Wang Wei re-analyzed the development logic of the DeFi market in 2020 from the perspective of first principles, shared in detail the root causes of the market outbreak this year, judgments on industry trends and many other dry goods, and answered questions about why high-quality DeFi applications rarely appear in China. The full text is compiled as follows, hoping to inspire readers.
01
Review and thinking
Question: In the past year, the DeFi ecosystem has seen explosive growth, and there have been many exchanges and discussions surrounding DeFi. In your opinion, what is the biggest misunderstanding of everyone’s understanding of DeFi? How to understand DeFi from the perspective of first principles?
Wang Wei: I think the first-principle perspective is very good. If you don’t look at the problem from the primary perspective, it is easy to produce some misunderstandings. For example, DeFi has two typical extreme views, both of which belong to this misunderstanding.
One is the question of whether DeFi has real value. Some people believe that this wave of popularity is entirely caused by liquid mining. When this heat passes, DeFi will pass. This completely ignores the fact that in the past two years, mainstream projects such as Uniswap and Compound, TVL has reached the level of one billion U.S. dollars when liquidity mining has not started, and the transaction volume has exceeded tens of billions of dollars.
Conversely, some people think that DeFi can do everything. For example, in the previous paragraph, a lending platform proposed to make a “credit loan”, which means that there is no collateral or the amount of loans that can be borrowed is higher than the value of the collateral. The General Counsel of Compound once expressed his views on this issue, and I also elaborated in a recent article: Credit loans are essentially financial activities based on examining the repayment ability of people in the real world. In fact, they are not suitable for DeFi.
Whether there is value, what can and cannot be done, these core questions can only be answered from the perspective of first principles. My view is that the entire financial system can be divided into a “credit” part and a “calculation” part. The credit part is responsible for the expansion and reduction of credit, and the calculation part is responsible for the circulation and distribution of resources.
The first principle of DeFi is that the answer to the question “Why do we use DeFi” is that the computational part of the financial system has a better way to implement it-blockchain + smart contract, which is also a value network and its exchange rules . I believe that the computational part of the entire financial world in the future can and should be realized with blockchain + smart contracts, which will make the financial system of the entire society more transparent and efficient, which is not only beneficial to the general public, but also convenient and effective. Supervision is an ideal model. This is my thinking on the first principles of DeFi.
This involves some in-depth thinking about the financial system. From the perspective of the development history of DeFi, the differences mentioned above are reflected: the earliest mature DEX, that is, the trading platform, because it is the trading behavior of buyers and sellers, which does not involve traders. Credit issues. One party has assets and one party has funds, and the price can be traded at the right price, so it is basically a computational process and can be directly realized through smart contracts. Second is the current mainstream DeFi lending platform. As long as there is excess collateral, it does not involve repayment credit issues. The entire process can be implemented with smart contracts without manual involvement.
The aforementioned “credit loan”, as it involves credit evaluation, certainly cannot be done entirely on the DeFi platform. But we can also analyze it further. It may be a good idea to disassemble the computational part and integrate it with the credit system. From the perspective of insurance, derivatives, etc., I personally feel that the latest DeFi projects are also developing in this direction-when people use research and analysis to effectively separate the “credit part” and “calculation part” of a financial scene At that time, DeFi platforms in these fields will emerge in large numbers, which is a typical innovation process.
Question: Many people attribute the outbreak of DeFi this year to liquid mining. What do you think is the root cause of the outbreak of DeFi ecology this year? From what perspectives should we view the rationality of the liquidity mining mechanism and economic model of each project?
Wang Wei: I think this year’s DeFi explosion is mainly due to the maturity and availability of some mainstream DeFi platforms, as well as the “Lego building block” model that can be combined between multiple DeFi platforms. Liquidity mining is indeed a very effective catalyst.
For example, Uniswap, this year’s popularity was mainly due to the launch of the v2 version, because it introduced custom trading pairs, which quickly increased market activity. In fact, Uniswap also had a TVL worth hundreds of millions of dollars during v1. V2 stabilized him to the $1 billion level (the sushiswap was a bit of a toss, but it eventually returned to this order of magnitude).
After Uniswap launched UNI mining, TVL peaked at US$3.3 billion and returned to the magnitude of US$1.5 billion after the end. From this context, it can be seen that liquid mining will indeed play a big role in promoting, but it has not changed the fundamentals and magnitude of a platform product. This is basically the same for other platforms such as Compound.
The mining mechanism of each major project has its own merits, and I am not an expert in this area, nor do I comment too much. But I always believe that the liquidity mining mechanism is an important means of a platform’s startup phase or an upward breakthrough phase, rather than a core factor in the development and success of the platform.
Question: In this year’s wave of DeFi, everyone has an obvious feeling that good projects are all abroad, so we started to think about a question, why are there few high-quality DeFi applications in China?
Wang Wei: Actually, there are many good projects in China, and there are also many good DeFi developers and teams. But after all, this wave of DeFi was initiated from abroad, and the country is a follower/chaser. From this perspective, it is also an objective fact to lag behind abroad. After all, DeFi belongs to the blockchain, so it is naturally open and global, and country boundaries are not as strong as centralized systems. Nowadays, some DeFi projects done by domestic people are also very popular in foreign communities. For some foreign DeFi projects, there are also many Chinese in the team.
I think everyone may have their own answers to this question, such as technical level, social environment, regulatory conditions, etc. The main thing I want to talk about is the level of geek spirit. In the past decade or so, domestic innovations were mainly driven by investment, which has a lot to do with the rapid economic development of the entire country. And foreign innovations have always had a geek spirit main line, parallel to the investment drive, and even dominated most of the time.
In the Internet field, it seems that the country is more successful at present, and Internet innovation is generally moving towards a broader integration with life, such as the recent lively giants selling vegetables. At this level, investment drivers have obvious advantages. But investment drive is not a decisive factor for all innovations, especially for many very early projects. In fact, creativity and realization do not require a lot of funds, and more rely on innovative ideas and even feelings. This is in a purely digital field like DeFi. Especially prominent.
To give an improper example, JK Rowling led unemployment relief to write Harry Potter in a cafe. No matter how much money you give her, it is estimated that you will not be able to write it. Therefore, the early blockchain and the current DeFi have the shadow of cyberpunk behind them, emphasizing “High tech, low life”, and the focus is not on making big money, but on a more free and fair environment. In this regard, investors who aim for financial returns may not be easy to support.
At a deeper level, this is also a microcosm of the entire society in our country. The slogan “High tech, low life” is unlikely to appear in a population who really has no money and lives in low life. Otherwise, many people might even laugh at his Ah Q spirit.
What I want to say is that the pressure for most of our young people to run for life is indeed detrimental to the motivation for innovation. In this environment, it is natural to hope to get more investors’ support.
Question: There have been many “innovations” in the DeFi industry this year. For example, the recent algorithmic stablecoins have attracted a lot of attention and controversy. How do you view the value of algorithmic stablecoins? How to distinguish between real product innovation and hype?
Wang Wei: Taking this example, I want to use the model that divides the financial system into “credit” and “algorithm” to conduct some analysis. Simply put, algorithmic stablecoins incorporate the concept of “stability” into the scope of algorithms. What is the source of “stability” for stablecoins? Simply put, stability is our subjective feeling, which comes from our daily life, currency is the unit of measurement for all other commodities. For example, living in Japan, the yen is a “stable currency”, but in fact, the yen may fluctuate considerably against the US dollar.
There are many kinds of algorithmic stablecoins that I know, and the design logic is not the same. Some of the design is exquisite and cannot be generalized. Let me give a simple example. Stock exchanges all over the world have the ability to “divide shares” and “join shares”. Assuming that every time the price of a stock rises to a certain level, it will split the shares and become a price increase. The previous price; each time the price drops to a certain level, the shares are merged and become the previous price following the decline.
In this way, the “nominal price” of this stock can remain the same, but if this is a good company, which pays a lot of dividends every year and everyone buys it, then after three years, the stock price has not changed on the surface, but the investors actually Still made a lot of money. Conversely, if it is a bad company and its stock price keeps falling, the final conclusion is still a loss. It can be seen that keeping the nominal price of face value constant through a certain algorithm will not make this asset a “stable currency.” This type of algorithmic stable currency is actually a game structure formed by taking advantage of people’s desire to make money and worrying about losing money.
So in my opinion, the concept of “stability” of stablecoin comes from why it is accepted by people as the unit of valuation for other assets. This is a concept from the external environment and people’s subjective ideas. It actually belongs to the “credit” in the financial system. The part, not part of the algorithm. For example, the legal currency of a country is determined by the national environment. The USDX or XUSD in our digital currency field is determined by many factors such as exchanges, and it is difficult for algorithms to play a similar role.
From this to the second question, how to distinguish between financial innovation and gimmicks? My suggestion is to analyze more from the perspective of financial logic, that is, from the perspective of “credit” and “calculation”, including more analogies.
02
Judging the trend
Q: In a recent study, Multicoin Capital pointed out that DeFi projects will have many risks such as contract errors, poor protocol parameterization, chain congestion, oracle errors, administrator robot/LP failures, and many other risks. At the same time, industry security accidents are also occurring frequently. To what extent do you think these risks can be mitigated in the future? Will the frequency of DeFi security incidents significantly decrease in the next few years?
Wang Wei: I am a technical person. Security accidents can be divided into two categories in general: one is inherent to the blockchain, such as congestion on the chain; the other is a typical human error, which is what we usually call program bugs. Or not optimized enough.
First of all, let’s talk about the inherent situation of the blockchain. What everyone talks about most is congestion. In essence, if we enjoy the ability of a special computing system like the blockchain, we should pay the corresponding cost or price, including speed, congestion, and GAS fees. . Hope that Ethereum 2.0 solves these problems, at least it will not be a very direct result.
A simple deduction: if the single transaction speed of Ethereum 2.0 is fast and the fee is low, then everyone will make more transactions. From the essence of the blockchain consensus mechanism, the overall average speed will drop again (because the capacity of a block limited). At the same time, if the single transaction speed is indeed much higher than 1.0, then everyone will be more inclined to pay high handling fees in exchange for speed. People who pay low GAS fees will not be in the queue and will still encounter congestion. If everyone competes for resources, the GAS fee will rise again. Therefore, in the end, everything is the choice of the market and users, not determined solely by technology.
Let’s talk about another type of problem, that is, human errors. In the final analysis, the program is written by humans. As long as humans make mistakes, many platforms are attacked. The main reason is that there are problems in design ideas or code logic. I have done traditional IT myself for many years, and to say responsibly, smart contracts have no more problems in this respect than traditional IT.
The problem is that the entire blockchain and smart contract system are exposed to everyone, without the protection of traditional firewalls and layered systems, so any problem can be attacked. Therefore, the possibility of these errors causing problems is higher than that of the traditional closed system, and the losses may also be greater. The DeFi industry has been making improvements in this area. It should be said that so far, the effect is still obvious, and the entire ecological environment has also developed.
Q: Now that the CeFi ecosystem is also developing rapidly, what do you think CeFi and DeFi will occupy in the industry in the future? Or what is the future relationship of existence?
Wang Wei: Uniswap surpassed Coinbase for the first time in transaction volume on August 30 this year, and the total transaction volume in September also surpassed Coinbase. I think in terms of DeFi that can achieve products with the same capabilities as CeFi, the general trend is still to surpass or even replace CeFi. Direction development.
The rapid development of CeFi is generally in two directions: one is that the logic of certain products is relatively complex, and the current implementation of smart contracts is not efficient and difficult to achieve results; the other is the ability of centralized systems to act as counterparties. This is the credit capability that we have always emphasized. For example, for some derivatives, the platform may not be a neutral role, but has its own funds to operate. The former is mainly a technical problem. I think this is where Ethereum 2.0 may exert its strength. Otherwise, other public chains may catch up. In short, if the technical problems can be solved, the general trend of DeFi will not change. The latter is what we said before. DeFi has some areas that cannot be covered because algorithms alone cannot solve the credit problem.
Therefore, I believe that CeFi and DeFi should form a relationship that is both competitive and cooperative in the future. The competition is mainly in the functions that both parties can achieve, such as transactions and mortgage lending. In this regard, DeFi’s advantages must be growing. The point of cooperation lies in different links in the long chain of asset issuance, circulation, and liquidation. Everyone can perform their own duties and learn from each other. Among them, I want to emphasize that the main direction of CeFi must be to connect with the real world, including legal currency digitization, credit lending, physical asset mortgages, etc. These links must be completed by relying on information in the real world or human credit.
I believe that the final big trend is that there is no longer a difference between CeFi and DeFi. For example, Maker is introducing real-world assets as collateral, and this must have a centralized management link. Can it be said that Maker is also entering CeFi? The site, or has it become CeFi? This brings us back to the first DeFi question answered at the beginning: in the future there will no longer be the difference between CeFi and DeFi, but the difference between “credit” and “calculation” in the financial system.
Q: There are more and more mergers and acquisitions among top DeFi projects represented by YFI. What impact do you think this will have on the industry?
Wang Wei: The DeFi platform is a set of smart contracts. It is code running on the blockchain. Project mergers and acquisitions are code mergers and acquisitions code? One smart contract acquires another smart contract? Obviously it’s impossible, so people and teams are actually acquired.
In the past, intangible assets, such as code, intellectual property rights, patents, etc., may also be included in the company’s merger and acquisition targets, but in a DeFi world where everything is open source and transparent, even these are missing. If we have to say what intangible assets there are, it is the ideas that have not yet been implemented in the developer’s mind, and the code release permissions of the existing running platform, including the github warehouse, the private key of the platform management address, and so on. From this point of view, in fact, the purpose of mergers and acquisitions is very clear, that is, team integration/cooperative behavior.
Further analysis, DeFi protocol is originally connectable and stackable, what benefits can team integration bring? Only one advantage is that through teamwork, the connection between mergers and acquired projects can be optimized, whether it is interface, process simplification, gas fee reduction, or agreement to coordinate user benefits, etc.
Assuming that mergers and acquisitions do produce such an effect, and if there are more and more such mergers and acquisitions, the result will likely change the DeFi world from independent agreements to one with strong internal interconnections and high synergy efficiency. “Protocol Family”.
Once this trend occurs, it will have a profound impact on the development of the DeFi industry. Whether it is a good thing or a bad thing is even unknown. It requires continuous observation and in-depth thinking.
Q: For the DeFi industry in 2021, what do you think are the three most important trends?
Wang Wei: I think there are three trends or directions in the DeFi industry next year:
The first trend is “innovation”, because the DeFi industry is still very early and there are many new areas that can be explored. The innovation mentioned here refers to the first principle of DeFi: the continuous disassembly of the “computability” part of the financial field. Whether it is insurance, interest rates, or derivatives, there are many innovation directions, but the direction of innovation must be grasped. This is the first problem in the development of DeFi. Mastering this law is effective innovation and will succeed; the other way around, no matter what new idea is, it will be short-lived at best.
The second trend is “security.” 2020 is the year of the outbreak of DeFi and the first year of systematic and large-scale attacks on DeFi. From the beginning to the end of the year, there have been constant attacks and hundreds of millions of dollars in losses. But I think new things always go through this process. As the law of smart contract security is more and more mastered, auditing capabilities are getting stronger, and the price determination mechanism is becoming more and more rigorous and reasonable, DeFi in 2021 will be greatly improved in terms of security, which is vital to the healthy development of DeFi. Has a vital role.
The third trend is “fusion.” There are many levels of integration. For example, the aforementioned project mergers and acquisitions are also a kind of integration. But what I want to talk about most is the integration with physical assets. This year Maker began to introduce off-chain assets as collateral. Many projects are also exploring how to integrate real economy financing activities with DeFi.
Originally, I felt that it might take another 2-3 years to see this situation. After all, DeFi is suitable for native digital assets, and the introduction of physical assets too early makes it possible that blind “blockchain+” appeared in previous years and repeated the same mistakes. . But considering the rapid development of DeFi, and that the DeFi of native digital assets has developed into its third year after all, next year may be the starting point for a new stage, which is the integration with off-chain assets.
