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If you let me choose the best concept of DeFi, I vote for synths. The power of such protocols starts with TVL.
If you have been following this year’s DeFi development, you may have noticed that almost every article uses TVL (Total Value Locked) as a measure of scale for a DeFi project. It came from traditional finance but has become a hit in DeFi.
A great portion of traditional finance is built on the credit system, take borrowing and spending for example. The banking system knows who you are and knows that any bad behavior (like default) affects your credit rating. If something bad happens, your losses in future financial activities outgrow the gains. Therefore, the cost of bad behavior is relatively high.
In the crypto world that advocates anonymity and where the development of a credit mechanism and digital IDs still lacks a lot, most economic activities are impossible within the margin of the traditional credit system. Here comes collateral and ensures that doing bad costs more than the profit of each user. The value of collateral is the TVL. For instance, I need to borrow 100 USDT. In various protocols, I need to pledge collateral of more than USD 100 in value, like USD 150 in BTC or ETH, to guarantee that if I fail to pay back the loan, this BTC or ETH will cover my debt.
Here is why judging by TVL you can estimate the operating scale of a project to a certain extent. However, can TVL alone reflect the whole DeFi? It seems we are missing out on a bigger thing which is the utilization rate of the locked assets.
Let me tell you a story. A kid asked his father, a financial sector employee: What is finance? The father asked the kid to bring him a piece of meat from the fridge. When the kid brought the meat, the father asked him to put it back and the kid did so. After that, the father asked: Is there less meat? The kid answered negatively. The father asked once more: Do you see the grease on your hands? The kid answered positively. The father said: This is what finance is. In this story, the meat is the principal and finance is the profit earned by principal circulation.
Thus, for a financial system to have high profit, its asset circulation has to be frequent. A financial system profits not when you move 100 lbs. meat one time but when you move 1 lbs. meat one hundred times. DeFi’s locking of most assets is contrary to the essence of traditional finance. When we look at DeFi’s development, it is definitely the process of increasing the utilization of the locked assets.
Here I list protocols in the ascending order of locked asset utilization:
On Uniswap, an ETH pledger can only be the counterparty of an ETH long trader, whereas in synth protocols, pledged digital assets like SNX or ROG can serve as the order book for global transaction counterparties. The pledged assets are the order book for traders who long or short BTC and traders who long or short crude oil etc. This brings huge utilization.
Besides, the locked funds themselves bring a tremendous leverage effect. See this example. In a synth protocol, a user who longs BTC has an equivalent of USD 10,000 and a user who shorts BTC has an equivalent of USD 9,000. The funds introduced in synth collateral only bear the long risk of USD 1,000. It means that USD 1,000 collateral can theoretically back a transaction volume of USD 10,000 + 9,000. What’s more, other synth targets can hedge the USD 1,000 risk exposure. Assume there is a concurrent USD 1,000 USD long risk exposure on crude oil. If BTC and crude oil move in the opposite directions, the risk of the debt pool will offset perfectly. Therefore, the more targets a synth protocol has, the weaker the correlation, the smaller the risk exposure and the higher the stability of the system.
Thus, you can see that DeFi synth protocols have the highest asset utilization and produce the most tangible effect and the highest leverage.
Two years down the DeFi development path, protocols like MakerDAO and Compound have reached relative maturity. Their logic is simplistic and scalability is limited. They just add new collateral assets or optimize the original model, while synth protocols like Synthetix and Wayki-X have uncovered less than 20% of their potential.
Take non-asset transactions like sports and event predictions for example. They work like financial derivatives. There is a certain event at a certain time and the same principle behind it. When Miami Heat and Lakers have a game, I can issue two synths. One is the token for Miami Heat’s victory and the other is for the Lakers’ victory. If both teams have the same odds, I assume that both tokens are worth USD 1 each. If Miami Heat wins, the oracle will feed their token price as USD 2 dollars and the Lakers’ token price will become zero. I only need one oracle to realize the sports prediction easily. You can build lotteries and draws with synths like that.
A long time ago, I said that big predictions or big finance must have these four elements: an initiator, participants, a rule-maker, and a result source. A perfect decentralized protocol has all four of them decentralized. A synth protocol can be this perfect protocol:
Recently, DeFi tokens had a sharp drop but DeFi does not end here. A bigger wave is waiting for us. As entrepreneurs, we should pay more attention to the meaning of the business. Only when you know the essence can you leave out the noise.
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