The path to breaking open finance in 2020

Author: MATTEO LEIBOWITZ Translation: Zoe Zhou

Source: Crypto Valley

  • 2019 will be considered the first year of breakthrough in open finance
  • Five trends in open finance in 2020

In a broad sense, open finance refers to unlicensed and transparent financial services and products that use blockchain technology.

These attributes-permissionless and transparent-unlike traditional capital markets, access to financial products and services has traditionally been geographically and demographically restricted, while rent-seeking intermediaries carefully hide the underlying mechanisms of financial services.

Although these products and services have not yet been adopted by the mainstream, 2019 may be considered the first year of breakthrough in open finance: the transaction volume settled by unmanaged exchanges this year exceeded $ 2.3 billion, and loans issued so far exceeded $ 667 million.

As 2020 approaches, here are five trends related to open finance that deserve our attention.


The agglomeration theory promoted by Stratechery's Ben Thompson claims that the monopoly of a particular industry comes from controlling the needs of end users and commoditizing suppliers. In an era of sufficient information, aggregate management can reduce the user's cognitive burden, and more importantly, allow the aggregation platform to put forward specified conditions for the supplier. Netflix, Facebook and Google are the main examples of successful integration in practice.

Aggregation theory also applies to the era of open finance, where the most important product of this era is liquidity. In the past 12 months, a large number of lending products and exchange products have emerged as barriers to entry into the financial services market have collapsed. The open source nature and inherent interoperability of the blockchain protocol has accelerated this process.

As emerging but largely homogeneous products enter the market more frequently, project founders are beginning to realize that they need to position themselves at the top of the channel. Similarly, user demand for converged services is increasing to take advantage of the most competitive market prices at any time: the new "decentralized transaction" execution management system just launched in August-1inch-has been Processed nearly 7% of total weekly transactions.

I expect this convergence trend to develop rapidly in 2020 as users realize the price-saving advantages and user experience advantages provided by the platform. In terms of "decentralized transactions", 1inch, Totle, DEX.AG, and Ox's Liquidity Bridge seem to be ready to grab market share, but I think that as they optimize the commodification of their products, only two or three companies will eventually occupy the main market share.

Aggregation is also applied to vertical loans. Platforms like Topo Finance and Taken's RAY can provide the highest yields for lenders and the lowest cost of debt for each block for borrowers. The mortgage market is also vulnerable to agglomeration effects, with projects like StakedDAO trying to provide investors with the highest yields.

However, at present, because of the additional special underlying risks associated with validator rewards, I still doubt whether this can be effectively implemented. Validator price comparison platforms like Union may eventually get better positioning here.

High-end financial products

It is no exaggeration to say that the market already has a solid foundation on which to replace the existing financial system. All that remains is to wait for higher-end financial products to come out, and I expect that many high-end financial products will emerge in the market in 2020.

In terms of options, the two protocols Convexity and look promising, but the design of both seems to be incompatible with the liquidity model of "peer-to-peer contracts". This model has promoted the success of many open financial projects in the past 12 months, and inefficient capital may hinder the rapid growth of projects. I am very excited about the implied volatility curve as a by-product.

Although UMA's BitDEX provides a viable method for implementing unmanaged perpetual swap contracts, futures products have not been fully developed.

I expect the fixed lending rate generated by Yield's zero-coupon bonds to be a different success, because open finance participants are disappointed with the highly volatile yields and rates offered by floating lending rate platforms such as MakerDAO, Compound and dYdX. Like the option agreement, I expect that the implicit yield curve generated from the Yield Protocol will be the basis for other financial products such as Eurodollar futures equivalents.

Finally, I expect the field of synthetic asset design to flourish.

MakerDAO shareholders have stated that they are willing to pursue DAI coins with different denominations, and according to the requirements of stable returns in the past two quarters, it shows that the market is very interested in low-volatility products (such as UMA's synthetic S & P500).

Greater liquidity


Several initiatives listed below are attracting more liquid products into the unmanaged trading market. I expect some institutions to stand out. As a result, the liquidity of open financial exchanges-measured by the declines of $ 1,000, $ 5,000, and $ 10,000-began to compete with centralized alternative products.

1. Unlike the ETH.ERC-20 structure mandatory in v1, Uniswap v2 will support ERC-20 / ERC-20 pools. This provides the possibility of deep liquidity for the stable coin pool, and liquidity providers no longer face "non-permanent losses".

In addition, the emergence of more complex financial products, especially options and volatility index-related instruments, has provided a way for ETH / ERC-20 liquidity providers to limit permanent losses through delta hedging. Therefore, the liquidity of the capital pool, which has historically been affected by high price fluctuations, will also be improved.

2. dYdX's native ETH / DAI market is currently one of the most liquid DAI procurement channels. As of November 1, the decline in order volume in the US $ 50,000 market was approximately 0.45%, lower than the 0.80% decrease at the end of September. This rapid liquidity transition has benefited from formal cooperation with market makers (including London-based Wintermute Trading).

3. Many well-known protocols like Ox v3 and Kyber are exploring the use of "rebate" tokens. In these agreements, the market maker will charge an ETH-denominated fee in proportion to the number of its shares.

But how effective this strategy is remains to be seen. Users are now faced with increasing explicit costs to reduce hidden costs. In addition, there is growing concern that non-market token holders can freely avoid the risk exposure of market makers. However, the rebate model has proven popular in the stock market and is worth experimenting with in the token space.

4. The extension of the "rebate" token model of Ox and Kyber is the strategy pursued by the Synthetix protocol. Users who provide liquidity for the syntheticETH / ETH trading pair on Uniswap will receive SNX as a reward in proportion, and regularly provide snapshots. This strategy has been successful so far. Because the sETH / ETH pool has more liquidity than the sum of the second, third, fourth, fifth, and sixth largest liquidity pools.

However, with limited partners starting to withdraw capital, Synthetix's inflation reward strategy will not continue indefinitely. What's more, unlike other ordering models, Uniswap's market makers do not adopt a neutral market strategy. Therefore, if sETH starts to deviate from the market, it remains to be seen whether sETH / ETH can retain capital.

5. The Hummingbot team proposed the concept of "Liquidity Mining". In short, Liquidity Mining provides a dedicated market for token projects and exchanges to meet the needs of market makers: bids and asking prices are expressed as a percentage.

This approach changes the traditional model of token projects and exchanges signing bilateral contracts with liquidity providers: if there is a lack of information on the open market, these contracts may be uncompetitive and monopolized by various market-making institutions, leaving the market facing The risk of a single point of failure. Coupled with Hummingbot's primary product, a product that deploys market-making strategies for retail investors, Liquidity Mining may help increase liquidity in the long-tail market and reduce the cost of market-making activities.

High leverage

According to the products of the past two years, the 150% guarantee ratio promoted by MakerDAO (later adopted by Compound) is too conservative: as of March 1, the median mortgage rate of CDP at the time of liquidation was 149.5%. This mortgage ratio lacks both capital efficiency and hinders the growth rate of the agreement: BitMEX's success depends largely on its ability to provide up to 100 times leverage for XBT / USD trading pairs. The initial increase in dYdX over the past 3 months-dYdX increased by $ 151 million, and MakerDAO'S increased by $ 78 million-may be partly attributed to the platform's support of 115% mortgage rate.

Therefore, I expect Ether's mortgage rate to fall across the lending space: a 125% mortgage rate seems to be a reasonable starting point, which means a maximum leverage of 5 times.

Regarding the mortgage rate, I think the emergence and adoption of CDP saving products such as DeFi Saver, Atomica, and SafeCDP will lead to a reduction in comprehensive liquidation, a significant reduction in revenue for the party running the liquidation robot, and a more competitive liquidation rate.

The decrease in once-rich income may have a second-order effect on the liquidity of unmanaged exchanges. Liquidators no longer gather funds but instead transfer them to a neutral market.

Construction of infrastructure

I hope that two specific infrastructure components will improve significantly in the next 12 months.

The first infrastructure was Layer 2 scaling solutions, Optimistic Rollup, and Zero Knowledge Rollup. In short, these designs move calculations off-chain and publish minimal data on-chain. Security is ensured through Optimistic Rollup's "cryptographic economics" theory and ZK Rollup's encryption technology. Unipig, as the first platform to validate the Optimistic Rollup concept, demonstrated the finality, gas limit and throughput advantages provided by Layer2. Since the upgrade of Ethereum's Istanbul network and the first phase of Ethereum 2.0 as another potential data source, gas costs have dropped by more than 75%. I expect a large amount of data will be migrated from open financial protocols to the general rollup chain in the coming months. In addition, how the most eye-catching Optimisim (formerly Plasma Group) and Matter Labs teams can profit from their work in a sustainable way will be very interesting.

In addition to liquidity and throughput (the former is limited by the latter), compared to many traditional centralized competitors, today's open financial products can provide users with a better user experience: the interface is intuitive and well-designed; one-click Log in; reduce the risk of counterparties through unmanaged nature and emerging insurance markets; transactions can be settled almost immediately; deposits and withdrawals are not restricted.

Finally, the proliferation of fiat currencies. Wyre, Ramp Network and Moon Pay have all made significant progress in the past 12 months. But they are still geographically limited and lack direct product integration. As the open finance team starts targeting the mainstream group, I expect these fiat currencies will quickly spread to the interface level and tighten the foreign exchange spread in both directions.

new challenge

2020 will also face difficulties. Protocol teams, users, and the broader Ethereum community will have to face new challenges, many of which have not yet been clearly addressed.

1. As we gradually accept the controversial ProgPow algorithm, Proxy formal governance in the consensus system is likely to surface. In particular, MKR holders may find that they can determine network specifications in the event of divergence. In this case, members of the wider Ethereum community must seriously consider how to mitigate the capture of the underlying layer by application stakeholders.

This trend will become more apparent as more projects such as Compound, Kyber, Synthetix, etc. transition to DAO-like structures. But there is a question: Assuming Compound is affected by EIP-1884 like Aragon, will 1884 be included in the Istanbul upgrade?

2. On the topic of MakerDAO: I expect the debate over the type of collateral that is "off-chain" (such as tokenized U.S. Treasury bonds and tokenized real estate) to become more intense. Despite the restrictive risk parameters of the support proposals, I think they will eventually be passed. But what these proposals include is likely to spark the "single collateral" branch. Considering the regulatory risks of MakerDAO, the team behind the "single collateral" branch should be as anonymous as possible.

3. Open financial protocols will begin to monetize, which may create some tension with existing users. These users are largely attracted by the sense of disintermediation and virtually zero fees. Also, as in the recent DDOS battle between 1inch and DEX.AG. As the project begins to generate revenue, the culture of cooperation created in open source development may be replaced by ruthless, aggressive competition.

4. As regulators like FinCEN and FATF become aware of the power and dangers of unlicensed financial activity, open financial protocols may prove to be victims of their own success. This situation is likely to be driven by parties such as Tornado Cash and Hopper.

I highly recommend reading "From unknown wallet to unknow wallet" by JP Koning, which covers the above topics. Although the exact form of enforcement is unclear, I expect it to be coerced by geofencing technology and termination of contracts.

5. As Phil Daian argues in her groundbreaking Flash Boys 2.0 paper that the opportunity for "miner extractable value" is increasingly disruptive, Ethereum is more and more likely to be a victim of open financial success.

Finally, I hope that the comparison of the advantages of homogeneous and non-homogeneous security models can be further discussed. The former is supported by Ethereum and Polkadot, and the latter is supported by network companies such as Cosmos.