DeFi | Self-Learn

History #

Barter is the first DeFi: peer-to-peer, but very inefficient because of matching problem.

Purpose of money:

Unit of account
Medium of exchange **
Store of value
Transfer of value

2008: Bitcoin

2021: Blockchain

Assume that all major financial institutions around the world are looking at the potential of tokenization, stablecoins and frictionless payments. – David Solomon, CEO Goldman Sachs

It is possible that money to have value even the currency isn’t necessarily backed by anything (Iraqi Swiss dinar is an example)

Intangible value of money is important for crypto space in general.

DeFi:

Enables peer to peer transactions without a centralized instituition
Tokenization -> efficient barter mechanism

Problems of CeFi #

Centralized control
Limited access: unbanked / underbanked
Inefficiency: 3% retail paid, 5-7% wire transfer, 2 days settlement time for stock transaction
Lack of interoperability: Plaid, but blocked by regulators
Opacity: need to rely on regulations
Inequality of opportunities

Origin of DeFi #

Origin of DeFi: “dark pool” trading, 1979

1991 Haber and Stornetta: Blockchain
2002: Initiated by the idea of requiring email sender to do a computational task before sending email to eliminate junk mail. Though low cost for one, high cost for millions
2008: Satoshi Nakamoto

Raised blockchain and proof-of-work. PoW ensures that the ledger could not be edited unless extreme computing power was available.

Crypto

eliminates the problem of double-spending
every transaction kept in immutable ledger
cryptographic scarcity: 21 million bitcoins
user sovereignty
portability

Ethereum: uses smart contract

dApps: no centralized, network effects

Proof-of-Work is a consensus mechanism of Bitcoin, used to solve “double spending” problem.

DeFi Foundations #

Blockchain #

Trust is within technology, not different parties – very different from CeFi.

Blockchain is a special ledger

distributed

distributed

Every 10 min, Bitcoin broke into blocks and check the fingerprint of the connection part of each block. It won’t match if one is broken.

Last line (hash) is repeated as the first line in the next block. -> chain

Altering any data in block 1 means the last line will change and will not match the first line in block 2.

Hashing

SHA256

Hashing is a one-way function

Ethereum blockchain uses Keccak-256

Miners add some data called nonce (number only once) to find a hash that get lots of leading zeros. It makes it difficult for adversary to change a block then change the future blocks to make everything works. Miners give blockchain unprecedented security.

An attacker needs to amass 51% of the network power (boundary of PoW security)

Cryptocurrency

It is a digital token.

asymmetric key cryptography

private key & public key: like ssh

Users of smart contracts need to pay a fee called gas.

Ethereum is turing complete -> 1. if 2. for loop 3. store data

In the context of smart contract platforms, an oracle is any data source for reporting information external to the blockchain.

Mining is asscocated with both strength (security) and weakness (costly).

Reasons of cryptos being volatility: no tangible value, bad liquidity

Problems DeFi Solved #

Risk #

DeFi closes the counterparty risk, and introduces a new class of risks.

Smart contract risk #

The key component in DeFi is a smart contract. If there are issues with that smart contract, then that opens the door to an exploit.

The software foundation gives attackers a large attack surface. Public blockchains are open systems, so if there’s any flaw in the code, it’s going to be exploited. This won’t be a problem in CeFi because people cannot enter the private website. This new attack vector is termed smart contract risk.

Audit

You develop your smart contract, you want to make sure there’s no mistake. So companies will employ a third party auditor to go through and stress test the smart contract. Sometimes you’ll employ two auditors.