BitMEX founder: DeFi is expected to attract hundreds of billions of dollars of funds into the encryption ecosystem
Editor's Note: This article comes fromBabbitt Information (ID: bitcoin8btc)Editor's Note: This article comes from
Babbitt Information (ID: bitcoin8btc)
, Author: Arthur Hayes, Compiler: Overnight Porridge, published with permission.
Note: The original author is Arthur Hayes, the founder and CEO of the Bitmex platform. In this article, he first analyzed the demand for loans from miners and speculators in the encryption market, and analyzed the principles and reasons for the rise of DeFi loans. In addition, He also judged that the dream of DeFi prototype banks will almost certainly not come true in this bull market, but this statement is expected to attract hundreds of billions of dollars of funds into the ecosystem. Despite this, Arthur Hayes said that his DeFi shitcoin position only accounts for a small part.
The original title is "A Farmer's Dream". Instead of running to nightclubs and most other forms of raving, I decided to become a cryptocurrency farmer. I'm farming the latest and greatest DeFi shitcoin projects. While I scoff at how many of these projects will be economically wasteful activities, there is indeed an underlying prototype banking infrastructure being built on the rails of Ethereum and other protocols.
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Market demand for encrypted credit
Miners who borrow fiat currency (usually dollars or renminbi) to pay electricity, rent, and wages: they use mining machines or BTC and ETH on their balance sheets as collateral for loans.
Speculators need fiat currency or cryptocurrency to participate in leveraged transactions. For example, to short a shitcoin, you need to borrow this shitcoin, and if you want to go long, then they usually need to borrow dollars. These loans are usually uncollateralized, and they require substantial fees for them, and exchanges are supposed to fund them. Even if a lot of people liquidate their positions, a trading platform with a proper margin call protocol will be able to protect their funds.
So why can’t small businesses or individuals who are squeezed out of the fixed income market due to crony capitalism use the crypto capital market?
To borrow cryptocurrency:
There is currently no industry where the entire value chain from producer to consumer is fully paid in Bitcoin. Imagine if you could only buy a bottle of sparkling water in bitcoins, meaning French producers paid for inputs in bitcoins, wholesalers paid producers in bitcoins, nightclubs paid distributors in bitcoins, and eventually Sparkling water consumers are also paying in bitcoin. If your production costs are not calculated in bitcoins, it is stupid to price them in bitcoins. This also means that your cost of capital should not be Bitcoin. And when this becomes a reality, it will be possible to use Bitcoin to provide loans to actual businesses.
Personal loans are also not possible in Bitcoin. The proletariat (yes, that's you) earn fiat currency, while there are plenty of people who are happy to take out bitcoin loans at low interest rates, but if the bitcoin price goes up, they will make very little money, but pay it back. It's expensive to pay, which is what leads to bankruptcies and bad loans.
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Borrow Fiat Stablecoins
For small and medium-sized enterprises, it is absolutely feasible to borrow Tether or other stablecoins with USD equivalent. However, outside of our small circle, not many vendors accept USD for payment. So, the borrower would borrow Tether, exchange it for USD (paying the fee), and then pay for the desired goods. When redeeming, they need to do the opposite operation, convert the dollar income into Tether (pay the fee), and then repay the Tether loan. While it's certainly doable, it's not easy. You might think, isn’t that what it is, but that’s because you’re in a crypto bubble. An even bigger problem is that in several legal jurisdictions there are no established origin banks that conduct proper credit analysis for SMEs entirely over the Internet. This kind of work is hard and involves risks. This is what banks used to do before the central bank crushed the yield curve. It is better to lend to people and companies whose debts are guaranteed by the central bank than to actually risk lending to productive SMEs.
If you are borrowing stablecoins on a personal basis, you have probably exhausted all other options such as credit cards, personal loans, home equity loans, etc. While these are expensive, they are available. If you live in a place where the credit pipeline is so broken, or your credit is so bad that these traditional products are not available to you, it will be very difficult for people who lend you money to learn the meaning of adverse selection .
For those of you whose brains have shrunk from watching too many TikTok videos, let me summarize.
I also lend money to individual speculators in my own garden (Translator's Note: Refers to BitMEX), because I know they will incur fees through leveraged trading, and I also know that I can get the loan back through the margin call process.
But I wouldn't lend money to SMEs, be it cryptocurrencies or fiat stablecoins. SMEs’ income and expenses are measured in fiat currency, and their cost of capital must also be in fiat currency. And I lack the ability to do a proper credit score, nor is it easy to use stablecoins outside of crypto capital markets.
I also will not lend money to any individual not related to me, whether in cryptocurrency or fiat stablecoins. Many people who live without any legal protection, or whose credit is so bad that no standard commercial bank will offer them a credit product, are terrible debtors.
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Supply of encrypted credits
Bitcoin and Ether holders you know who you are and you will not sell them no matter what the price is. However, while you’re waiting in your basement for “BTC to $20,000, ETH to $1,200,” you still want to make a profit. When you put your cryptocurrency in third party custody, your biggest concern is whether they can keep the coin safe. If you are a prudence, you also worry that the solidity code will make the smart contract inaccessible, if this is the case, then your funds will become worthless! You trust no one but only the code. But then you worry about the actual code. You'll assume that anyone who borrows money from you will run away. If you've been in this sandbox long enough, you've seen and experienced all kinds of scams and dealings in all sorts of outrageous ways. Therefore, you will only lend money to large and well-known platforms (exchanges, mining companies, large origin banks).
Even if these platforms don’t provide you with collateral, they can profit a lot from their commerce, and if you don’t pay you back, their reputation will be greatly damaged. In this ecosystem, a good reputation is essential. We don't have a national government that forces its citizens to use our services even though we lie, cheat, and steal. If you can get a banking license, great.
Fiat Stablecoin Lender Back in 2013, when I started trading Bitcoin, the second largest low-risk transaction was lending USD on the Bitfinex platform. The yield was sometimes close to 1% per day. I know many people who put USD Remitted to the Bitfinex lending market, and thus obtained huge profits. What's the first one? It annoys me that the futures basis on a pay-for-lot deal usually has over 200% pa and now the basis has jumped to over 5%.
A note on why speculators like to be net long: Bitcoin and other shitcoins can go down to 0, but their upside is infinite, plus cryptocurrencies are extremely volatile, and when you combine high volatility, infinite When you combine significant upside with limited downside, you have an attractive call option. Therefore, as a speculator, you should consider buying, not selling. Probabilistically speaking, you may not be able to make money, but if successful, you can get the best odds.
middleman
When savers are struggling with zero and negative interest rates, they will be willing to take some risk, and if you are willing to take a small amount of risk, then the crypto capital market is the best place to earn positive returns.
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middleman
We have demand, we have supply: so let's dance together. So who is in the middle and collects the crumbs?
1. Exchanges In the cryptocurrency industry, if an exchange does a good job, it will be very profitable. When traders pay as little as zero fees to execute spot trades, they always pay margin. As a result, more funds can be directed to risk-seeking speculators, and the higher the trading volume, the greater the fee income. Speculators should get trade free cash flow (FCF) at a price that allows them to trade more. At some point, the amount of capital demanded by speculators will overshadow what exchanges can offer. At that point, the exchange will need to raise funds elsewhere. Exchanges host billions of dollars worth of cryptocurrencies. As a depositor, you need to trust the exchange to take good care of your assets and not choose to steal or run away. Essentially, you need to trust the operator. If any bad news spreads on social media and suggests that the exchange has bad credit, it could lead to a large loss of storage users, which will cause the exchange to lose fee income.
Exchange operators must maintain a good reputation in the eyes of the public, and the largest exchanges, if they are stolen, will cause the most losses. So when they say I'll pay you 1% per month on your USD deposit, you'd trust them to cover both the interest and the principal. Exchanges are the cheapest middlemen I say because they have the most to lose if they are fraudulent.
The exchange then spends 1% of the funds each month and lends it to speculators at 10 basis points per day. If exchanges get 100% usage, they have a spread of 2% per month (10bp * 30 days – 1%). The largest leveraged trading platforms have plans to raise assets to lend to speculators.
2. Lending platforms These platforms do not own exchanges and therefore have more traditional banking functions. They don't have an inherent, profitable use case for financing, so they match lenders and borrowers. Popular platforms like BlockFi, Genesis, Renrenbit, PayPal Finance, and MatrixPort have launched this business. In the retail market, they offer very attractive interest rates on cryptocurrencies and stablecoins, and these are unsecured loans. And in the over-the-counter market, they make large trades based on supply and demand, and these trades are often collateralized. This market is nascent and will become important as the ecosystem's need for credit expands. In the marketplace, institutional lenders and borrowers can transact purely on trusts.
Generally, the borrower will be:
Miners who need to mortgage Bitcoin or Ethereum to borrow legal currency: the lending platform will require over-collateralization to protect depositors, and general borrowers can borrow 50% of the US dollar value of their mortgage assets. If the price of Bitcoin falls by 30%, there will be a margin call, and if the price of the currency falls further, and the borrower does not make a margin call, then his collateral will be liquidated. This is part of the reason for the constant decline in the price of Bitcoin on March 13. Bitcoin and Ethereum collateral must be liquidated to protect depositors.
Hodler who needs fiat currency liquidity: To live a high-quality life, you still need a considerable amount of fiat currency, and Hodler who wants to move from the basement to a better place needs to calculate carefully, and these borrowers will also need over-collateralization just like miners.
Big trading firms are always on the lookout for using other people's money to boost returns. Given that the best companies are also trading in traditional markets, cryptocurrency traders always grab more money from headquarters at reasonable rates. Some companies will offer U.S. dollars as collateral to obtain cryptocurrencies, while others, because of the way they are set up, can borrow without collateral.
These lending platforms are the closest thing to a bank in our ecosystem. They compete for deposits by paying high interest rates and run credit analyzes on borrowers to determine how leveraged the loans are and require overcollateralization to protect depositors. With the efforts of the platform, the net interest margin (NIM) can be obtained. These platforms differ from traditional commercial banks in that they cannot expand the money supply in the cryptocurrency capital market. They operate full reserve banking and they can only lend as much as deposits.
In addition, these platforms can create their own tokens and try to convince the market that this token has income for lenders. This token can then be used as a cash equivalent on exchanges or as payment for encrypted goods and services. If someone had the audacity to mint money out of thin air and convince the market that it was worth more than zero... I think you'd know where it would go.
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I'm a Farmer Now - DeFi Primordial Bank
So why not "decentralize" the lender function? Why not create programmable finance? Why not have this lending and lending all happen on the blockchain and be completely transparent?
This is called a dream. Various projects have taken up this challenge and created an entire ecosystem of dapps attempting to perform the functions of a bank in a decentralized and trustless manner.
Below is an example of a very simple DeFi lending project. Of course there are many more beautiful examples, but let's keep it simple:
Choose a good protocol to build your own DeFi bank, and currently the most popular choice is Ethereum. This means that the project will use the ERC-20 token standard;
Create a smart contract where users can deposit a selected amount of ERC-20 tokens and earn a return. Currently the most popular tokens include encapsulated Bitcoin (such as WBTC, renBTC), ETH, DAI, USDT, USDC, etc.;
Create a smart contract where borrowers can deposit collateral. For example, I want to borrow ETH, so I need to overcollateralize my WBTC. After I deposit the collateral into a smart contract, I can intercept the ETH I want and put it into my wallet. If the exchange rate of ETH/BTC rises (that is, ETH rises faster than BTC, or BTC falls faster than ETH), then my WBTC collateral may be liquidated on a decentralized exchange (currently Uniswap is very popular), and ETH is returned to the lender. I can keep my ETH, but on the other hand I lose my WBTC collateral;
The project either charges fees in the form of reduced interest rates or simply for arranging transactions; a. The platform also issues its own native token, which can be obtained by acting as a lender, borrower, or both Use the platform.
This business model is actually an original bank engaged in full reserve loans, and its key point is that outstanding loans must be <= deposits. Interestingly, it is a programmable finance and the owner is the people who actually use the service. In stark contrast, the shareholders of ordinary banks are the government, large asset managers, and some retail investors. Equity ownership is conferred through the purchase of stock, not through use of the Services. Token economics (which Dan Larimer will be teaching as a new major at Wharton) is intriguing, and it's also where the yield farming movement is born. Using the example above, I create a fixed supply of tokens, and the only way to get those tokens is by borrowing. Of course, you can also choose to buy these tokens on the open secondary market.
Such tokens have the following properties:
All fee income from the project will be transferred to token holders after deducting operating costs.
Token holders can submit improvement proposals and use their tokens to vote. Here are some things that holders can vote on: a. Operational costs; b. List of approved unsecured borrowers (such as transaction firm); c. The leverage ratio of mortgage loans; d. The fees charged by the platform.
The next question is how do you value this token in the open market? As a token holder, I can obtain the income expressed by the following formula: My annual income of tokens = #Tokens I hold*[Service fee income/Total supply of tokens]
Annualized rate of return of my tokens = annual income of my tokens / [Price Paid per Token * # of Tokens]
Let's say the yield is 5%, and ignoring the risk of poorly built smart contracts, I have to evaluate the investment based on something like that. If all loans were at least fully secured, I wouldn't have to worry about the credit quality of the loan book. I'm also assuming that I can sell collateral on a margin call without a market crash. That means, when evaluating my returns, I should look to U.S. Treasuries. The U.S. government can print money at will, so denominating in dollars is risk-free. We're not talking about the purchasing power of the dollar after M2 inflation is rampant, but that if you lend $100, you get $100 back.
Short-term (<2yr) US Treasuries yield slightly above 0%, so investing in tokens that yield >0% is a better use of your capital.
And your risk of investing in the DeFi prototype bank is as follows:
The lower the amount of assets locked in a smart contract, the lower the potential fee income. So if AUC drops after you buy tokens, your expected annual fee income will be enough to generate enough yield;
Impairment of the loan book, if all loans are at least 100% collateralized, means that when trying to liquidate the collateral, market liquidity does not allow the protocol to recover all the value of the loan currency. For example, if you mortgage $110 of WBTC and borrow $100, when the price of WBTC drops by 10%, the agreement will liquidate WBTC into USDT, and you can only get back 90 USDT. Now, the $10 loss must be deducted from the retained earnings pool, or depositors will experience a deduction in proportion to their percentage of the total deposit asset pool.
If money is lent to institutions that are considered high-quality and creditworthy (such as exchanges), which means that the collateral will be less than 100%, then the borrower may default. A similar impairment of income or principal will occur similar to point 2.
There could be a crypto bank heist, due to an intentional or unintentional vulnerability in the smart contract code, which causes investors to run wild on their assets, or the assets will become inaccessible.
Here's what happens when yields rise if there's a bull market ahead:
Token holders vote on appropriate credit policies that allow the extension of credit that is not 100% collateralized at an acceptable level of risk. This means that default impairment costs are lower than the interest income earned from these riskier activities;
Most DeFi projects require Staking as well as some uneconomic activities. As a reward for participation, you farm tokens created out of thin air with uncertain ownership and disputes over any potential revenue streams from the project. Some of the memes are downright comical (YAM, BASED, etc.), and the fact that these tokens are worth more than zero is a testament to the financial repression central banks are exerting on savers. When faced with high income inequality, and then some lucky ones get free money, then financial speculation will proliferate. Would you rather serve a large company for 30 years, work for stagnant or negative real income, or take a gamble in the intellectual fields of financial markets? At least in the field, you can still imagine that you still have hope.
Against this potentially dystopian backdrop, where more than 50% of the population relies on some sort of basic income, trading worthless memes under the guise of innovative technology is less silly.
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Bitcoin's holy grail
In order for Bitcoin to be a real currency, the cost of capital of certain businesses and individuals must be priced in Bitcoin terms. Any connection to fiat currencies would keep Bitcoin capital markets short of the dollar for a long time. All links in the value-added chain of commodity production must be able to borrow cheaply in the form of Bitcoin.
The rise of DeFi prototype banks and the right of users to obtain net interest margin will bring a wave of inclusive banking services to enterprises and individuals.
This is the dream of the DeFi archetypal bank, and in this bull market, it almost certainly won’t happen, but the narrative promises to attract hundreds of billions of dollars into the ecosystem. Sustained pull requires a strong narrative, and I believe this serves that purpose.
Keep an eye out for this area, we're working on some cool stuff.
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About my DeFi Shitcoin transaction
Like other gangsters, I enjoy yield farming meme tokens, but I fully expect to lose most of the money I "invest" in these projects. In the back of my head, I tend to believe that I can read market sentiment and flee at the top of a bull market. But in reality, like most other traders, I would buy at the high, hold, and sell after the high.
If you're not willing to roll in the dirt, you'll never find a truffle.
Of course, my position is small, my core investment is still gold, silver miners and physical gold, and the attractive potential return rate of 100 times makes me decide to buy YAM, YFI, DOT or any other Shitcoin.
No nightclubs here, I'm substituting shitcoin for sparkling water, at least, I'm learning something.
I, like many other pseudo-smart keyboard warriors, have a huge upside target for Bitcoin. I'll talk about that in my next article, but generally speaking, the fourth quarter of this year is going to be very exciting.
