The profit-seeking nature of capital will inevitably cause some funds with high risk preferences to enter the DeFi field.
Original title: “Can DeFi become a spark in the era of negative interest rates? 》
Written by: Yang Linyuan and Jiang Xiaopei, working at DFUND
The world enters the era of negative interest rates
“At first, no one cared about this disaster, until this disaster is closely related to everyone.”
From the detection of cases in January 2020 to the current global raging, the social and economic impact of this new crown epidemic has exceeded everyone’s imagination. The epidemic has caused severe damage to the world economy. In order to save the weak economy, the central banks of the United States, Europe, and Japan are racing to release water. Global liquidity is flooding, reaching the highest level since World War II.
Here, the European Central Bank has cut the deposit mechanism interest rate by 10 basis points to -0.50% in September 2019; the Bank of Japan has implemented a large-scale monetary easing policy since early 2013, and introduced a negative interest rate policy in early 2016. In response to the impact of the epidemic on the U.S. economy, the Federal Reserve announced twice on March 3 and 15 that it will urgently lower the federal funds rate, lowering it to a historical low of 0-0.25%. The United States has entered the “zero interest rate era” overnight, and when the “negative interest rate” card will be used is already in sight.
The world is sliding into an era of negative interest rates.
What does negative interest rate come from?
Interest rates measure the time value of money, and “negative interest rates”, especially when nominal interest rates are negative, overturn our common sense. A negative nominal interest rate means that the lender (depositor) transfers the right to use funds to the lender (bank). Not only is there no return, but currency is also required. It means that the borrower is rewarded and the lender is punished.
The cause of negative interest rates is mainly due to the superposition of the current economic cycle stage and our current economic growth momentum.
Our current financial system is built on “money-credit”. The economic cycle is largely due to the growth and dissolution of credit.
Credit growth
At the beginning of the business cycle, the debt level is low, people are full of confidence and vision for the future, credit begins to expand, if there are enough positive returns, people’s confidence in the future will increase, credit expansion, interest rates fall, it is easier for companies to raise funds, individuals Easier to borrow and economic growth. Therefore, people are more confident about the future. The central bank cuts interest rates or issues more currency, credit continues to expand, the economy continues to grow, and technology develops strongly throughout the process. This process is called the boom period. During the boom period, the income growth of enterprises or individuals exceeds or keeps up with the expenditure required to repay the growing debt. The process becomes sustainable and the economy prospers.
Credit dissolution
We know that the real measure of social assets is social “goods + services + investment assets”, and currency and creditor’s rights are only symbols representing social assets. During the boom period, the growth of borrowing and currency will push up the prices of goods/services/investment assets, but the borrowing needs to be repaid in a certain period in the future. When the growth rate of borrowing exceeds the growth rate of assets, some borrowers begin to sell goods /Services/Assets in order to obtain currency to repay borrowings, the prices of goods/services/assets fall, and the decline in prices will make people less purchase goods/services/assets, and the economy will begin to decline. When the creditor’s rights held by the creditor’s rights cannot bring sufficient returns, the creditor’s rights will be converted into goods/services/assets. When it was discovered that some creditor’s rights had failed to convert, more and more creditor’s rights were sold, forming a run. If no measures are taken at this time, a large number of enterprises will go bankrupt, and the elimination of credit will be completed in a more drastic way.
With the growth and dissolution of credit, the alternating prosperity and recession of the business cycle is like a curse. The end of the recession cycle must be accompanied by large-scale currency and debt restructuring, and the debt bubble can be eliminated in a drastic way to give the next cycle a favorable soil. The transition between prosperity and recession often confuses people who are in it, and people only realize it when recession comes.
We are at the end of a debt cycle, and the following macro factors are added:
- Aging population structure;
- Technological innovation has entered a bottleneck period;
- The new crown epidemic broke out.
From 2020, it is a high probability event that the global economy enters a recession period. At this time, the “big water release” and “negative interest rate” seem to blow a few more breaths at a balloon that is about to burst, which is a life-saving effort for governments in the face of economic decline. Straw is obviously not good in the long run.
DeFi is helping fiat currency to migrate to digital currency
Under negative interest rates, capital accelerates the migration from legal currency to digital currency
Profit-seeking is the nature of capital. The expectation of returns drives the flow and conversion of capital across the globe and asset classes. Negative interest rates are driving capital to accelerate the escape from the currency system with high inflation.
The new crown epidemic has intensified and reverse globalization has spread worldwide. The separation and gap between legal currency and legal currency and transnational capital has become deeper and deeper, which has accelerated the search for possible hedging alternatives for capital on a global scale. Gold hit a record high of more than $2,000 per ounce in August this year. The digital currency represented by BTC has also started a new round of rise in 2020. This round of rise is accompanied by some structural changes. Cryptocurrencies are From the barbaric growth cycle of retail investors to the professional cycle of institutional running into the field.
In 2020, Grayscale Bitcoin Trust, the world’s largest crypto-institutional asset management company, increased its holdings of BTC from 270,000 at the beginning of the year to 466,591 BTC disclosed in October. At the end of August, Fidelity Investments publicly announced that it would officially launch the company’s first Bitcoin investment fund, and Bitcoin ushered in the first fund initiated by a major Wall Street institution. MicroStrategy, the world’s largest independent BI company, bought more than $250 million in BTC in August, and then purchased another $175 million in BTC in September. Institutional investors’ demand for Bitcoin has been increasing. There is no doubt that the obstruction of the fiat currency world and people’s inflation expectations for fiat currency have intensified the great migration of value from fiat currency to digital currency.
DeFi is growing rapidly
Decentralized Finance (Decentralized Finance), in a broad sense, DeFi can refer to the entire crypto community and applications starting with Bitcoin. The ultimate vision of DeFi is to build a global open financial system without borders. For more than ten years, the crypto world has continued to evolve toward this ultimate vision, from Bitcoin, which aims to become a global decentralized currency, which opened the bud of digital currency, to the once clamorous decentralization of Ethereum with Turing-complete smart contracts. In the third quarter of 2020, liquidity mining (IDO) is in full swing in the narrow DeFi field.
In the process of migrating from legal currency to digital currency, DeFi’s infrastructure is accelerating to mature. Whether it is Tether issuing USDT or MakerDao pledged ETH to issue Dai, it is an innovation in the way of currency issuance, opening up a new process for the migration of legal currency to digital currency Paradigm. Super stable currencies such as DCEP and LIBRA, which have attracted widespread attention and heated discussion, have greatly increased the popularity of digital currencies, and will provide a more robust and faster path for the migration of legal currencies to digital currencies.
In the third quarter of 2020, DeFi (in a narrow sense) is a subset of the large process of currency digitization. It includes stablecoins, decentralized lending, derivatives, etc., and it has been continuously deepened during the development process (the following is convenient for writing, DeFi Both refer to DeFi in a narrow sense).
The growth of narrow DeFi has been exceptionally rapid this year. When we evaluate the development of DeFi ecology, the most commonly used indicator is the Total Value Locked (TVL) of DeFi.
From the data of DeFiPluse, it can be seen that from the beginning of November last year, DeFi TVL was US$602 million, and by the beginning of November 2020, DeFi TVL was US$12.014 billion, an increase of about 20 times. In the first half of 2020, DeFi experienced an extreme market of 3.12, from about 1 billion U.S. dollars on March 10 to 550 million U.S. dollars on March 14. The total lock-up value has shrunk by nearly half. Subsequently, the total locked position value continued to rise.
According to data from DeFiMarketCap and DeFipulse, as of November 6, 2020, the total market value of the DeFi project’s tokens reached 15.2 billion U.S. dollars, and the total locked value (Total Locked Value) exceeded 12 billion U.S. dollars. Throughout the entire development history of DeFi, it took only two years to reach such a huge lock-up total.
Data from DeFipulse November 6, 2020
Data from DeFipulse November 6, 2020
The three engines of DeFi
The prosperity of the DeFi industry depends on the promotion of three engines: stablecoins, lending platforms and decentralized exchanges (DEX). They provide the liquidity necessary for the industry to mature, and also give the entire economic system a certain degree of flexibility, thereby effectively resisting adverse impacts from the outside world.
Stablecoin
Digital currencies generally have greater volatility and are not ideal trading media and accounting units. Stablecoins effectively connect various value islands, accelerate the frequency of value exchange, and ultimately promote price discovery. Therefore, stablecoins have become an ideal tool for cross-currency arbitrage and provide prerequisites for the prosperity of other DeFi products.
According to DeBank data, as of November 7, the total issuance of stablecoins was 16.85 billion U.S. dollars, and the top five stablecoins included USDT, USDC, DAI, BUSD, and PAX.
Borrow
The digital currency lending platform has constructed an effective value model to provide investors with additional liquidity.
According to DeBank data, as of November 7, the capital scale (deposit plus loan collateral amount) of mainstream DeFi lending products exceeded 2.56 billion US dollars. Compound surpassed Maker in June with the model of “borrowing is mining”, and is still the leader in decentralized lending, with a total capital of more than 1.35 billion US dollars. Followed by Maker, Aave and dYdX.
Decentralized exchange
In the early stage of blockchain development, the objective conditions of insufficient liquidity and depth gave birth to the birth and development of centralized exchanges. With the development and improvement of Oracle (oracles) and AMM (automated market makers), DEX has also begun to accelerate its development, its performance and experience have also been steadily improved, Uniswap has been updated, and it has also driven the development of its imitators.
According to DeBank data, as of November 7, the 24-hour trading volume of DEX was US$545 million. Among them, the transaction volume of Uniswap V2 exceeded 313 million US dollars, accounting for about 57%; SushiSwapCurve was about 43.8 million US dollars, accounting for about 8%; CoFiX was about 36.9 million US dollars, accounting for about 6.7%.
DeFi (narrow sense) accelerates the process of legal currency to digital currency
Compared with the traditional interest rate market’s over-collateralization, profit expectations, credit evaluation, etc., the DeFi market is relatively early and does not have a sound interest rate risk pricing mechanism. At present, DeFi mainly builds a liquidity pool for over-collateralization to meet user liquidity needs and the use of agreements to increase leverage in digital currencies, while providing users with risky and high-yield solutions.
Crazy liquidity mining, using the Token scheme to incentivize users’ borrowing behavior, allowing users to borrow assets as part of the market-making pool, accelerates the construction of the liquid asset layer in the development of DeFi, and makes the small DeFi pool thriving. Compared with the ICO in 2017 and transaction mining in 2018, “liquid mining” has the side that is prone to irritate users, but there are also differences:
- Most of the services provided by DeFi projects are real needs that have been verified by the traditional financial sector, such as lending. DeFi lending is exploring the use of more optimized models (disintermediation) to provide services; many ICOs have not solved any problems.
- ICO has no underlying assets, and most of them package “pseudo-demand” into new assets; while the DeFi protocol has real underlying assets, and the collateral for loans based on over-collateralization is locked in a smart contract.
The profit-seeking nature of capital will inevitably cause some funds with high risk preferences to enter the DeFi field, but most of the current users are composed of arbitrage traders in order to obtain rewards in the liquidity pool, with limited space and time. The ultimate long-term driving force of DeFi is to increase the number of usage scenarios that require funds.
Judging from the current stage, the first to develop is other real use scenarios in the DeFi network, such as derivatives trading, primary market investment, games, etc., and there are many grand prospects in a higher dimension-in the new Build an unprecedented (no borders and no intermediaries) financial format on top of the infrastructure.
In addition, the corresponding CeFi in the encrypted world will also enter a new stage of development. The relationship between CeFi and DeFi is not either one or the other. In fact, the two complement each other to complete the historical migration from paper currency and traditional currency to digital currency and build a more prosperous digital currency ecosystem. At this stage, DeFi still has a high level of awareness and barriers to use, even for practitioners in the circle, it is not particularly easy to use, let alone those who have just entered the digital currency field. CeFi’s liquidity and ease of use will continue to be the largest channel and first choice for a large number of users and funds to enter for a considerable period of time. Moreover, the path between digital currency and legal currency requires CeFi to supplement compliance and anti-money laundering assistance. It can be foreseen that in the near future, an excellent CeFi product platform will become an aggregator and entrance to integrated DeFi product modules.
DeFi composes a song of ice and fire
The current world financial system is built on “money-credit”. When the era of negative interest rates arrives, we are deeply trapped in the curse of the debt cycle. Global finance seems to have entered a dilemma. Every cycle overlaps with currency and credit. Debt restructuring and wealth redistribution.
The technology finance represented by DeFi is composing a song of ice and fire. Can it become the spark of the new cycle? let us wait and see!
