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After the thunderstorm of crypto institutions, I understand why DeFi will never die?

From | Bankless

Author | Donovan Choy

Compilation | Jordan, PANews

In the past few months, the crypto industry has suffered unprecedented blows: multi-billion-dollar cryptocurrency banks face bankruptcy, the largest hedge fund dumps NFTs to deal with liquidation, and centralized crypto institutions face collapse... but it is surprising Surprisingly, after experiencing this storm, DeFi is still standing. I believe this also reflects the value proposition that the encryption community has been promoting to the outside world-creating an open, public, and accessible financial ecosystem open to the world.

Because of this, DeFi will never die.

Why do you say that DeFi will never die?

Designing a resilient economic system begins with acknowledging the complexity of the real world and accepting human instincts of greed and ignorance. In addition, you also need to understand that the resilience of the economic system has nothing to do with the performance of the bull market, and mainly depends on the ability to adapt to market changes without the intervention of regulators or giants.

Second, to judge whether an economic system is sufficiently resilient in the financial market, the following questions are also crucial:

1. Can the system effectively clear bad debts?

2. Does the system choose to eliminate or support unsustainable business models?

3. Can the above two points be achieved before systemic risks accumulate to a certain level?

4. When systemic risks arise, can the problem be solved by minimizing active management and negative spillover?

In fact, compared with the centralized financial system, the decentralized financial system is more closely related to the above goals, because no matter from the perspective of the design of the protocol token economic system, or from the perspective of daily financial management and balance sheet From the perspective of health, everything in the DeFi system is on the blockchain, and it is open and transparent. Anyone can observe and monitor it in real time. Everyone can clearly understand the investment trends and potential risks of giant whales.

We often see mainstream media describe DeFi as the "Wild West in the financial sector", but this metaphor is not appropriate, because DeFi's self-regulatory mechanism is actually very complete——

Self-regulation of DeFi

Take Lido Finance and Solend as examples:

With Lido staking nearly one-third of the total ETH supply, it may start to pose a centralization threat to Ethereum after transitioning to proof-of-stake. Therefore, Lido launched a governance proposal vote to decide whether to limit the amount of ETH deposited into the liquid pledge agreement. As a result, the self-limiting governance proposal failed and 8 new validators were added to further decentralize the Lido validator set.

As the largest lending protocol on the Solana chain, Solend faces an even more urgent situation. It was found that if the price of SOL continued to fall, liquidating a whale's margin position ($170 million) would have catastrophic consequences and severely impact the entire chain. To this end, Solend developers put forward a series of governance proposals to the community, such as taking over the accounts of giant whales and performing safe liquidation, but the final solution is to introduce a new rule-limiting the borrowing amount within 50 million US dollars (the giant Whale borrowed $108 million).

Of course, although Lido and Solend may not be able to get out of the predicament after adopting relevant governance, the uniqueness of DeFi can already be felt only by the governance process of these two platforms.

Thanks to the transparency of blockchain rules and on-chain activities, a community of internal and external stakeholders has the same goal and works together to solve problems. In the two cases mentioned above, community members followed up in time after discovering danger signs, and finally gave solutions after in-depth technical discussions to prevent problems before they happen.

Conversely, if people turn a blind eye to these risk choices, the system will inevitably be attacked maliciously, and the consequences will be disastrous. So is there a general solution to this kind of problem? In this regard, TradFi (traditional finance) replied like this: "The government will solve it through laws", and DeFi's answer is very cool: "Everything is decided by the code."

The Decline of Centralized Finance

Compared with DeFi's active self-help, encrypted banks that have fallen like dominoes in the past month appear to be much more passive. In fact, the center of this storm is the most important hedge fund in the encryption field, the liquidity problem of Three Arrows Capital was exposed as early as mid-June. $400 million.

Soon, the liquidation incident of Three Arrows Capital revealed other high-risk shadow trading problems of encrypted banks: misappropriation of depositor funds, such as BlockFi providing Three Arrows Capital with over-collateralized loans of US$1 billion, and Voyager Digital providing it with about 670 million dollar loan. Although Voyager Digital's capital ratio is relatively safe (the loan interest rate is only 4.3%), it also fell into trouble due to a wrong decision to provide concentrated loans exceeding twice its total capital to Three Arrows Capital. dilemma.

Of course, risky transactions in finance are everywhere, not just in crypto banks. The key to the problem is how the system governs and deals with risks when they come.

Unlike the way DeFi handles risk, since the balance sheets of encrypted banks are centralized, the community cannot conduct independent investigations, and these over-leveraged and risky transactions of encrypted banks can only be carried out when the paper package is not popular. Known to the outside world, and at this stage, it is too late. The biggest problem with this kind of "centralized" encrypted bank is that most of the transactions are closed-door bilateral off-exchange transactions, only insiders can know, and they will only disclose information after a liquidity crisis occurs, because this is in Legally the only condition for getting money back.

The openness and transparency of DeFi can avoid the risks brought by "centralized players"

If you want to gain insight into the comparative advantages of DeFi, then you can look at how centralized players conduct decentralized exchanges.

Let's look at three examples -

Example 1: Celsius

The Celsius problem was exposed for the first time because they had signs of insolvency in a series of on-chain loans. For example, there was a pledge transaction of 17,900 WBTC in the Maker vault that could not be repaid. The drop led to liquidation of the collateral (the loan was repaid in full on July 7), and Celsiu's other loan problems soon followed, including a 458,000 stETH pledge on the Avalanche chain, and a Loan collateralization on Compound and Oasis.

At the beginning, the CEO of Celsius also vowed that there would be no problems, but since the transactions of Maker, Avalanche and Compound on the blockchain are open and transparent, crypto users quickly discovered the potential risks and began to tell the community Forewarning. Sure enough, Celsius soon announced the suspension of withdrawals. Although the alarm bell sounded a little late, if there is no public information about DeFi, more people may suffer losses and the problem will last longer.

Example 2: Terra

In fact, Terra’s disaster was initially discovered because of the transparency of DeFi, because Terra’s liquidity was rapidly drying up on the Curve protocol.” The UST exchange rate was first under pressure on Sunday, May 7, mainly due to USTw - An 85 million USD exchange from UST to USDC in the 3CRV Curve fund pool... This large transaction further shook the public's confidence in the liquidity providers of the fund pool, and people quickly withdrew their 3CRV, resulting in May 8th Funding pool UST: 3CRV down to 77%: 23%.”

The story after that, I believe everyone already knows.

Millions of Terra investors panicked, Do Know famously tweeted that "more UST will be deployed", and Luna Foundation Guard, the centralized entity behind Terra, began to transfer $1.5 billion worth of Bitcoin to stabilize Its algorithmic stablecoin. All these operations were not based on smart contract rules. As a result, when the "flood" of Anchor poured out, Terra crashed.

Example 3: Three Arrows Capital

As far as Three Arrows Capital is concerned, many analysts know that its balance sheet is not healthy, as the on-chain data clearly proves that they lost $560 million in LUNA lockup in May of this year, and then delisted stETH in July position. The mystery of 3AC's bankruptcy is not complete, but a few fragments are enough to allow us to speculate on what went wrong.

In the end, you will see that these centralized players are rapidly approaching bankruptcy. Why should they go to bankruptcy? Because the high-risk and leveraged closed-door bilateral transactions between CeFi platforms can only be resolved through legal means, which is their only choice, and they may be able to win a better result for themselves in court. In contrast, DeFi will not have similar problems, because under the premise of openness and transparency, you cannot argue with smart contracts.

The above three examples all prove one point: Celsius, Terra, and Three Arrows Capital are not real DeFi on the chain, and we only learn about the risks before the night comes. It is indeed difficult to completely avoid and prevent such crises, but if they It is the real DeFi, maybe the tragedy will not happen.


Greed and stupidity may be human nature. As the Scottish Enlightenment philosopher David Hume said, a truly resilient political and economic system should be based on the basic facts of human nature. He said:

"...every man should be considered a scoundrel who has no purpose in all his actions but his own self-interest. We must govern him by that interest, which, though still insatiable and ambitious, will be willing to serve seek cooperation in the public interest."

The advantage of DeFi is actually to take advantage of human nature, and then design a ruthless smart contract around this nature. In DeFi, the code is the liquidator, and the code is the settlement engine. So you will find that Celsius, Terra, and Three Arrows Capital have fallen, while major DeFi protocols such as Aave, Compound, and Maker are functioning well. For example, in June 2022, Compound, Aave, and Maker have successfully completed "9 figures" Liquidation transactions, of which the liquidation amount of Compound is about 9.9 million U.S. dollars, the liquidation amount of Aave is about 2.6 million U.S. dollars, and the liquidation amount of Maker is about 49 million U.S. dollars.

In DeFi, there are no closed-door negotiations, no delaying issues to the courts, and no lobbying regulators. Everyone only does one thing: abide by smart contracts, and isn’t this what a resilient economy should look like?

This is DeFi.

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