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DeFi

How to defi

Intro

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Defi vs. Cefi

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Total Value Locked (TVL)

a measure of the amount of capital locked inside DeFi protocols, has been increasing at a breakneck speed, breaching the magic number of $1 billion in May 2020 and ending the year with $15.7 billion in TVL.

Liquidity mining

Liquidity mining refers to the reward program of giving out the protocol's native tokens in exchange for capital.

It was first introduced by Synthetix back in July 2019 and was later popularized by Compound in June 2020.2

The more capital that firms have, the better.

Why called yield farming?

liquidity mining programs saw many projects launched in the summer of 2020, with many incorporating food and vegetables token names such as Yam and Pickle. Users had a busy summer being “yield farmers” -rotating their capital.

capital allocated is used to provide services to end-users, the fees charged to users are then shared between the capital providers and the protocol.

Exchanges - Provide capital for market-making on decentralized exchanges, earning transaction fees in return.

Lending - Provide loans to borrowers, earning an interest.

Insurance - Underwrite insurance, earning premiums while

undertaking the risk of paying out claims during disasters.

Options - Underwrite options by selling call and put options to

earn a yield.

Synthetic Assets - Mint stablecoins or other synthetic assets,

earning fees in return.

After Locked up

In most cases, the locked capital is used to offer services such as market making, lending, asset management, and arbitraging across the ecosystem, earning yields for the capital providers in the process.

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Why does Defi increase the ETH gas fee?

Solution to high gas fee

Layer- 2 (e.g., Optimism, Arbitrum, and zkRollups)

sidechains (e.g., xDAI and Polygon)

competing Layer-1 chains (e.g., Binance Smart Chain, Solana, and Terra).

Examples

SushiSwap, a fork of Uniswap, was launched. SushiSwap conducted a “vampire mining” attack to migrate liquidity away from Uniswap by introducing the SUSHI token to incentivize users.

The team offered to reward free SUSHI tokens to anyone that provides liquidity on the SUSHI/ETH trading pair on SushiSwap.

Web3 Marketing

Airdrops

Initial DEX Offerings (IDO)

Initial Bonding Curve Offering (IBCO)

Liquidity Bootstrapping Pool (LBP)

Initial Farm Offering (IFO)

Cons of AMMs

Price Slippage, important for large fund

In (x * y = k), the larger the order, the larger the price slippage that a user will incur.

Front-runningI(Sandwich Attack)

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Impermanent Loss(since the $ of tokens is changing, and in uni k is constant, so ur token balance will change)

DEX Aggregator

Born for helping traders with the best price execution across the various DEXs, searches for cheaper rates

across multiple liquidity source

DEX aggregator’s performance:

Routing Algorithm

SourcesofLiquidity

Current Market State

Size of Transaction

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Stabel coins Models

A rebase model controls the price by changing the entire supply of the stablecoin

A seigniorage model[most of the algo statble coins in 2020] controls the price by introducing a reward system that influences market dynamics.

Why does Frax succeed?

Frax is partially collateralized by USDC, which instills community confidence in the system to maintain its peg. As of 8 May 2021, 85.25% of FRAX is backed by USDC.

Frax keeps the collateralization ratio flexible, addressing market demands for pricing FRAX at $1.

Collateral is redeployed elsewhere to earn interest. This helps to bring in external revenue and keeps the protocol afloat, which is then used to buyback and burn FXS.

Price volatility of FRAX is shifted to FXS because of its buyback and burn mechanic.

Defi Risk

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Different kinds of Risk needs to be considered

Absense of Trade is a cost(traffic)

systemetic risk like a bug

maket power

distorted incentives

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Important take aways

it is essential to look at TVL over time to measure the retention of capital and user stickiness.

Pain point of CEX: being users of centralized entities do not hold custody of their assets

DEX enables 24/7 market hours

AMM has to be two equal ration tokens, so it cannot be only one assets

Balancer has a variable pool supply criteria and Curve has a dynamic pool supply criteria, not 50/50

The high divergence between the value of holding your tokens in the pool and wallet

Flash loans are useful for arbitrage traders as they are capital- efficient in making arbitrage trades across the various DeFi Dapps.

Cream: highest borrowing rates - diverse list of assets for users to borrow

Price oracles may fail or can be exploited. In November 2020, Compound’s price oracle was exploited by driving up the price of DAI by 30% on Coinbase Pro, resulting in $89 million worth of loans being liquidated

To overcome this, algorithmic stablecoins offered eye-watering incentives in the form of extremely high liquidity mining rewards. The problem with this approach is that it primarily attracted speculators looking to make a quick flip, birthing a new species of yield farmers known as Algo-Farmers. Algo-Farmers had one objective - look for new algorithmic stablecoin protocols before anyone else, farm the native stablecoin by providing liquidity, and exit the system once other Algo-Farmers start pouring in. Therefore, distribution was centralized within the first group of Algo- Farmers, and dumped onto latecomers.

While FRAX has largely been successful, one could argue that it is not truly decentralized.

Traders may then arbitrage the price down until the price reaches its $1 peg

Older algorithmic stablecoins prioritized capital efficiency over everything else.

Older generations focused on rewarding “correct” user behavior (i.e., arbitrageurs).

Many algorithmic stablecoins protocols are also heavily reliant on competent arbitrageurs to maintain the price peg.

Algorithmic stablecoins require a strong community that believes in the project’s fundamentals.【also applies to other decentralized projects】

If the project has strong math formulars as the base contracts, they wna to lower the power of staking & voting

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