Introduction to Decentralised Finance: Trusting a Trustless System
Does Decentralised Finance (DeFi) trump Centralised finance (CeFi)? This week Michael A. Bentley, an Oxford alumnus who founded Euler xyz, a permissionless lending protocol based on Ethereum, gave his views on why DeFi is experiencing exponential growth. The event was jointly hosted by OFLS and the Oxford Blockchain Society.
DeFi’s growth can be attributed to the short-comings of CeFi such as lack of transparency, permission requirements (such as know your customer checks), centralisation, regulation, and putting trust in humans. For example, despite facing fines for allegedly imposing involuntary overdraft fees on its customers, HSBC still recorded profits of more than £12 billion. RBS was implicated in allegedly misleading staff to use salaries to buy shares in the bank.
In light of this, DeFi offers numerous advantages over CeFi. They are trustless as trust is placed in smart contracts, transparent (immutable), permissionless, and allow trading without intermediaries. Users can borrow, lend, and trade on synthetic assets on a peer-to-peer basis. Maker, Uniswap, Compound and Yearn are examples of successful DeFi platforms. Maker is one of the most successful decentralised, autonomous organisations to date and provides the stablecoin Dai on Ethereum. Dai is stable as its pegged to the US dollar. Uniswap enables easier trading on decentralised exchanges (DEXs) as it facilitates permissionless listing and trading of assets.
Euler xyz emerged from Spark University Hackathon in 2020 and recently raised $800,000 seed funding led by Lemniscap. It is a permissionless lending protocol, targeting the long tail of the market ,where users can borrow and lend any Ethereum ERC20 token. Michael was inspired by control theory during the first lockdown of 2020 and used it to develop Euler. Euler uses Uniswap’s TWAP oracle, provides risk adjusted borrowing limits, under collateralised loans, and reactive interest rates backed by control theory.
Michael expressed optimism that despite DeFi experiencing several hacks like the DAO hack in 2016, which saw more than $50 million worth of Ether lost to hackers, things have improved with proper auditing of smart contracts before deployment. Bounties are being offered which will make arresting hackers easier. Furthermore, DeFi insurance has also grown since then, with the entry of players such as Nexus mutual.
Finally, the outlook for DeFi looks promising with the prospect of Automated Market Makers competing with traditional market makers, the growth of synthetic assets, and the explosion of financial products which will increase volumes and drive up the total valued locked. In future, those investing in Euler will receive shares in tokens, participate in the decentralised network, and gain revenue on the protocol.