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Finance has existed for as long as civilization. And like most things before the Internet age was based on the trust of centralized law and authority (like banks and governments). Decentralized Finance (DeFi) is the movement that asks could we perform our financial transaction with out centralized trust. Finance has evolved many instruments to meet the needs of civilization, all of which are based on trust (store of value, currency, loans), de-fi will search for equivalences of each of these.

The jobs of finance

I spent some time thinking about finance. I’m guessig there’s some truth here, but a finance guy would probably help me get a better grip on it.

Representing and storing value

Fungible Entities - Sheep

Non Fungible Entities - The Shaman’s crown

Exchanging value - Markets

Liquidity - When is the market open, and who is there?

Compensating Risk - Interest

Capitalizing an entity - Rent

Insurance - Paying to redue risk

Hedging - Derrivatives

Speculations - Derrivatives

Market Makers -

Auctions -

Loans with collatoral -

Loans w/o collatoral -

Market Makers -

Speculations - Derrivatives

Market Makers -

Auctions -

From TradFi to DeFi

Representing and storing value Traditional Instrument DeFi Instrument
Representing and storing value Concept Concept
Fungible Entities Sheep Bitcoin/ ERC20
Non Fungible Entities - The Shaman’s crown Shaman’s Crown ERC721
Exchanging value - Markets Concept Concept
Markets - Order Book NASDAQ  
Liquidity When is the market open, and who is there? Uniswap
Compensating Risk Interest  
Compensating For use of an entity Rent Rent
Hedging Derrivatives dx/dy
Speculation Derrivatives dx/dy
Loans w/Collatoratal Mortgage BlockFi
Loans w/o Collatoral Bookie; Mafia (bodily harm is collatoral) Flashloans ERC 3156
Reducing Risk Insurance  

DeFi 101

Store Of value - Bitcoin

Currency - ERC20

Identity

The ledger for store of value

Imagine we’re a parent of young kids Alice and Bob. Instead of giving them cash you keep track of how much money they have on a piece of paper. That piece of paper is a ledger so:

At the start of time Alice has 100$

  • T0: Initialize: 100$ to Alice

Now Bob does the dishes for Alice, and she gives him 20$

  • T1: Alice gives 20$ to BOB

At this point if we look at the ledger we know Alice has 80$ and Bob has 20$

What is the actual trust model here?

Easy to say we don’t trust anyone, but we must trust something. Here is our requirements to have a trust worthy system.

Lets start with the bitcoin model which is easier:

  1. There is one public ledger and it is the source of truth.
  2. The ledger can only be updated with valid transactions
  3. Valid transactions imply the sender and receiver both both consent to the transaction.

Ethereum and Smart Contracts

More then a ledger

Transaction costs

Ethereum Virtual Machine

Smart Contracts, DAPPS

Smart Contrats, DAPPS

Fungible Tokens ERC20

Non Fungible Tokens ER721

Interacting with off chain state

Oracles to keep offstate on state

Building your own contracts

Tool chains

Poly - the default language

The default language

Vyper - the simpler programming language for python programmers

Ganache - a personal etherium ledger and VM

https://www.trufflesuite.com/ganache

Risks

Speculatave Bubble- The Tulip Bubble

No one wants to miss a chance for a quick buck, and back in 1637 the quick buck was to be had by investing in Tulips *Many individuals suddenly became rich. A golden bait hung temptingly out before the people, and, one after the other, they rushed to the tulip marts, like flies around a honey-pot. Every one imagined that the passion for tulips would last for ever, and that the wealthy from every part of the world would send to Holland, and pay whatever prices were asked for them. The riches of Europe would be concentrated on the shores of the Zuyder Zee, and poverty banished from the favoured clime of Holland. Nobles, citizens, farmers, mechanics, seamen, footmen, maidservants, even chimney sweeps and old clotheswomen, dabbled in tulips.

People were purchasing bulbs at higher and higher prices, intending to re-sell them for a profit. Such a scheme could not last unless someone was ultimately willing to pay such high prices and take possession of the bulbs. In February 1637, tulip traders could no longer find new buyers willing to pay increasingly inflated prices for their bulbs. As this realization set in, the demand for tulips collapsed, and prices plummeted—the speculative bubble burst. Some were left holding contracts to purchase tulips at prices now ten times greater than those on the open market, while others found themselves in possession of bulbs now worth a fraction of the price they had paid. Mackay says the Dutch devolved into distressed accusations and recriminations against others in the trade.[13]*

Taking over the chain, the 51% attack

https://www.investopedia.com/terms/1/51-attack.asp

The attackers would be able to prevent new transactions from gaining confirmations, allowing them to halt payments between some or all users. They would also be able to reverse transactions that were completed while they were in control of the network, meaning they could double-spend coins.

Buggy Software - Yam

Great Story around speculation and software bugs

Team decided to create a new currency, Yam, with several good properties. Elastic money supply, community governance, treasury to fund future improvements via stable coin, through money supply code.

  • August 1st - Team had an idea for a new smart contract, furious coding
  • August 11th - Currency launches
  • August 11th - 150M in funding for initial offering
  • August 12th - 500M in funding for second round.
  • August 12th - Bug found, requiring majority of community to vote on govenrance before 8am
  • August 13th 7am - Enough people voted, but found a bug, so the protocol could not be used.
  • August 14th - Protocol worthless. Many people got their money out of the protocol, but 25%?? did not?

Buggy software and anonymous helpers

600M was stolen from Poly. What’s fascinating about this attack, is that due to the public ledger nature of the attack the “robbed from”, could ask others to not accept coins from the robbers which they did on twitter But then, a hacker wrote into the ledger a recommendation for the robbers to liquidate their bounty, which worked. The robbers then gave the tipster a 45K tip.

MEV

Miner extractable value (MEV) is a measure to study the profit of a miner (or validator, sequencer, or other privileged protocol actor) can make through their ability to arbitrarily include, exclude, or re-order transactions from the blocks they produce. MEV includes both ‘conventional’ profits from transaction fees and block rewards, and ‘unconventional’ profits from transaction reordering, transaction insertion, and transaction censorship within the block a miner is producing.

Salmonella Attack

https://github.com/Defi-Cartel/salmonella

Sandwich Attack

Cost of consensus - Proof of Work

Cost of consensus - Proof of Stake

You “vouch” for valid transaction getting paid if they are valid, and losing your money if you attest to invalid transactions. Way less computing power required.

https://ethereum.org/en/developers/docs/consensus-mechanisms/pos/

Unlike proof-of-work, validators don’t need to use significant amounts of computational power because they’re selected at random and aren’t competing. They don’t need to mine blocks, they just need to create blocks when chosen and validate proposed blocks when they’re not. This validation is known as attesting. You can think of attesting as saying “this block looks good to me”. Validators get rewards for proposing new blocks and for attesting to ones they’ve seen.

If you attest to malicious blocks, you lose your stake.

Defi - “Nations”. Laws, Governance and Monetary Policy

Arguably, the different blockchains are the equivalent of major entities, with their own sets of laws (though laws enforced by computer programs), governance and monetary policy.

For example:

Nation Capabilities Montery Policy Governance Proof Of Work
BitCoin Ledger      
Etherium Virtual Machine - Solidatary      
Etherium 2.0 Virtual Machine      
Polygon        
Chia VirtualMachine ChiaLisp      

Capabilities

Foreign Exchanges

Monetary Policy

Governance

Poof of Work

Within each of these “Defi Nations” there are different currencies and Defi Systems, and forieng exchanges

Policy Questions

Within each of these there

What’s wrong with centralized finance

Is it just drug dealers

To be categorized

Identity Providers - Certificate Authority to Web Of Trust