DeFI: What should the future of open finance look like?

Share by: Liu Yi Finishing: blockpunk (Endless Community)


DeFi itself still has many risks and challenges, but can we stand on the basis of these financial originals and enjoy the future open financial infrastructure? In this issue, we invite an old friend of the Endless Community, Liu Yi, the founder of cdots to share: from DeFi to open finance. Easy to read, here are the core points:

  • DeFi partially replaces the financial services provided by traditional financial intermediaries, with three additional features: no license, anti-censorship, and minimal trust.
  • Among the three elements of finance, DeFi is severely limited in credit and leverage, but basically eliminates counterparty risk.
  • DeFi singularizes the source of credit and changes the risk from a pedigree to a single point. This is not financial progress, but retrogression.
  • In the future, open financial markets must be compliant, but to comply with future regulations, not current ones.
  • Open finance is a market where various financial intermediaries and many decentralized encryption protocols are integrated. We can start from the model of the exchange to speculate on the overall structure of open finance in the future.
  • Everyone can try the public chain application chain. As long as you really do innovation, do n’t be a scam, do n’t go to full pockets, and do n’t waste social resources. The current domestic policy easing must allow everyone to do it. experience.



DeFi is an abbreviation for Decentralized Finance. Take these two words apart.

What is finance first? Huang Qifan said that finance is actually very simple, that is, to manage wealth for the rich and to finance those who lack the money. Such a type of intermediary service is called finance. So what is decentralization? The word decentralization is very vague and has different meanings in different contexts.

If used to decorate a service, I think it means that the service has several attributes:

  • Without permission

No license means that anyone can use the self-generated ID to use the service, without registration, without providing identification information, and without the approval of anyone and the organization.

  • Anti-censorship

Anti-censorship means that anyone can use the service equally, and will not be discriminated or denied service because of the difference in identity or the difference in his data.

  • Minimize trust

Trust minimization means that the user only needs to trust the whole of the encryption protocol community. He does not have to trust individual or a few entities, nor does he have to trust the counterparty.

DeFi is a decentralized encryption protocol that partially replaces the services provided by traditional financial intermediaries. The content of the service has not changed. It is still about managing wealth for the rich and financing for the lack of money, but its attributes have changed, and it has the above three attributes under decentralization.


Is DeFi the future of finance?

Finance has three elements, credit, leverage and risk. With the addition of this decentralized attribute, all three elements of finance have changed.

The first is credit. Credit refers to the attachment between people, organizations and organizations, and in the course of commodity transactions, a trusting production relationship and social relationship are formed. Credit is dependent on identity, that is, who or what kind of credit they have.

DeFi has no identity, so there is no traditional credit. Or DeFi's credit currently has only one source: over-collateralization.

Under the premise of exceeding the mortgage, the leverage ratio is limited, and this leverage ratio can be calculated:

For example, MakerDAO has a mortgage rate of 150%. Ideally, the price of DAI is strictly one dollar. Then we take 100 USD of ETH as a collateral, and get a DAI of 66.7 USD, and then use this 66.7 USD of DAI belt to buy ETH, and get a DAI of 44.24 USD on the mortgage. The process of cyclically buying a mortgage is obtained by using a series of proportional formulas. With a principal of 100 US dollars, a maximum of 300 US dollars of CDP (mortgage contract) can be held, which means that the leverage is tripled.

Can DeFi increase its leverage? The calculation process just explained that the leverage ratio is determined by the pledge rate:

Leverage multiple n = mortgage rate ÷ (mortgage rate-1)

Because all DeFi are over-pledged, the mortgage rate is always greater than 1. At this time, the smaller the pledge rate, the higher the leverage. However, the price of crypto assets is highly volatile. In order to ensure security, it is difficult to increase the leverage of this place.

So from the analysis just now, it can be seen that DeFi is severely restricted in terms of credit and leverage.


What are the advantages of DeFi? At present, it seems to reduce the risk, and some even think that it is eliminated.

So where is it reflected? It is mainly counterparty risk and intermediary moral hazard.

Eliminating counterparty risk, DeFi basically does it. However, due to two technical obstacles, the moral hazard of DeFi's intermediary, that is, the moral hazard of this encryption protocol, has not been completely eliminated.

The first technical obstacle is that the current form of the DeFi protocol is basically smart contracts, but smart contracts lack governance methods. The lack of governance methods brings two problems: the first problem is that the agreement cannot follow the community consensus to upgrade and evolve; the second problem is that after you find that the smart contract is defective, you cannot modify it, you can only consider yourself unlucky.

Therefore, in order to achieve a certain degree of contract upgradeability and control losses in the event of defects, DeFi's smart contracts have a back door, or super authority, to varying degrees, allowing developers to perform emergency braking. , Or change the scope of this super permission.

The second technical obstacle is that there is no reliable decentralized oracle. Many DeFi protocols require off-chain data.

I think these two technical obstacles can be solved:

  • The first solution to the obstacle is to develop a dedicated "application chain" to implement DeFi, which is actually the subject of cross-chain discussions. Unlike the smart contract DeFi, the application chain can achieve effective governance.
  • The second problem , decentralized oracles are currently underway in many projects, and there should be useful solutions in the next few years. After the two technical obstacles are removed, the intermediary moral hazard of the DeFi encryption protocol can be eliminated.


So do you think this is the embryonic form of future finance?

I don't think so, because finance is not designed to eliminate risks, but to encapsulate the various types of assets and cash flows into products and put them on the market to meet different needs in the three dimensions of risk, return, and maturity.

The degree of financial development can be measured by the size of financial markets and the diversity of financial products. From this perspective, DeFi is not as good as the financial market composed of Chinese money houses and pawnshops 300 years ago, let alone compared with the current global financial market.

DeFi singularizes the source of credit and changes the risk from a pedigree to a single point. This is not financial progress, but retrogression.

Now DeFi is like a group of curious children, who have discovered a novel set of Lego bricks. This set of bricks contains some models of new financial components . We can try to develop crypto protocols and do decentralized community operations. , Do protocol governance, and so on. Some of them will gain experience and become the designers of future open financial buildings.


What will open finance look like? Although it is difficult to predict now, I think two points are relatively certain:

  • Open finance is a regulated and compliant market.
  • Open finance is a market where various financial intermediaries and many decentralized cryptographic protocols work together.

To illustrate these two perspectives, you need to understand some basic principles of financial markets and financial regulation. Finance is an intermediary business, why is it needed? Because of the asymmetry of information, this creates two major types of problems:

  • One type is called the reverse selection before the transaction is reached . That is, under the condition of asymmetric information, inferior products will occupy the market and good products will be eliminated.
  • One type is the problems that come with the transaction , that is, moral hazard. Under the condition of asymmetric information, the transaction agreement is usually incomplete. After an agreement is reached, one party to the transaction does not have to bear the full consequences of their failure or default, thereby damaging the interests of the counterparty. This is moral hazard. For example, for example, after someone has fire insurance, they no longer pay attention to fire prevention. Anyway, there is a fire. An insurance company is responsible for compensation.

In financial markets, financial intermediaries are used to solve the problems of adverse selection and moral hazard caused by information asymmetry. However, in the case of asymmetric information between the two parties entrusted by the intermediary, the problems of adverse selection and moral hazard of financial intermediary have arisen. Without strict supervision and professional intermediary, serious adverse selection and moral hazard will be caused. Therefore, capital markets around the world are under strict supervision.

Finance needs supervision. This is not because of the game between countries or the struggle for power by government departments, but because it cannot develop without supervision of the financial market. 1CO can be regarded as a test for open finance in the field of direct equity investment. In an environment without supervision, the response choice and moral hazard performance are vivid.

So open finance must be a compliant regulatory market. The question now is how to supervise, how to comply, and who complies with these issues. No one can answer systematically at this time, and there will be no answer soon. Some scholars suggest that blockchain entrepreneurs embrace regulation. I think this is too early. Blockchain entrepreneurship is to comply with future regulations, not current regulations.

This may sound like an impossible task, but it is not difficult. Just do the following two things:

  • The first point is that blockchain entrepreneurship is about real innovation .

For example, DeFi is designed to make financial markets more efficient, fairer, and more secure. If it deviates from the nature of finance and does not help the real economy, it can only be a scam in the final analysis.

  • Second, resources should not be wasted excessively.

Have to invest in the development and operation of the encryption protocol used for this fund. If the agreement is successfully implemented, then the entrepreneurs share the benefits with other participants in the community; if this agreement is not successful, as long as the entrepreneurs do not have enough money, this is the reasonable price society pays for innovation.

Real entrepreneurs don't have to rectify compliance issues. Future regulation will embrace you.


Open finance is a market where various financial intermediaries and many decentralized encryption protocols are integrated.

There is certainly no objection to this, but the key is how to merge? Or what kind of structure will open finance present?

Then last month the well-known crypto investment fund Multicoin published an article called the exchange is open finance. But to be precise, the exchange should be the embryonic form of open finance, and the overall structure of open finance in the future can be inferred from the model of the crypto asset exchange.

The climax of the 2007 subprime mortgage crisis was the refusal of the US government to rescue Lehman and let it go bankrupt, which triggered a tsunami in the financial markets. Why did the United States make this decision? Because bailouts raise moral hazard, if large financial institutions know that the government will not sit idly by, they will be more confident and bold in speculation.

In fact, the large financial institutions did take advantage of their irresistible status, harming the interests of the entire society. 2008

In the financial crisis of the year, millions of families in the United States lost their homes, and the US government did not help them. But after the collapse of Lehman, the Treasury Department and the Federal Reserve feared to trigger a chain reaction that would cause the entire market to collapse, and could only allocate funds to help large financial institutions. This triggered strong social dissatisfaction, and the Occupy Wall Street movement in 2011 was the darkest moment in the United States.

I encountered a similar incident in the crypto market. In 2014, the MT.gox exchange accounted for 80% of the global crypto asset trading volume, but after being attacked, MT.gox closed down directly, and no one was rescued. He did not affect a large area. But I used to use my wallet to deposit coins, not on the exchange, so it was unscathed.

But if I bought Lehman's financial products, is there any way to avoid the loss caused to me by the collapse of Lehman? Thinking about this problem, you will find that Lehman and MT.gox are both important financial intermediaries, but they are very different.

Lehman is an investment bank. In addition to intermediaries, it acts as a counterparty to investors and financiers in a large number of transactions . In a complex financial trading network, the collapse of Lehman has made a large number of assets toxic, and a large number of counterparties (ie, its associated institutions) are in crisis. No one knows the scope of the loss and the amount of the loss. Therefore, it is a veritable movement of the whole body. If I invest in this Lehman financial product, there is no way to avoid its loss of failure.

In fact, after the subprime crisis, it was found that Lehman's net loss was not large. If there was no panic in the market at that time, and liquidity was maintained at a reasonable level, Lehman could definitely overcome the difficulties through borrowing or additional issuance. So the collapse of Lehman Brothers, or the entire subprime crisis, is a structural flaw in the current financial market.

Crypto asset exchanges are the embryonic form of open financial intermediaries. They provide services for matching transactions and collect service commissions, but they do not act as counterparties. More importantly, encrypted assets are recorded on the blockchain's distributed ledger and need to be controlled directly through the private key. The exchange is also not the ultimate bookkeeper.


Traditional financial intermediaries have assumed the triple roles of server, counterparty, and bookkeeper. Open financial intermediaries only provide services and assume part of the bookkeeping responsibilities, and should not act as counterparties.

There is also a type of basic ledger that acts as a full bookkeeper, which is a public chain like Bitcoin , but the number will not be large. Because value storage itself has a network effect, the more people use this asset to store value, the stronger its social consensus, and the better the liquidity of the asset. There will be tens of thousands of crypto assets in the future, and people will only hold a few, only buying or redeeming them into other assets when needed.

Users and financial institutions will have accounts on these basic ledgers. So users can directly control their assets through the private key. There will be a large number of transaction agreement ledgers (or application chains) outside the basic ledgers, which are actually different types of financial markets, such as equity markets, borrowing markets, and derivatives markets.

I think there are two types of these transaction agreement ledgers:

One is where financial institutions act as bookkeepers, and financial intermediaries are still companies, such as centralized exchanges. Enterprises can choose their own place of registration, which means they choose which regulatory authority to supervise. These financial institutions should have an account of this basic ledger (such as BTC), that is, it must publish his fiat currency account and basic ledger account to the society and regulatory authorities, which is equivalent to the bank's basic reserve.

The other type is the transaction agreement ledger, and the current DeFi agreement belongs to this category. For example

MakerDAO, he will accept the pledge of the underlying assets and output a dollar-bound asset. The input and output assets of these transaction protocols should mainly be basic assets, such as RMB and Bitcoin. These agreements do not have a clear investor and operation and maintenance body, so they need the incentive of community tokens for maintenance. Such agreements are transnational, but the authorities can supervise the issuing and trading of their community tokens.



Uncle Red Army: I mentioned a lot of questions about supervision and the central bank, so what will you do about the role of the central bank's digital currency and the future pattern?

Liu Yi:

I think the central bank's digital currency is useless in the short to medium term, especially for countries such as China where electronic money has become popular. But in the long run, it will change the structure of the entire financial market. China's DCEP maintains a two-tier structure and is transitional, avoiding the impact on the market structure, and especially reserved a place for commercial banks. But in the long run, I think the central bank's digital currency will make commercial banks lose their current dominant position.



Will commercial banks transform under this shock? In what direction?

Liu Yi :

The existing financial intermediaries all face the problem of transformation. The biggest conversion is actually to separate from the identity of the counterparty and the bookkeeper and focus on the intermediary service.

In this way, one of the biggest structural problems in financial markets can be avoided: financial institutions are too big to fail, or monopolies hijack the entire society. Of the thousands of listed companies in China in the last decade, half of their profits have been created by listed companies in the banking industry. Why do financial institutions make so much money? It is because they are in an overly important position.

Commercial banks not only act as a service provider in the allocation process, but actually act as an intermediary. In other words, they make a difference. And because of its network effect, it has in fact monopolized the market, so the spreads it earns will grow larger.

I think that the future financial intermediary should be service-oriented, relying on this understanding of investors and financiers, and relying on the ability to obtain data and analyze data to provide services and earn profits instead of spreads. Such a service provider can be considered a channel provider or a distributor.

And the status of financial intermediaries should be unlicensed. If any of your business organizations has a sufficient understanding of the financial business, or you have enough user data, you can efficiently complete the intermediary of this financial transaction, and you can serve as a trading center. Competition for efficiency.


Uncle Red Army:

Some people complain that the experience and threshold of DeFi products are not good. They think that DeFi can only become a niche product in some password circles. Tell us what you think based on the status quo?

Liu Yi:

Now all the addresses are decentralized, we can choose. In other words, application-based encryption protocols have a poor user experience, are slow, expensive, and technically complicated. DeFi is because the frequency of transactions is low and the value of a single transaction is high, so it has a higher tolerance for poor user experience and high use costs. So he was a general in the dwarf and stood out. As technology advances, this problem can be solved, I think.


Uncle Red Army:

At present, everyone basically recognizes that DeFi is the main battlefield of Ethereum. Recently, Kava in the cosmos ecosystem has also been launched. What do you think of the development of other DeFi in the non-Ethereum ecosystem? What practical problems do they need to overcome?

Liu Yi:

Everyone knows that my cdot project is cross-chain and my main research direction.

Once cross-chain is achieved, the type of assets that can be used first is expanded. The market value of ETH is US $ 20 billion and the market value of BTC is close to US $ 200 billion. If it can cross ETH and BTC, the amount of assets that the agreement can use will almost double. Ten times.

The second one can go across other ledgers, such as central bank digital currencies. Or access tokenized securities, gold or other derivatives. The more types of assets you can access, the amount of underlying assets can expand. Because DeFi leverage and production utilization are not high, the amount of basic assets determines how much business you can do.

One of the key points of DeFi is composability. Assets and trading rules in financial transactions can be combined. Cross-chain not only allows you to expand the type of basic assets you use, but also different transaction rules can be combined. We need to divide it into different chains, and we need cross-chain to achieve such composability.


Uncle Red Army:

10 24 After the speech, the voice and enthusiasm of the alliance chain suddenly came up. How do you understand the decentralized defi and the alliance chain under supervision?

Liu Yi :

Because the alliance chain is a productivity tool, there is no challenge to his supervision. The alliance chain constitutes a publicly audited database, which can well replace the original enterprise data exchange and EDI system. The productivity tools just improved the productivity of this bookkeeping. The original business alliance was still there, the original business relationship has not been changed, and the original regulatory rules still apply.

The decentralized, cross-border, and no center, regulation of this encryption protocol is a problem. One of the main points I share this time is that you do a decentralized encryption protocol. No matter what you do, you don't have to worry too much about regulatory issues. As long as you are innovating to promote the real economy, it will really increase efficiency. Second, you don't spend money arbitrarily, and you don't have a lot of money. I think so. Regulation cannot guide you in doing this. This is our experience of reform and opening up. Cross the river by feeling the stones. After you cross the river, you can get the government or the regulatory authority's opinion.



Uncle Red Army:

So can the application chain also be understood as a positioning between the public chain and the alliance chain? That is not as big as the public chain, not as dead as the alliance chain?

Liu Yi :

Because we did not have the concept of this application chain, we are collectively called the public chain. In fact, most of the original public chains were only inaccessible, that is, they were public. General purpose public chain, you can do various applications on it, but in fact the public chain is also open, he just does not use general purpose.


Uncle Red Army: After listening to it, it is estimated that many people have a confusion, that finance needs supervision, and there is a moral hazard problem if there is no supervision. Supervision can only be done in the alliance chain. Is entrepreneurship a whole time window?

Liu Yi :

Uncle, this is what I want to express: a public chain or an application chain can do it. As long as you say that you really do innovation, do n’t be a scam, do n’t go to full pockets, and do n’t waste social resources. The easing period for everyone's policy allows everyone to innovate.

In fact, I think that the alliance chain is not a matter of the blockchain world, just like we don't take the internal information system of the enterprise as a part of the Internet industry.

Because we did not have the concept of this application chain, we are collectively called the public chain. In fact, most of the original public chains were only inaccessible, that is, they were public. General purpose public chain, you can do various applications on it, but in fact the public chain is also open, he just does not use general purpose.