What is decentralized finance? Where does it come from? What are the things worth remembering in the area of defi in 2020? What is its future? You will find the answer to the above question here.
Let's start from the beginning.
Although there is no specific date for the birth of decentralized finance, some important historical events make the emergence of defi possible.
The first important event was the invention of bitcoin by Nakamoto in 2009.
Whether bitcoin should be classified as defi or not, its birth is a key driving factor for the whole cryptocurrency industry, and decentralized finance is a part of the cryptocurrency industry.
Bitcoin allows users to pay around the world in a decentralized way, and the field of payment belongs to finance, so in my opinion, bitcoin can also be used as WiFi.
But most importantly, bitcoin supports the creation of Ethereum, which is the default blockchain for all top-level WiFi protocols.
While it's cool for people to send bitcoin around the world, finance is more than that. Every sound financial system needs a series of other important services, such as lending, trading, financing or derivatives.
Bitcoin's language (called scripting) is relatively simple and limited, and it is not suitable for deploying the above applications. The limitation of bitcoin language is one of the most important factors for vitalik buterin to create Ethereum.
Ethereum launched in 2015 and quickly began to attract more and more developers, who want to build a variety of decentralized applications, from games, such as cryptokitties, to financial applications.
With the stability of its Turing complete programming language and erc20 standard for creating new tokens, Ethereum has rapidly become a smart contract platform for construction.
This reminds us of maker, one of the oldest defi projects in Ethereum.
Maker is a protocol that allows the creation of decentralized stable coin Dai. The project was created by Rune Christensen in 2014, inspired by bitshares, another blockchain project created by Dan Larimer.
Venture capital funded the development of maker, which was eventually launched at the end of 2017. The first iteration of the agreement is single guarantee Dai (only eth is supported as collateral). This program was later extended to the multi guarantee Dai launched at the end of 2019.
Maker remains one of defi's most important projects and is clearly one of the pioneers in the whole field of decentralized finance.
Another project worth mentioning is etherdelta, which was very popular in 2017.
Etherdelta is the first decentralized exchange (DEX) based on Ethereum, which allows users to exchange erc20 tokens without permission.
The exchange is based on an order book. As we all know, it is difficult to build a trading commission book exchange in Tier 1, which usually leads to a poor user experience. Nevertheless, especially in the ICO era, etherdelta is one of the most popular exchanges for trading different erc20 tokens.
Unfortunately, the exchange was hacked at the end of 2017. Hackers obtained the access permission of etherdelta front desk, and proxy the traffic to a phishing website, eventually defrauding users about $800000.
In addition, the founder of etherdelta was accused by the securities and Exchange Commission of operating an unregulated stock exchange in 2018, which was a fatal blow to maker.
Also in 2017, ICO (initial token issue), one of the first important use cases of Ethereum, flourished.
Instead of using traditional methods to raise funds, the new project began to offer its own token in exchange for eth. Although the concept of decentralized financing is good in theory, many hyped projects have raised a lot of funds without even a few pages of white paper.
In a large number of ICO projects, there are also many projects that we classify as defi today.
The most famous defi projects in the ICO era are:
AAVE - lending
Syntix (formerly known as havven) - liquidity agreement for derivatives
Ren (former Republic protocol) - a protocol that provides mobility access between blockchains
Kyber Network -- on chain liquidity protocol
0x -- an open protocol that allows point-to-point exchange of assets
Bancor: another on chain liquidity protocol
Interestingly, despite the infamous ICO boom of 2017, some of the projects that emerged at that time are now considered to be the top-level agreements for defi.
One of the major breakthroughs at that time was to allow users to interact with smart contracts that contain the common funds of multiple users, rather than directly interact with other users.
This creates a new "user to contract" model, which is more suitable for decentralized applications because it does not need as much interaction with the underlying blockchain as the user to user model.
After the end of the ICO boom and the beginning of the bear market, defi experienced a relatively quiet period of development. But in fact, some of the major defi protocols are under construction.
I usually call this period "pre comp period".
We'll see later why compound's comp liquidity mining is a major breakthrough for defi.
Before we discuss this issue, let's explore some other important agreements and events during the quiet period of the development of defi, which happened during this seemingly quiet period.
Pre comp period
On November 2, 2018, the initial version of uniswap was released to the Ethereum main network. It's the culmination of more than a year's work by its creator Hayden Adams.
Uniswap is obviously one of the most important projects in the field of defi. Unlike etherdelta, uniswap is based on the concepts of liquidity pool and automated market maker (AMM). It again utilizes the user to contract model discussed earlier.
The first version of uniswap was funded entirely by the Ethereum foundation.
In July 2019, another important event happened. Syntix launched its first liquidity incentive program, which later became one of the key catalysts for the summer of defi in 2020.
In addition, a number of other defi projects launched their agreements on Ethereum's main network between 2018 and 2019. These include compound, Ren, kyber and 0x.
On March 12, 2020, the price of eth dropped by more than 30% in less than 24 hours due to global concerns about the spread of the new coronavirus.
This is one of the biggest stress tests on the still fledgling defi industry. As multiple users tried to increase the collateral for different loans or trade between different assets, the gas cost of Ethereum rose sharply to more than 200 Gwei (which was really high at that time).
One of the protocols most affected by this event is maker. The liquidation tide caused by the devaluation of eth mortgaged by users leads to keeper bots (external players in charge of liquidation) being able to buy eth through 0dai. This resulted in an eth gap of about $4 million, which was later compensated by the creation and auction of additional MKR tokens.
Of course, even if an event like Black Thursday may be quite serious, its emergence will make the whole defi ecosystem stronger and stronger.
The main period of the development of defi - "summer of defi" followed.
Summer of defi
The main catalyst for the summer of defi is the comp token liquidity mining project launched by compound in May 2020.
Defi users began to earn rewards by borrowing on compound. Additional incentives in the form of comp tokens have led to a substantial increase in the annual interest rates for the supply and lending of different tokens. This has also promoted the development of yield farming, because users can constantly switch between borrowing and lending different tokens in order to obtain the best benefits.
The incident also spawned a wave of other agreements to distribute their tokens through liquidity mining, and created more and more opportunities for yield farming.
It also created compound governance, where users using comp tokens can vote on different proposed changes to the protocol. Compound's governance model was later reused by several other defi projects.
Another major defi protocol, year finance, was born with this wave.
The project is a revenue optimizer developed by Andre cronje in early 2020. It focuses on maximizing the ability of defi to make money by automatically switching different lending agreements.
In order to further decentralize year, Andre decided to distribute the governance token yfi to the year community in July 2020.
Yfi token is fully distributed through liquidity mining. It has no venture capital, no management reward and no development reward. The first mock exam has attracted a lot of support from DeFi community and has locked over $600 million into the liquidity pool.
The price of yfi token was about $6 when it was first launched on uniswap. Less than two months later, the price of each token exceeded $30000.
Like all the groundbreaking projects in defi, the success of year was soon imitated by other teams. They launched similar projects, but made some minor changes on the basis of the original projects.
Another project that is getting more and more attention because of its unique flexible supply mode is Ampleforth.
This model was quickly borrowed and iterated by another defi protocol, yam.
After just 10 days of development, "yam" will be launched on August 11, 2020.
Yam tokens were distributed in the spirit of yfi, and the agreement soon began to attract a lot of liquidity.
The agreement aims to continuously attract traffic from the defi community by rewarding comp, lend, link, MKR, SNx and yfi holders to stack their tokens on the yam platform.
In just one day, rebase mechanism found a serious vulnerability after the total value of 500 million dollars was locked in the protocol. Although the vulnerability only affected a part of the liquidity providers (LP) in one of the pools (ycrv yam), and they later tried to re launch the agreement, it was enough to make people lose interest in yam,.
Then came sushiswap. The agreement, released by an anonymous team at the end of August 2020, introduces a new concept of vampire attack, aiming to suck up the liquidity of uniswap.
By using sushiswap tokens to motivate uniswap's liquidity providers, sushiswap can attract up to $1 billion in liquidity.
After chefnomi, sushiswap's main developer, sold all his sush tokens, the agreement eventually transferred a lot of uniswap's liquidity to their new platform.
Many projects of different quality were launched during the summer of defi. Most of them are just iterations of existing open source projects, trying to benefit from the excessive prosperity of a new industry.
After "yam" and "sushi", there are many projects named after different kinds of food. For example, pasta, spaghetti, kimchi, hotdog, etc. Almost all projects fail after a day or two of attracting a lot of attention.
The last big event in the summer of defi is the release of uniswap token Uni. All users and liquidity providers prior to uniswap received airdrop awards worth more than $1000. In addition, uniswap launched liquidity mining projects in four different liquidity pools, attracting more than $2 billion of liquidity. Most of them were snatched back from sushiswap.
During the summer of defi, all key indicators of defi have improved significantly.
The monthly turnover of uniswap increased from US $169 million in April 2020 to US $15 billion in September 2020, a substantial increase of nearly 100 times.
The total value of locked in defi increased more than tenfold from $800 million in April to $10 billion in September.
The number of bitcoins transferred to Ethereum tripled from 20000 in April to nearly 60000 in September.
Winter of defi
Of course, in the long run, the upsurge in defi is unsustainable. At the beginning of September 2020, market sentiment will turn sharply. The main defi token began to depreciate rapidly. The liquidity mining income from the value of distributed tokens is also getting lower and lower, and the cold winter has come.
Throughout September and October, negative emotions continued to spread, even though the defi ecosystem was still very active and developers continued to build new defi protocols.
The market finally bottomed out in early November, with some of the top WiFi deals down 70-90% from their all-time highs a few months ago.
After a rapid rebound of more than 50%, the WiFi market began to show an upward trend.
Interestingly, in the winter of defi, uniswap's capacity is still much higher than in early 2020. In addition, the total value locked in defi has been on the rise at the end of the year, exceeding $15 billion.
Of course, throughout 2020, the defi industry has been plagued by a variety of hackers, such as BZX, harvest, Akropolis and pickle.
At the end of 2020, with bitcoin breaking the record high in 2017, it seems that defi is preparing for a new round of parabolic rise.
Looking ahead, the future of defi is bright.
Defi developers are constantly building new innovation projects.
Ethereum 2.0, layer 2 solutions and even other blockchains will be expanded. This will allow a new group of users to start participating in the defi. It will also help to discover new use cases that were previously impossible due to high network costs.
Bringing new, more traditional assets to defi by token or creating a composite version of them will also open up new opportunities.
Competition among layer 2, Ethereum 2.0, bitcoin and other chains will also play an important role. Interoperability protocols and cross chain mobility may become very important.
Other areas, such as credit authorization and low secured or non secured loans,