2/3 of the change can be explained, and about 1/3 of the change cannot be explained. This can also be attributed to the Alpha of the DeFi token revenue. Generally, there are four sources of income should be the first line is the fair on the extent of the community to give more to the center of the project the higher the rating, as the founder and team no initial token distribution or pre-dug. The second is a pure valuation grounds, new themes always been favorable for the market valuation of natural high. The third is expected to be long-term stability of mining income, the higher the mining proceeds logically, the greater purchasing power, the more valuable tokens, similar to a fixed-income products. The fourth is the fundamentals of the project, including technical foundation, team, code quality, community activity, long-term operation time, etc.;
Interestingly little to DeFi tokens and Ether, that does not live up to the positive also, if only departure from the model, has little to DeFi tokens and Ethernet Square ecology. However, the design of Ethereum does have a certain deviation from the prosperity of the above applications (that is, weak value capture ability) , and there are many types of tokens that can be used for liquid mining, not limited to Ether;
Since the data only starts on June 19, there are fewer data points, and more data points can be further classified in the future;
You can also add more independent variables, such as other external factors. However, due to a small minority of DeFi tokens, select another category such as Zayn Khamisa selected in the article VIX, oil, gold, etc., we feel little significance. If the other independent variables are clear, you can further strip the factors from Alpha.
Summary and outlook
DeFi paper market was some sort of judgment and, overall, long-term market potential DeFi several sub-categories are available, we are optimistic about automated market makers, synthetic products, insurance and other direction to the center. Liquidity moment with a hot mining industry but also have some problems, in addition to the token mechanism innovation, the future will leave some valuable business model. The income characteristics of DeFi tokens are similar to other small altcoins, indicating that they are still the characteristics of early blockchain projects. The alpha income part is expected to be related to the degree of decentralization, valuation and long-term mining income and project fundamentals. There is a big relationship.
Reference
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