Finally, someone said what DeFi is and what it can do | DeFi Series

In the digital currency ecology, other track patterns tend to be stable, and decentralized lending still has a blank.

Since the beginning of 2019, DeFi has become a hot topic in the field of blockchain. The platforms and products that provide DeFi services have also sprung up. Among them, decentralized lending projects have caused a lot of waves in the market. DeFi is considered to be a “new financial revolutionary movement”. What is the nature of DeFi, how does decentralized lending work, what are its innovations and pain points, and where are the opportunities worthy of attention? This research report will mainly answer the above questions.

table of Contents

First, DeFi overview

Second, decentralized lending overview

2.1 Background of decentralized lending

2.2 Characteristics of decentralized lending

2.3 Decentralized lending service crowd

Third, the comparison of decentralized lending models

3.1 Three modes of decentralized lending

3.2 Decentralization degree comparison

Fourth, the development and future of decentralized lending

Five, reference materials

First, DeFi overview

1.1 What is DeFi?

DeFi is an acronym for Decentralized Finance, also known as Open Finance. It actually refers to the decentralization protocol used to build an open financial system, designed to allow anyone in the world to conduct financial activities anytime, anywhere.

In the existing financial system, financial services are mainly controlled and regulated by the central system, whether it is the most basic access transfer, or loan or derivative transactions. DeFi hopes to establish a transparent, accessible and inclusive peer-to-peer financial system through distributed open source protocols, minimizing the risk of trust and making it easier and more convenient for participants to obtain financing.

These DeFi platforms have three major advantages over traditional centralized financial systems:

a. Individuals with asset management needs need not trust any intermediary's new trust to rebuild on machines and code;

b. Anyone has access and no one has central control;

c. All agreements are open source, so anyone can collaborate on building new financial products and accelerating financial innovation under the network effect.

DeFi is a broader concept, including: currency issuance, currency trading, lending, asset trading, investment and financing.

We see the birth of BTC and other cryptocurrencies as the first phase of DeFi. However, the decentralization of currency issuance and storage only provides a solution for peer-to-peer settlement, and is not enough to support a rich financial business. In the past two years, the rapid development of decentralized lending agreements will have the opportunity to further open up the financial system of the blockchain world and bring DeFi into the second stage.

Second, decentralized lending overview

2.1 Background of decentralized lending

Previously, ICO was banned in the country and STO required a higher threshold and was still in the test stage. For companies, the cryptocurrency market needs new financing tools. According to Pan Chao, head of MakerDAO China market, the debits on MakerDAO are mainly enterprises, which also indicates that the project side will decentralize lending as a financial tool. For mature financial markets, richer financial instruments will lead to higher market liquidity. It is foreseeable that after decentralized lending, equity products and derivative products will gradually enter the public's field of vision and decentralize. Borrowing is an important step in leading cryptocurrencies into financial services.

In addition, in the second half of 2018, the price of digital assets declined overall, and the holders of the money changed from speculative to “financial management”, borrowing, and margin trading to carry out value-added preservation. The balance of active loans on December 31, 2018 reached US$71 million, an increase of 1083% compared to US$6 million on December 31, 2017, which also reflected a significant increase in the acceptance of decentralized lending platforms.

2.2 Decentralized lending characteristics

Decentralized lending refers to matching borrowers and lenders through a decentralized lending agreement, and then immediately transferring assets and completing lending after confirmation of pledge.

The decentralized lending agreement provides the platform with a technical basis for standardization and interoperability, and plays a role in security management during the loan process. Compared with the traditional lending model, the decentralized lending model has the following characteristics:

a. The combination of legal currency loans and digital asset loans (the stable currency model can be regarded as a combination of legal and digital assets);

b. Mortgage based on digital assets;

c. Real-time transaction settlement through automation and reduce actual costs;

d. Substitute credit review with over-collateralization, which means more people can be served than traditional services.

The form of “mortgage loan” commonly used in decentralized lending platforms: Borrowers must use assets with a value higher than the borrowings as collateral to ensure that the lender can obtain collateral if the debt cannot be repaid. The business process of a mortgage is as follows:

2.3 Decentralized lending service crowd

Who is the digital currency debit and credit?

Debits: including quantitative trading platforms, cryptocurrency hedge funds, blockchain project parties, mines, etc., they want to obtain cash flow through mortgage digital assets, or hedge against risk through borrowing.

Lenders: including asset managers, family offices, and high-net-worth individuals, who want to use their equity loans to get extra income.

Third, the comparison of decentralized lending models

3.1 Three modes of decentralized lending

The most famous four decentralized loan agreements are Compound, Dharma, dYdX and MakerDAO, which we have grouped into three modes:

(1) P2P coupling mode

Dharma and dYdX are point-to-point agreements that combine debit and lender. Therefore, the number of loans and loans based on these two agreements is equal.

For example, in Dharma, a smart contract acts as a “guarantor” to assess the asset price and risk of the borrower. The creditor decides whether to lend to the borrower according to the evaluation result provided by the “guarantee party”, and when the borrower fails to repay the loan on time, the “guarantee party” automatically performs the liquidation procedure. The Dharma platform has a loan period of up to 90 days and the loan interest is fixed. The lender is locked in during the lending period and only begins to earn interest after matching the borrower.

The dYdX protocol is also P2P mode, but the main difference between it and other lending platforms is that dYdX also supports transactions other than borrowing and lending, such as futures trading. When the trader opens the position in dYdX, he will borrow the deposit and agree with the lender to negotiate the terms and conditions through the platform to conduct the margin trading. Therefore, the target customers of dYdX are mainly margin traders. The interest on the dYdX platform is variable, and the user has no lockout period or maximum period when lending on dYdX.

(2) Stabilized currency mode

The model is typically MakerDAO, no lender has a debit, and the only asset that can be borrowed is DAI. The borrower borrows the newly created DAI through the mortgage digital asset (now ETH). DAI is a stable currency linked to the US dollar issued by the MakerDAO platform. The pledge ratio of pledged assets and borrowings must remain above 150%. The interest is global and is determined by the MKR holder by voting. Interest is not stable and has risen from 2.5% to 19.5% in more than a month.

(3) Flow pool trading

Taking Compound as an example, borrowers and lenders trade through a liquidity trading pool rather than matching counterparties. The interest rate for each loan and loan is determined by the pool's liquidity, which is the ratio between the total amount of money provided by the lender and the total demand of the borrower. Compound does not set a fixed loan term, and the lender can deposit funds into the loan pool to earn interest and withdraw assets at any time. The borrower has an unlimited contract period.

3.2 Decentralization degree comparison

Different decentralized loan agreements contain common basic components:

(1) Asset custody: refers to the management method of debit pledge and lender funds, such as hosting by the platform or self-management.

(2) Additional notice of pledge assets: similar to the margin call, because the price of the pledged assets (digital currency) will fluctuate. Some projects design additional notices when value fluctuations cause the pledge rate to be greater than a certain threshold. The way of notification is divided into direct notification by the platform, incentives to inform others by economic mechanism, and some platforms will directly liquidate.

(3) Providing additional liquidity of the pledged assets: that is, the liquidation method of the pledged assets, such as direct auction or sale by the platform, or liquidation by others through incentive mechanisms.

(4) Liquidation price determination: that is, the pricing problem when liquidating pledge assets is centralized or decentralized.

(5) Interest setting: Whether the loan interest is set is centralized or decentralized.

(6) Protocol development: Whether the agreement is developed by a fixed team or decentralized.

Taking traditional finance as an example, the third-party custody of the platform is still centralized. When the risk of default occurs, the bank compulsory liquidation, the value of the assets is determined by the bank, and the interest on lending is also stipulated by the bank. These factors show different degrees of decentralization in different projects. Accordingly, DeFi can be classified.


(1) Dharma

In Dharma, when a borrower initiates a loan request, it generates an address to store the pledge and keeps the borrower's assets for the duration of the contract. The private key is kept by the borrower, so the fund custody is decentralized.

Dharma's interest rates are centrally set and are currently subsidized by the operators of the platform.

The Dharma core contract and the hosting contract are developed by the Dharma team, the hosting contract is open source, and the loan originating contract is a closed source.

(2) MakerDAO

Hosting: MakerDAO Smart Contracts are open source and unmanaged from the perspective of loan origination.

Initiation of additional pledge assets notice: Pledged asset monitoring and additional notices are exempt from authorization, incentives and dispersion.

Additional pledge asset liquidity: Providing liquidity is non-authoritative, decentralized and motivating.

Price Determination: The MakerDAO price supply is semi-centralized and is determined by the MKR holder's vote.

Interest: Voted by the MKR holder, this is a semi-distributed approach.

Development: The MakerDAO contract is focused on development and open source.


Custody: The Compound Smart Contract is open source and non-custodial from the perspective of loan origination.

Initiate additional pledge asset notifications: Monitoring and append notifications are decentralized.

Additional pledge asset liquidity: Providing liquidity is non-authoritative, decentralized and motivating. Compound uses 5% of the collateral liquidation as incentive monitoring to initiate and provide liquidity for additional pledged assets.

Price feedback: The price supply is directly calculated by the owner of the whitelisted address controlled by Compound.

Interest: The current interest rate is determined centrally.

Development: Centralized development and open source.

(4) dYdX

Custody: From the perspective of loan origination, dYdX smart contracts are not kept.

Initiate an additional pledge asset notification: An additional notification can be initiated by anyone. 5% of the collateral liquidation is used to motivate the initiator.

Additional pledge asset liquidity: Anyone can provide additional pledge assets to notify liquidity, so that this function is dispersed.

Price Determination: The price of dYdX supplies the price supply mechanism for anchoring MakerDAO, Uniswap and ETH2DAI. For this reason, we believe that the price supply of dYdX should be considered as scattered, but not completely dispersed.

Interest: dYdX sets the interest rate model parameters to enable them to centrally control interest rates.

Development: The dYdX Smart Contract is a centralized development and closed source.

Fourth, the development and future of decentralized lending

In December 2017, with the launch of MakerDAO's dollar-linked stable currency DAI, decentralized loans began to strengthen. As of December 31, 2018, nearly 97% of active loans were made through the MakerDAO agreement, with the main users being companies. In September 2018, Compound was launched, mainly serving small loan users. MakerDAO only supports the lending of an asset from DAI, and Compound becomes the second.

Due to the emergence of Compound and dYdX to provide users with new lending channels, total borrowing increased in the second half of 2018.

Among them, DAI became the most borrowed asset in 2018 (US$207 million), accounting for nearly 98% of all borrowed assets.

At the same time, the distribution of lending assets on different platforms is also different:

The lender provided $39 million in assets in 2018, of which 96% passed Compound, followed by dYdX, and the more centralized Dharma had the least:

The emergence of Compound and dYdX provides new lending opportunities, with loan lines starting from the third quarter of 2018:

The pledge ratio is an important indicator of the security of the lender in the loan. Compound has the highest pledge ratio among the four major agreements, which is one of the reasons why it becomes the most popular platform for lenders:

The above decentralized lending market is based on the Ethereum ecology, and some people have recently classified the EOS REX, which is relatively hot, into a decentralized lending based on the EOS ecology. However, we believe that EOS REX is a resource leasing mechanism within the EOS ecosystem. The difference between leasing and lending is that there is no risk of loss of assets in the lease. After the lease term expires, the leaser no longer has the right to use, and the assets are still the lessor, and the loan is borrowed. The pledge is needed to guarantee the risk of loss of the borrowed assets, which is not the same. I won't go into details here, we will focus on the EOS REX mechanism in the next article. Of course, this also shows that decentralized lending based on other ecosystems such as EOS is still blank, and there is a lot of imagination for entrepreneurs.

In general, decentralized lending is the second step in DeFi's cryptocurrency. Under the background of closed corporate financing channels and lack of asset distribution channels, the three models of the platform gradually opened up the market with their respective advantages, and have begun to take shape since the beginning of last year. There are centralizations in various projects to varying degrees (of course, decentralization is not necessarily better than centralization. For example, in the absence of liquidity in the market, companies like Tether still have a great advantage to provide a centralized lending. platform).

The widespread use of DeFi still has a long way to go. But in terms of cost savings, trust resolution, and financial risk reduction, we have long been optimistic about DeFi and decentralized lending.

V. References:

Digital Asset Lending via Open Protocols 2018

Decentralized Lending: An Overview

How Decentralized is DeFi? A Framework for classification Lending Protocols

Author| Little Parker Edit | Hao Fangzhou

Produced | Odaily Planet Daily Research Institute

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