Security Token Show Highlights: #51 – Decentralized Finance (DeFi) 101

Listen to this clip of the Security Token Show where Kyle Sonlin and Herwig Konings discuss DeFi and yield farming!

Absolutely and that concludes the market update i think it’s a good time to transition into our main topic we’re talking defy and yield forming and we’re picking today’s episode to discuss this concept of decentralized finance or defy because the space is really exploded in short order i mean with an emergence really in 2019 spawning from the rise of decentralized

Exchanges and stable coins defy really only took off when lending protocol started becoming a reliable new source of alpha after the ico market more or less dried up and we’re gonna take a look at three different news articles that came out last week to explain to you five but if you want to get a little primer on this topic i highly recommend watching the main

Topic for episode 42 collateralized lending with crypto assets which by the way everyone for those of you don’t know all of these main topics are now available separately from the paska podcast itself exclusively on youtube so you can check out our full library of over 50 episodes of main topics without needing to listen to all of the other segments of the show

With each episode yeah i think it’s long overdue that we finally talked about dphi as a subject i think we should really break down how the space is evolved and really what this term of yield farming is because it is pretty funny to say and we should start at the basics defy as with any term and blockchain as a loose meaning so i’ll describe you know what i think

It means first i personally would boil it down to using blockchain and financial technology to deliver financial services from loans to banking to insurance to investing without the middleman which is usually the bank or an agent or a manager and one could even go a step further that these defy applications need to be inherently decentralized so that the trust

Is in the smart contracts not those middlemen but i think we could probably make a whole main topic out of that to be it alone so kyle you tell me do you agree with my definition tell our listeners well you might change your add to that yeah you’re totally right i think that cutting out the middleman is a key here we’ve covered that before episode 44 about market

Making and how that work without needing a centralized party but d-phi is incredibly interesting because from what i’ve seen the culture around defy has become just as poignant as the actual functionality itself i define the defi movement as a transition to permissionless finance many of the defi community members believe that privacy is a key component as well

Personally i’m definitely on board with the permissions piece anyone around the world should have access to an open financial system in my eyes a few main products do need to be available for anyone those would be a store of value a transfer of value and a line of credit d5 strives to achieve these things with tokenized products and smart contracts which is why

It’s fascinating yeah so let’s get right into the biggest use case that is really making defy so relevant over the last several months and now of course is lending and borrowing so kyle can you please break down for us this concept as simply as possible maybe maybe just use aetherium as you know the only currency in your example yeah totally so listeners bear with

Me certainly if you have any questions about what we cover feel free to reach out to us we love having these conversations but when we’re talking about decentralized lending you’ve got protocols like maker or compound which facilitate peer-to-peer loans these organizations known as dowse which stands for decentralized autonomous organizations are governed by the

Governed by the community and share all the profits made in the lending process to the community by leveraging smart contracts essentially the lending works by allowing someone to collateralize their current assets for additional leverage from the market if i have say a hundred aetherium in my account i could lock up a portion of it say 50 into the protocol and

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Receive a loan from that protocol the amount i received back for my 50 depends on the lending history that i have with the protocol in addition to the overall liquidity that the system has to determine the amount that i will receive i’m given a collateral factor that will allow me to easily calculate the amount that i would receive for everyone deposited into the

System understandably this would be from a zero to one scale and almost never at one you pretty much always have to over collab you’re alone which means you have to give 50 and maybe get back 35 just to give it a little bit of cushion for the system the amount i am left does is a significant portion lower and so for example i might get 50% as a first time user and

So in this example that means that i would place 50 in my locked savings account and would receive 25 in a liquid account that i could spend how i see fit in this way my loan is over collateralized so that the system has that cushion in case of a price or in case the price of my locked aetherium drops below my owned amount so that the position could be liquidated

And no one gets hurt so essentially what that means is that i’m giving more so that in the case that anything happens and that price decreases with a value rather decreases then at some point it would reach a one-to-one ratio and my position would be closed they would take the iii reom that i had locked and then we be even the books would be cleared my loan would be

Forgiven because i’ve got my 25 it took it’s 25 and unfortunately that additional cushion that i had was lost in the price depreciation in addition i’m actually rewarded for locking up my 50 because that 50 is then turned around and lent to other users who have also staked this asset in this way i not only received the 25 up front but i’m actually paid a consistent

Fixed rate for lending my assets as well i believe it’s around five to ten percent so i think it’s like seven or eight maybe this return is paid in the native token of the protocol in this case co mp or nk are tokens which are not only a store of value but also allow me to govern the protocol by voting using my tokens in this way i am both a debtor and a lender at

The same time which kind of makes that decentralized peer-to-peer system and the only cost to me are the gas fees of the transaction to power those underlying smart contracts no middleman to squeeze any percentage out of it gotcha gotcha it’s a great breakdown so going back to that whole decentralized component the result is lending protocols have come out creating

Smart contract solutions to enable borrowing lending and staking and have created their own tokens usually just disease governance tokens to incentivize users on both sides what i’m hearing and this term by the way staking is really just referring to an incentive to hold the token meaning that you will earn more as a reward from holding or locking your tokens as

Opposed to using them this creates all kinds of effects mostly liquidity benefits because it ensures a level of stability and sometimes even appetite for buying more when staking is related to not just how long you hold it but how much you hold as well so now today we’ve got all kinds of lending protocols that have been released enabling cryptocurrency holders to

Either borrow against lend out or stake their different digital assets there and the results have been fascinating for example the bat token the b80 token which is the native advertising token that is used in the brave privacy browser at one point actually became more traded in volume than ether itself due to demand for it in the defy community so specifically what

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Happened was the compound lending protocol offered really great returns for the bat token and apparently more than 500 million worth of that was borrowed on the protocol in june alone the protocol itself is worth over 1.5 billion according to the cop token value and by the way that’s only less than a month old – so i mean that is explosive growth it has absolutely

Exploded has an entirely how do i put this simply to our users defy has over two billion dollars worth of assets being borrowed against now and the market cap for the underlying token protocols has now reached over seven billion we’re starting to get those ico like growth figures and behavior in the d 5 space and it’s got a lot of people excited i mean it’s almost

Getting scary from a certain perspective – there was another article that came out that explained how there’s three times more dye being lent out then there’s actually available in total supply and so i think we’re gonna take a crack at trying to explain how that works with its synthetic product we see double counting accounting principles and so as you can imagine

With many of these startups they they don’t really follow the generally accountant principles and so when these assets are locked up and debt is issued that synthetic is counted as net assets despite the fact that it technically should be canceled out by the collateralized amount this process has been replicated multiple times leading to a significant swell in the

Outstanding currency hold on colony let me try to break that down so in essence someone borrows let’s call it a hundred million died for say a hundred million usd see coins in return as collateral they then deposit the hundred million die they just received to get say a lending return on the bat tokens that is a better yield then of course the usd see coins that

They have and that also means that the hundred million die can be lent out again by the protocol right starting the process all over again as the rates then change behind different underlying tokens the yield chasers you know redeposit and move to the better rate and the process starts all over again hence this new term described as yield farming so while on the

Surface it doesn’t seem like a big deal that the die is borrowed three times out it’s just the one significant risk factor in programmatic liquidation i’m not exactly sure how the value is calculated for these lending protocols because it’s very complicated but the main risk factor is that if i put in my hundred eath of a different token like the bat token and

The price of bat drops quickly or in the case where the the yield dries up and it’s no longer exciting for someone to actually farm that coin if you will we could then see mass liquidation caused by the protocol as it pulls out of a lot of these contracts in the event that this happens we then see bank run stylist areas as the protocol can’t really handle the

Outflow of capital in the same way that it can handle new deposits right because you’re staking this currency to get your returns if you want to quick pull it out that’s not the point they’re paying you to keep it in but if they can’t keep you to keep your cash in it can cause some serious problems so i hope that to account for this the protocols rebalance their

Portfolios so that they’re not over leveraged in any one particular asset like for example if they have all of their if they have all the you in quotes stacked in bat tokens but that’s staked for let’s say i’m certainly not the length of time they could then in theory otc a significant portion of those bat tokens into something with more stable value or value

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So that in the event that that bat has a crunch or a price decrease they have their value outside of that they can then rebuy and supply as someone wants to pull it back out but they have to have that programmatically updating at all times to account for these potential risks and quite frankly i’m not exactly sure that’s happening that means great smart contracts

That means great community consensus and organization definitely all interesting things that power these lending protocols that are decentralized in in essence so you know the applications for defy they are novel but accept you know there’s this very real problem that kyle’s describing that it’s entirely built on underlying artificial digital assets which is why

There’s you know that very reason for concern that kyle’s bringing up but it’s also to me an opportunity it’s exactly what vittala was referring to to bring real-world assets in to defy world you know to create more stable and valuable assets that create real consistent yield and can be used as reliable collateral you know we’ll see how they end up succeeding in

The meantime i expect many more projects around defiance security tokens to enter the market i mean we already did catch a glimpse of it with centrifuge and tokenizing paper chain royalties and council frightened voices and in fact we ourselves are working on a stealth project over a security token capital that will be relevant to this trend as well so you know

For me this was all truly really exciting stuff defy is creating a better illustration towards the use of blockchain and its benefits in my opinion and you know at the end of the day i will say that’s not perfect unless you have real-world assets and security tokens as part of that mix i think yeah i also really like the direction it’s all headed but as you’ve

Alluded to the theory behind a lot of this doesn’t always depict reality for example many d 5 players push back against the idea of identifying investors and renounce anti money laundering laws but i feel that these rules are in for a good reason to prevent fraudulent schemes along the same vein it’s nearly impossible to predict market action because there are

So many outside variables and the fact that the market doesn’t act rationally which you just can’t predict and so many of those things aren’t accounted for which leaves room for programmatic layers to execute transactions swiftly and cheaply but it’s also very important to consistently monitor and make changes to our protocols as we see concerning metrics like the

Swelling of synthetic assets that we’ve covered in this episode so it’ll be very interesting to watch we’re gonna keep our eye on this and i’m sure the market will as well but i think that’s about it from us here and our main topic as her we mentioned we are uploading all of these main topics separately from the podcast as well on youtube so if you want to revisit

A topic or just explore some of the topics while skipping maybe the the news that isn’t quite as relevant six months later they’re now all live on youtube all 50 episodes and 51 including this one you can go check that out i have no doubt kyle that we will be seeing dphi come up in the main topics again in the future but with that that’s our show and i want to

Thank everybody for listening i hope to catch you tuning in next week on tuesdays you

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Security Token Show Highlights: #51 – Decentralized Finance (DeFi) 101 By Security Token Market