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The Future of Money
Decentralized Finance
Matteo Binfarè
November 10, 2021
University of Missouri
Table of Contents
1. Centralized Finance (CeFi)
2. The Origins of DeFi
3. Decentralized Finance (DeFi)
4. A Deep Dive Into DeFi
5. Risks of DeFi and The Future of DeFi
2
Centralized Finance (CeFi)
The Financial System As We Know It
1 Centralized Ñ Banks as intermediaries
4
The Financial System As We Know It
1 Centralized Ñ Banks as intermediaries
2 Fiat currency Ñ  has legal tender
✓ Accepted as mean of debt/tax repayment
✓ Issued by a central authority (e.g. Federal Reserve)
✓ Intrinsic value “ 0 Ñ Trust
4
The Financial System As We Know It
1 Centralized Ñ Banks as intermediaries
2 Fiat currency Ñ  has legal tender
✓ Accepted as mean of debt/tax repayment
✓ Issued by a central authority (e.g. Federal Reserve)
✓ Intrinsic value “ 0 Ñ Trust
3 Infrastructure
✓ Liquidity
✓ Allocate funds
✓ Facilitate payments
4
Problems with CeFi: Centralized Control
30
35
40
45
50
1995 2000 2005 2010 2015
5−Banks Concentration (%)
7 Control interest rates
7 High switching costs and fees
7 „ in digital ads. (Amazon, Facebook, Google,...) 5
Problems with CeFi: Limited Access
6
Problems with CeFi: Limited Access
7
Problems with CeFi: Costs and Inefficiency
12
13
14
15
16
1995 2000 2005 2010 2015 2020
Interest Rates on Credit Cards (%)
7 Hard to finance projects even if NPV ą 0
7 Economic growth Ó
8
Problems with CeFi: Costs and Inefficiency
.5
1
1.5
2
2.5
2005 2010 2015 2020
Mastercard/Visa
Diner’s Club
Amex
Credit Card Fees (%)
7 Up to 3 percent for (some) merchants
7 High remittance fees
9
The Origins of DeFi
Blockchain 1.0: Bitcoin 
11
Blockchain 1.0: Bitcoin 
1 Peer-to-peer
11
Blockchain 1.0: Bitcoin 
1 Peer-to-peer
2 Without a financial
institution
11
Blockchain 1.0: Bitcoin 
1 Peer-to-peer
2 Without a financial
institution
3 Hashing + digital signature
Ñ No double spending
11
Blockchain 1.0: Bitcoin 
1 Peer-to-peer
2 Without a financial
institution
3 Hashing + digital signature
Ñ No double spending
4 Proof-of-work
11
Blockchain 1.0: Bitcoin 
1 Peer-to-peer
2 Without a financial
institution
3 Hashing + digital signature
Ñ No double spending
4 Proof-of-work
5 Block + Chain = Blockchain
Ñ append only
11
Blockchain 1.0: Bitcoin 
1 Peer-to-peer
2 Without a financial
institution
3 Hashing + digital signature
Ñ No double spending
4 Proof-of-work
5 Block + Chain = Blockchain
Ñ append only
6 Distributed (nodes)
11
Blockchain 1.0: Bitcoin 
1 Peer-to-peer
2 Without a financial
institution
3 Hashing + digital signature
Ñ No double spending
4 Proof-of-work
5 Block + Chain = Blockchain
Ñ append only
6 Distributed (nodes)
11
Blockchain 1.0: Bitcoin 
12
Blockchain 1.0: Bitcoin 
✓ The Block rewards, known as the Coinbase, sent to this address
✓ Block was mined on January 08, 2009 at 8:54 PM CST by Unknown
✓ The miner(s) of this block earned a total reward of 50.000 BTC
13
Blockchain 1.0: Bitcoin 
14
Cryptography 101
Question: Matteo and Scott want to communicate without being
understood by other people
15
Cryptography 101
Question: Matteo and Scott want to communicate without being
understood by other people
Problem: They cannot use English or any other language
15
Cryptography 101
Question: Matteo and Scott want to communicate without being
understood by other people
Problem: They cannot use English or any other language
Solution: Cryptography
15
Cryptography 101
Question: Matteo and Scott want to communicate without being
understood by other people
Problem: They cannot use English or any other language
Solution: Cryptography
1 Matteo sends Scott instructions:
Plain A B C ... H I ... M N O ... S ... T ...
Cipher Y Z A ... F G ... K L M ... Q ... R ...
15
Cryptography 101
Question: Matteo and Scott want to communicate without being
understood by other people
Problem: They cannot use English or any other language
Solution: Cryptography
1 Matteo sends Scott instructions:
Plain A B C ... H I ... M N O ... S ... T ...
Cipher Y Z A ... F G ... K L M ... Q ... R ...
2 Matteo cipher message to Scott: “FG QAMRR”
15
Cryptography 101
Question: Matteo and Scott want to communicate without being
understood by other people
Problem: They cannot use English or any other language
Solution: Cryptography
1 Matteo sends Scott instructions:
Plain A B C ... H I ... M N O ... S ... T ...
Cipher Y Z A ... F G ... K L M ... Q ... R ...
2 Matteo cipher message to Scott: “FG QAMRR”
3 Scott can now decipher Matteo’s message in plain alphabet
15
Cryptography 101
Question: Matteo and Scott want to communicate without being
understood by other people
Problem: They cannot use English or any other language
Solution: Cryptography
1 Matteo sends Scott instructions:
Plain A B C ... H I ... M N O ... S ... T ...
Cipher Y Z A ... F G ... K L M ... Q ... R ...
2 Matteo cipher message to Scott: “FG QAMRR”
3 Scott can now decipher Matteo’s message in plain alphabet
4 “HI SCOTT”
15
Cryptography 101
Question: Matteo and Scott want to communicate without being
understood by other people
Problem: They cannot use English or any other language
Solution: Cryptography
1 Matteo sends Scott instructions:
Plain A B C ... H I ... M N O ... S ... T ...
Cipher Y Z A ... F G ... K L M ... Q ... R ...
2 Matteo cipher message to Scott: “FG QAMRR”
3 Scott can now decipher Matteo’s message in plain alphabet
4 “HI SCOTT”
Problem: Trust! Matteo can share the “private key” with bad actors
15
Cryptography 101
Question: Matteo and Scott want to communicate without being
understood by other people
Problem: They cannot use English or any other language
Solution: Cryptography
1 Matteo sends Scott instructions:
Plain A B C ... H I ... M N O ... S ... T ...
Cipher Y Z A ... F G ... K L M ... Q ... R ...
2 Matteo cipher message to Scott: “FG QAMRR”
3 Scott can now decipher Matteo’s message in plain alphabet
4 “HI SCOTT”
Problem: Trust! Matteo can share the “private key” with bad actors
15
Cryptography 101
Solution: Cryptographic Hash and Digital Signatures
1 Hash Function (SHA-256):
16
Cryptography 101
Solution: Cryptographic Hash and Digital Signatures
1 Hash Function (SHA-256):
17
Blockchain (Cont’d)
18
Blockchain (Cont’d)
Nonce of 72608 added to the data and hashed Ñ four (4) leading 0s
19
Blockchain (Cont’d)
Tampering with the blockchain is (almost) impossible!
20
Blockchain 2.0: Ethereum
Ethereum is a censoriship resistant, decentralized, world computer.
1 ETH is the native token
2 Not only payment data Ñ smart contracts invoked with ETH
Bitcoin Ethereum
Founder Satoshi Nakamoto Vitalik Buterin
Protocol Primitive scripting language Ethereum Virtual Machine and smart contracts
Supply 21 million Unlimited
Transactions Pay BTC fees Add ETH fees but different transcation have different price - gas
Blockchain Proof of Work Proof of Work
Block time „10 minutes „14 seconds
Block size <1MB „15-20kb and based on computational complexity
Scalable No Yes
Usage Digital currency Digital currency, smart contracts
Off-chain Orphanes Uncles
Accounts Store of BTC Store of BTC; Smart contracts
Issuance Genesis block + mining Pre-mine, block rewards, uncle rewards
21
Decentralized Finance (DeFi)
What is DeFi?
Definition
DeFi is an ecosystem of blockchain-based financial instruments
designed in a decentralized way without legacy institutions
‹ Running on smart contracts Ñ (automated) piece of code 
23
Infrastructure
24
Services it Provides
25
Total Value Locked (TVL)
0
20
40
60
80
2017 2018 2019 2020 2021
Total Value Locked ($ Billions)
26
A Deep Dive Into DeFi
MakerDAO
28
MakerDAO
Definition
2-tokens protocol that creates a cryptocollateralized stablecoin,
soft-pegged to the US dollar that runs on the Ethereum blockchain
29
MakerDAO
Definition
2-tokens protocol that creates a cryptocollateralized stablecoin,
soft-pegged to the US dollar that runs on the Ethereum blockchain
✓ Resistant to hyperinflation due to its low volatility
✓ Decentralized, unbiased
✓ 1 Dai = 1 USD 
✓ „ collateralized mortgage loan
29
MakerDAO
Definition
2-tokens protocol that creates a cryptocollateralized stablecoin,
soft-pegged to the US dollar that runs on the Ethereum blockchain
✓ Resistant to hyperinflation due to its low volatility
✓ Decentralized, unbiased
✓ 1 Dai = 1 USD 
✓ „ collateralized mortgage loan
Steps:
1 Create and Collateralize (ą 150%) a Vault  (e.g. deposit ETH)
29
MakerDAO
Definition
2-tokens protocol that creates a cryptocollateralized stablecoin,
soft-pegged to the US dollar that runs on the Ethereum blockchain
✓ Resistant to hyperinflation due to its low volatility
✓ Decentralized, unbiased
✓ 1 Dai = 1 USD 
✓ „ collateralized mortgage loan
Steps:
1 Create and Collateralize (ą 150%) a Vault  (e.g. deposit ETH)
2 Generate Dai from the Collateralized Vault
29
MakerDAO
Definition
2-tokens protocol that creates a cryptocollateralized stablecoin,
soft-pegged to the US dollar that runs on the Ethereum blockchain
✓ Resistant to hyperinflation due to its low volatility
✓ Decentralized, unbiased
✓ 1 Dai = 1 USD 
✓ „ collateralized mortgage loan
Steps:
1 Create and Collateralize (ą 150%) a Vault  (e.g. deposit ETH)
2 Generate Dai from the Collateralized Vault
3 Pay Down the Debt and the Stability Fee
29
MakerDAO
Definition
2-tokens protocol that creates a cryptocollateralized stablecoin,
soft-pegged to the US dollar that runs on the Ethereum blockchain
✓ Resistant to hyperinflation due to its low volatility
✓ Decentralized, unbiased
✓ 1 Dai = 1 USD 
✓ „ collateralized mortgage loan
Steps:
1 Create and Collateralize (ą 150%) a Vault  (e.g. deposit ETH)
2 Generate Dai from the Collateralized Vault
3 Pay Down the Debt and the Stability Fee
4 Withdraw Collateral
29
MakerDAO: Maintaining the Peg
It is critical to maintain the 1:1 peg to USD Ñ if not, there is no utility
in using MakerDAO
1 Stability fee (i.e. interest rate)
‹ Paid on your DAI debt
‹ Can be raised or lowered to shift supply of funds
2 DAI Savings Rate (DSR) Ñ r on “deposits”
Stability Fee ě Savings Rate
3 Debt ceiling: adjusted to Ö supply
4 Governance mechanism: MKR token makes decisions
30
DAI-USD Peg
.98
1
1.02
1.04
1.06
2020 2020 2021 2021 2022
DAI−USD
31
Compound
32
Compound
Definition
Protocol on the Ethereum blockchain that establishes money mar-
kets for lending (borrowing) and earn (pay) a variable rate.
✓ Aggregates liquidity (i.e. supply)
✓ Users can borrow from the pool
✓ Rates determined by market forces
✓ Overcollateralized Ñ each ERC-20 has ‰ ratio
‹ Factor ranging from 0 to 90
‹ Ratio “ 100 ˆ pCFq´1
✓ Automatic liquidation if ValueCollateral ă ValueDebt
Why Compound? Unlock value of asset without selling it (taxable!)
33
Compound: Key Features and Terms
1 Borrow Interest Rates are a function of
‹ Utilization Ratio = Total Borrow
Total Supply
‹ Base rate: borrow rate at 0 percent borrow demand
‹ Slope: ∆ in rates
2 Supply Interest Rates = Borrow Rate ˆ Utilization Ratio
3 Reserve Factor: % of borrow payments set aside in reserve pools
(i.e. insurance)
34
Borrowing and Lending on Compound
0
5
10
15
20
25
2019 2020 2020 2021 2021 2022
Lend
Borrow
Interest Rates on Compound (%)
35
Uniswap
36
Uniswap
Definition
Uniswap is an automated liquidity protocol powered by a con-
stant product formula and implemented in a system of smart
contracts on the Ethereum blockchain.
37
Uniswap
Definition
Uniswap is an automated liquidity protocol powered by a con-
stant product formula and implemented in a system of smart
contracts on the Ethereum blockchain.
✓ Automated market maker: liquidity is pooled and Uniswap
stands ready to provide it (i.e. swap tokens) Ñ facilitate trading
37
Uniswap
Definition
Uniswap is an automated liquidity protocol powered by a con-
stant product formula and implemented in a system of smart
contracts on the Ethereum blockchain.
✓ Automated market maker: liquidity is pooled and Uniswap
stands ready to provide it (i.e. swap tokens) Ñ facilitate trading
37
Uniswap (Cont’d)
✓ Accept one token for the other as long as the “constant product”
formula is preserved
x
lo
omo
on
reserve for x
ˆ y
lo
omo
on
reserve for y
“ k
lo
omo
on
Invariant
38
Uniswap (Cont’d)
✓ Trades will change the reserves of the swapped pair resulting in
a new price
p “
y
x
1 Pstart “ 1200
400 “ 3
2 Pend “ 123.03
399 “ 3.015
39
Risks of DeFi and The Future of
DeFi
DeFi Risks
41
SQUID
42
DeFi Risks
DeFi completely eliminates counterparty risk, but many risks still
remain (or are created).
1 Smart contract risk
‹ Logical error ($90 million in Compound)
‹ Economic exploit
2 Governance risk
‹ Undermine democratic voting
3 Regulatory risk
‹ KYC/AML
‹ SEC/IRS
4 Custodial risk
‹ Self (lost or locked keys)
‹ External hack (e.g. Coinbase)
5 Environmental risk
‹ Energy consumption Ñ Migrations to PoS 43
Thank you!
44

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The Future of Decentralized Finance

  • 1. The Future of Money Decentralized Finance Matteo Binfarè November 10, 2021 University of Missouri
  • 2. Table of Contents 1. Centralized Finance (CeFi) 2. The Origins of DeFi 3. Decentralized Finance (DeFi) 4. A Deep Dive Into DeFi 5. Risks of DeFi and The Future of DeFi 2
  • 4. The Financial System As We Know It 1 Centralized Ñ Banks as intermediaries 4
  • 5. The Financial System As We Know It 1 Centralized Ñ Banks as intermediaries 2 Fiat currency Ñ  has legal tender ✓ Accepted as mean of debt/tax repayment ✓ Issued by a central authority (e.g. Federal Reserve) ✓ Intrinsic value “ 0 Ñ Trust 4
  • 6. The Financial System As We Know It 1 Centralized Ñ Banks as intermediaries 2 Fiat currency Ñ  has legal tender ✓ Accepted as mean of debt/tax repayment ✓ Issued by a central authority (e.g. Federal Reserve) ✓ Intrinsic value “ 0 Ñ Trust 3 Infrastructure ✓ Liquidity ✓ Allocate funds ✓ Facilitate payments 4
  • 7. Problems with CeFi: Centralized Control 30 35 40 45 50 1995 2000 2005 2010 2015 5−Banks Concentration (%) 7 Control interest rates 7 High switching costs and fees 7 „ in digital ads. (Amazon, Facebook, Google,...) 5
  • 8. Problems with CeFi: Limited Access 6
  • 9. Problems with CeFi: Limited Access 7
  • 10. Problems with CeFi: Costs and Inefficiency 12 13 14 15 16 1995 2000 2005 2010 2015 2020 Interest Rates on Credit Cards (%) 7 Hard to finance projects even if NPV ą 0 7 Economic growth Ó 8
  • 11. Problems with CeFi: Costs and Inefficiency .5 1 1.5 2 2.5 2005 2010 2015 2020 Mastercard/Visa Diner’s Club Amex Credit Card Fees (%) 7 Up to 3 percent for (some) merchants 7 High remittance fees 9
  • 14. Blockchain 1.0: Bitcoin  1 Peer-to-peer 11
  • 15. Blockchain 1.0: Bitcoin  1 Peer-to-peer 2 Without a financial institution 11
  • 16. Blockchain 1.0: Bitcoin  1 Peer-to-peer 2 Without a financial institution 3 Hashing + digital signature Ñ No double spending 11
  • 17. Blockchain 1.0: Bitcoin  1 Peer-to-peer 2 Without a financial institution 3 Hashing + digital signature Ñ No double spending 4 Proof-of-work 11
  • 18. Blockchain 1.0: Bitcoin  1 Peer-to-peer 2 Without a financial institution 3 Hashing + digital signature Ñ No double spending 4 Proof-of-work 5 Block + Chain = Blockchain Ñ append only 11
  • 19. Blockchain 1.0: Bitcoin  1 Peer-to-peer 2 Without a financial institution 3 Hashing + digital signature Ñ No double spending 4 Proof-of-work 5 Block + Chain = Blockchain Ñ append only 6 Distributed (nodes) 11
  • 20. Blockchain 1.0: Bitcoin  1 Peer-to-peer 2 Without a financial institution 3 Hashing + digital signature Ñ No double spending 4 Proof-of-work 5 Block + Chain = Blockchain Ñ append only 6 Distributed (nodes) 11
  • 22. Blockchain 1.0: Bitcoin  ✓ The Block rewards, known as the Coinbase, sent to this address ✓ Block was mined on January 08, 2009 at 8:54 PM CST by Unknown ✓ The miner(s) of this block earned a total reward of 50.000 BTC 13
  • 24. Cryptography 101 Question: Matteo and Scott want to communicate without being understood by other people 15
  • 25. Cryptography 101 Question: Matteo and Scott want to communicate without being understood by other people Problem: They cannot use English or any other language 15
  • 26. Cryptography 101 Question: Matteo and Scott want to communicate without being understood by other people Problem: They cannot use English or any other language Solution: Cryptography 15
  • 27. Cryptography 101 Question: Matteo and Scott want to communicate without being understood by other people Problem: They cannot use English or any other language Solution: Cryptography 1 Matteo sends Scott instructions: Plain A B C ... H I ... M N O ... S ... T ... Cipher Y Z A ... F G ... K L M ... Q ... R ... 15
  • 28. Cryptography 101 Question: Matteo and Scott want to communicate without being understood by other people Problem: They cannot use English or any other language Solution: Cryptography 1 Matteo sends Scott instructions: Plain A B C ... H I ... M N O ... S ... T ... Cipher Y Z A ... F G ... K L M ... Q ... R ... 2 Matteo cipher message to Scott: “FG QAMRR” 15
  • 29. Cryptography 101 Question: Matteo and Scott want to communicate without being understood by other people Problem: They cannot use English or any other language Solution: Cryptography 1 Matteo sends Scott instructions: Plain A B C ... H I ... M N O ... S ... T ... Cipher Y Z A ... F G ... K L M ... Q ... R ... 2 Matteo cipher message to Scott: “FG QAMRR” 3 Scott can now decipher Matteo’s message in plain alphabet 15
  • 30. Cryptography 101 Question: Matteo and Scott want to communicate without being understood by other people Problem: They cannot use English or any other language Solution: Cryptography 1 Matteo sends Scott instructions: Plain A B C ... H I ... M N O ... S ... T ... Cipher Y Z A ... F G ... K L M ... Q ... R ... 2 Matteo cipher message to Scott: “FG QAMRR” 3 Scott can now decipher Matteo’s message in plain alphabet 4 “HI SCOTT” 15
  • 31. Cryptography 101 Question: Matteo and Scott want to communicate without being understood by other people Problem: They cannot use English or any other language Solution: Cryptography 1 Matteo sends Scott instructions: Plain A B C ... H I ... M N O ... S ... T ... Cipher Y Z A ... F G ... K L M ... Q ... R ... 2 Matteo cipher message to Scott: “FG QAMRR” 3 Scott can now decipher Matteo’s message in plain alphabet 4 “HI SCOTT” Problem: Trust! Matteo can share the “private key” with bad actors 15
  • 32. Cryptography 101 Question: Matteo and Scott want to communicate without being understood by other people Problem: They cannot use English or any other language Solution: Cryptography 1 Matteo sends Scott instructions: Plain A B C ... H I ... M N O ... S ... T ... Cipher Y Z A ... F G ... K L M ... Q ... R ... 2 Matteo cipher message to Scott: “FG QAMRR” 3 Scott can now decipher Matteo’s message in plain alphabet 4 “HI SCOTT” Problem: Trust! Matteo can share the “private key” with bad actors 15
  • 33. Cryptography 101 Solution: Cryptographic Hash and Digital Signatures 1 Hash Function (SHA-256): 16
  • 34. Cryptography 101 Solution: Cryptographic Hash and Digital Signatures 1 Hash Function (SHA-256): 17
  • 36. Blockchain (Cont’d) Nonce of 72608 added to the data and hashed Ñ four (4) leading 0s 19
  • 37. Blockchain (Cont’d) Tampering with the blockchain is (almost) impossible! 20
  • 38. Blockchain 2.0: Ethereum Ethereum is a censoriship resistant, decentralized, world computer. 1 ETH is the native token 2 Not only payment data Ñ smart contracts invoked with ETH Bitcoin Ethereum Founder Satoshi Nakamoto Vitalik Buterin Protocol Primitive scripting language Ethereum Virtual Machine and smart contracts Supply 21 million Unlimited Transactions Pay BTC fees Add ETH fees but different transcation have different price - gas Blockchain Proof of Work Proof of Work Block time „10 minutes „14 seconds Block size <1MB „15-20kb and based on computational complexity Scalable No Yes Usage Digital currency Digital currency, smart contracts Off-chain Orphanes Uncles Accounts Store of BTC Store of BTC; Smart contracts Issuance Genesis block + mining Pre-mine, block rewards, uncle rewards 21
  • 40. What is DeFi? Definition DeFi is an ecosystem of blockchain-based financial instruments designed in a decentralized way without legacy institutions ‹ Running on smart contracts Ñ (automated) piece of code  23
  • 43. Total Value Locked (TVL) 0 20 40 60 80 2017 2018 2019 2020 2021 Total Value Locked ($ Billions) 26
  • 44. A Deep Dive Into DeFi
  • 46. MakerDAO Definition 2-tokens protocol that creates a cryptocollateralized stablecoin, soft-pegged to the US dollar that runs on the Ethereum blockchain 29
  • 47. MakerDAO Definition 2-tokens protocol that creates a cryptocollateralized stablecoin, soft-pegged to the US dollar that runs on the Ethereum blockchain ✓ Resistant to hyperinflation due to its low volatility ✓ Decentralized, unbiased ✓ 1 Dai = 1 USD  ✓ „ collateralized mortgage loan 29
  • 48. MakerDAO Definition 2-tokens protocol that creates a cryptocollateralized stablecoin, soft-pegged to the US dollar that runs on the Ethereum blockchain ✓ Resistant to hyperinflation due to its low volatility ✓ Decentralized, unbiased ✓ 1 Dai = 1 USD  ✓ „ collateralized mortgage loan Steps: 1 Create and Collateralize (ą 150%) a Vault  (e.g. deposit ETH) 29
  • 49. MakerDAO Definition 2-tokens protocol that creates a cryptocollateralized stablecoin, soft-pegged to the US dollar that runs on the Ethereum blockchain ✓ Resistant to hyperinflation due to its low volatility ✓ Decentralized, unbiased ✓ 1 Dai = 1 USD  ✓ „ collateralized mortgage loan Steps: 1 Create and Collateralize (ą 150%) a Vault  (e.g. deposit ETH) 2 Generate Dai from the Collateralized Vault 29
  • 50. MakerDAO Definition 2-tokens protocol that creates a cryptocollateralized stablecoin, soft-pegged to the US dollar that runs on the Ethereum blockchain ✓ Resistant to hyperinflation due to its low volatility ✓ Decentralized, unbiased ✓ 1 Dai = 1 USD  ✓ „ collateralized mortgage loan Steps: 1 Create and Collateralize (ą 150%) a Vault  (e.g. deposit ETH) 2 Generate Dai from the Collateralized Vault 3 Pay Down the Debt and the Stability Fee 29
  • 51. MakerDAO Definition 2-tokens protocol that creates a cryptocollateralized stablecoin, soft-pegged to the US dollar that runs on the Ethereum blockchain ✓ Resistant to hyperinflation due to its low volatility ✓ Decentralized, unbiased ✓ 1 Dai = 1 USD  ✓ „ collateralized mortgage loan Steps: 1 Create and Collateralize (ą 150%) a Vault  (e.g. deposit ETH) 2 Generate Dai from the Collateralized Vault 3 Pay Down the Debt and the Stability Fee 4 Withdraw Collateral 29
  • 52. MakerDAO: Maintaining the Peg It is critical to maintain the 1:1 peg to USD Ñ if not, there is no utility in using MakerDAO 1 Stability fee (i.e. interest rate) ‹ Paid on your DAI debt ‹ Can be raised or lowered to shift supply of funds 2 DAI Savings Rate (DSR) Ñ r on “deposits” Stability Fee ě Savings Rate 3 Debt ceiling: adjusted to Ö supply 4 Governance mechanism: MKR token makes decisions 30
  • 53. DAI-USD Peg .98 1 1.02 1.04 1.06 2020 2020 2021 2021 2022 DAI−USD 31
  • 55. Compound Definition Protocol on the Ethereum blockchain that establishes money mar- kets for lending (borrowing) and earn (pay) a variable rate. ✓ Aggregates liquidity (i.e. supply) ✓ Users can borrow from the pool ✓ Rates determined by market forces ✓ Overcollateralized Ñ each ERC-20 has ‰ ratio ‹ Factor ranging from 0 to 90 ‹ Ratio “ 100 ˆ pCFq´1 ✓ Automatic liquidation if ValueCollateral ă ValueDebt Why Compound? Unlock value of asset without selling it (taxable!) 33
  • 56. Compound: Key Features and Terms 1 Borrow Interest Rates are a function of ‹ Utilization Ratio = Total Borrow Total Supply ‹ Base rate: borrow rate at 0 percent borrow demand ‹ Slope: ∆ in rates 2 Supply Interest Rates = Borrow Rate ˆ Utilization Ratio 3 Reserve Factor: % of borrow payments set aside in reserve pools (i.e. insurance) 34
  • 57. Borrowing and Lending on Compound 0 5 10 15 20 25 2019 2020 2020 2021 2021 2022 Lend Borrow Interest Rates on Compound (%) 35
  • 59. Uniswap Definition Uniswap is an automated liquidity protocol powered by a con- stant product formula and implemented in a system of smart contracts on the Ethereum blockchain. 37
  • 60. Uniswap Definition Uniswap is an automated liquidity protocol powered by a con- stant product formula and implemented in a system of smart contracts on the Ethereum blockchain. ✓ Automated market maker: liquidity is pooled and Uniswap stands ready to provide it (i.e. swap tokens) Ñ facilitate trading 37
  • 61. Uniswap Definition Uniswap is an automated liquidity protocol powered by a con- stant product formula and implemented in a system of smart contracts on the Ethereum blockchain. ✓ Automated market maker: liquidity is pooled and Uniswap stands ready to provide it (i.e. swap tokens) Ñ facilitate trading 37
  • 62. Uniswap (Cont’d) ✓ Accept one token for the other as long as the “constant product” formula is preserved x lo omo on reserve for x ˆ y lo omo on reserve for y “ k lo omo on Invariant 38
  • 63. Uniswap (Cont’d) ✓ Trades will change the reserves of the swapped pair resulting in a new price p “ y x 1 Pstart “ 1200 400 “ 3 2 Pend “ 123.03 399 “ 3.015 39
  • 64. Risks of DeFi and The Future of DeFi
  • 67. DeFi Risks DeFi completely eliminates counterparty risk, but many risks still remain (or are created). 1 Smart contract risk ‹ Logical error ($90 million in Compound) ‹ Economic exploit 2 Governance risk ‹ Undermine democratic voting 3 Regulatory risk ‹ KYC/AML ‹ SEC/IRS 4 Custodial risk ‹ Self (lost or locked keys) ‹ External hack (e.g. Coinbase) 5 Environmental risk ‹ Energy consumption Ñ Migrations to PoS 43