Writing a book on decentralized finance is a bit like describing a riddle, wrapped in a mystery inside an enigma, to borrow from Winston Churchill. First, one must summarize the origins of modern decentralized finance, then the mechanics of the blockchain technology that provides the sector’s backbone, and only then do you arrive at DeFi’s infrastructure. It all should be done in 191 pages, too, including glossary, notes and index. It is not an undertaking for the faint of heart.
Fortunately, the authors of DeFi and the Future of Finance — Duke University finance professor Campbell Harvey, Dragonfly Capital general partner Ashwin Ramachandran, and Fei Labs founder Joey Santoro — were up to the task. After recapitulating the “five flaws of traditional finance” — inefficiency, limited access, opacity, centralized control and lack of interoperability — they go on to explain how DeFi improves upon the status quo.
Take the problem of centralized control. Governments and large institutions hold a “virtual monopoly” over the money supply, rate of inflation, as well as “access to the best investment opportunities,” wrote the authors. DeFi with its open protocols and immutable properties “upends this centralized control.”
As for how DeFi answers traditional finance’s opacity shortcoming: “All [DeFi] parties are aware of the capitalization of their counterparties and, to the extent required, can see how funds will be deployed,” which mitigates counterparty risk. As goes inefficiency, “A user can largely self-serve within the parameters of the smart contract” in a decentralized application by exercising a put option, for instance.
What about traditional finance’s failing in limited access? DeFi gives underserved groups like the world’s unbanked population direct access to financial services, wrote the authors, offering yield farming as an example, a DeFi process where users are rewarded for staking capital in the form of a governance token that makes them, in effect, part-owners of the platform, “a rare occurrence in traditional finance.”
The authors also described the ways that DeFi protocols can be layered atop one another (i.e., DeFi’s composability, sometimes referred to as “DeFi Legos”), which helps to deal with the interoperability deficit. Once a base infrastructure has been established (to create a synthetic asset, for instance), “any new protocols allowing for borrowing or lending can be applied. A higher level would allow for attainment of leverage on top of borrowed assets.”
Taking a deep dive
Chapter 6 explores eight leading DeFi protocols in depth: MakerDAO, Compound, Aave, Uniswap,Yield, dYdX, Synthetic, and Set Protocol. Each section is accompanied with a very useful table, where the first column describes how traditional finance solves a particular problem, and the second column how a specific DeFi protocol deals with that problem.
For example, in Table 6.3, “Problems that Aave…
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