A brief history of (failures in) Defi
Incredible lessons from the wild wild west of finance. learn where is the Future of Decentralisation heading
Defi short for decentralised finance is an incredibly hot area over the last few years as it promises be game-changing compared to traditional finance.
At the heart of it, a typical Defi protocol is nothing but a financing platform. Lenders want to make some fixed income yield, and borrowers want to borrow money and offer this yield to lenders. Like any typical securitized loan, borrowers need to post 2x-5x collateral of loan value to make sure the loan is considered 'safe' by the lender.
Most defi protocols also have a governance token that needs to be used for various fees that the platform demands thus keeping up the demand for a protocol token.
Now if you are thinking hey this is what most financial institutions do, you are right except here it's all run by a 'decentralized protocol' without a single party in control, no office, no companies, no servers of your own to maintain etc as all this is execution right on blockchains like ethereum, polygon, Solana etc.
Enter the Oracle
Borrowers of asset-backed loans in the real world do end up getting margin calls from time to time when the price of collateral drops below a certain threshold, to enable this same functionality ( of margin call ) the real world price of an asset from real-world say Bitcoin / ethereum / Solana is fed into the Defi protocols using the so-called "Oracle"
Oracles feed this real-world price data into the blockchain to execute decentralized margin calls should the price of the collateral drop below a certain level.
These oracles are in theory supposed to be many and decentralised and feed a honest price to the blockchain
If you are thinking who's to decide the 'correct price' in a decentralised world of blockchain? congratulations you are smarter than most people in who invested in these decentralised protocols hoping to making it rich over night.
You see even though these oracles claim to be 'decentralised' and only relay objective truth, these oracles have no real fool-proof governance mechanism to enforce this. In the real world, exchange CEOs go to jail if they are caught attempting price manipulation, however in the bold new world of DeFI nobody ever goes to jail for anything ( all thanks to decentralisation and pseudonymous identities)
here's one of 1o00s of cases of defi failures
The mirror protocol's oracle got hacked and was feeding in a 1000x higher price for collateral, as a result of which borrowers are able to borrow far more valuable assets from the protocol compared to the collateral they were offering.
Terra Luna Crash
For the uninitiated Terra luna is again lending / stable coin protocol which was minting stable coins for locking in underlying token Terra and offering a 20% annual yield. now if you are thinking this sounds like a Ponzi well it is and investors in Terra lost 99.99% before the project shut down.
These Crashes are just the tip of the iceberg in the long history of crashes of Defi
Transparency and Self-Custody
wondering why investors put up hard ended money when almost 99% of Defi projects have failed already?
The alternative to Defi is traditional finance/banking. As you know traditional banking/ finance has its own share of problems - enormous regulations over years have increased the cost of doing business significantly so much so that huge chunks of populations are unbanked.
Traditional banking demands trust in the operators and that trust goes belly up occasionally as the unscrupulous bankers chase ever higher risks.
There is a huge demand for exploring an alternative to traditional custodial lending that offers 'Self-Custody and Transparency'.
For all its pit-falls, Defi protocols do offer transparency where every transaction is visible to the public to audit the functioning of the underlying protocols. DeFi also offers 'self-custody' wherein you control your loan process through your keys
BlockFi - A crypto lending platform is forced to pay $100 Million in Penalties as it violated users' trust by re-hypothecating user's collateral
The verdict is clear - people want self-custody and not having to rely on a single point of failure.
Billions of dollars will enter a solution over time that can offer these features which are missing in traditional finance.
The Practical Middle Path
Feeding the real world data into the blockchain without having to trust any nodes is a mathematical impossibility ( which the Defi fan-boys and VCs/ Investors will learn the hard way )
Bitcoin is the only protocol that achieved 'trust-lessness' in feeding real-world information to the blockchain with an incredible innovation of 'Proof-of-work'. Proof-of-work achieves this impossible feat ( of trustlessness ) by solving increasingly difficult puzzles that demand an enormous amount of energy to be spent. For all the negative press that bitcoin receives, POW is the only solution that works without breaking in the last 13 years all while carrying billions of value securely ( read more about how POW achieves trustlessness )
We at Valuete have yearned for a more feasible solution that works in the real world ( without breaking ) without a single point of failure for a long time and felt a middle ground between Defi and TradFI/CeFi is the right path to go.
i.e Peer-to-peer financing marketplace driven by Multi-sig protocols
How multi-sig works?
Multi-sig short for multi-signature address is an incredible advance in bitcoin protocol which enables sharing of custody of bitcoin at the core protocol level.
A multi-sig address is created by combining say 3 normal bitcoin addresses which look exactly like a regular address. However, the movement of funds from a multi-sig address only works with a minimum of 2 signatures ( as set during the creation of this multi-sig address ) needed from the underlying 3 bitcoin holders
Multi-sig wallets offer incredible use-cases including vastly improving security, custody sharing, transparency etc and are poised to revolutionize many industries in the future.
The Valuete Model
The valuete model combines the security and decentralisation offered by 2-of-3 multi-sig wallets with direct peer-to-peer lending and borrowing between a lender and borrower.
In this process, a lender ( either an individual or an institution ) gets into a financing contract with a borrower of interest directly. The borrower borrows US dollars from the lender and offers his/her Bitcoin as collateral to be kept safely in a 2-of-3 multi-sig wallet created from public keys of Lender, Borrower and Valuete. This setup offers incredible security to borrowers and lenders as no single party/address has the power to move collateral without the consent of a second party.
Even though this set-up does require a company, legal contracts, and servers to run the lending marketplace it offers legal protections that investors crave without compromising on transparency and 'self-custody'.