DeFi & DEX: The Mechanism and Potential of the New Finance System
Hello. This is Koki Hosogane from LGG.（https://twitter.com/Hosogane_LGG）
Today, we’ll simplify the world of “DeFi,” where you can see many mysterious words frequently, such as:
・ Smart contract
・ Yield farming
・ PoW, PoS
Its concept and mechanism are too abstract, so in this article, let’s take a look at Axie Infinity as an example, which is well-known as “Play to Earn.”
1. What is DeFi?
If we translate the word “DeFi” literally, it means “Decentralized Finance.”
You don’t have to memorize the words “Decentralized Finance.”
The point is, “You can send your money directly by connecting your wallet on the Internet without going through banks or cryptocurrency exchange.”
Blockchain can support security of our money, as I explained in the previous article.
What’s the Difference between traditional finance and DeFi?
In today’s financial transactions, financial companies, such as banks and virtual currency exchanges intervene in our transactions, so that we can ensure credibility and security of our money. To do so, we have to pay extra cash to those companies for intermediate fees.
On the other hand, DeFi was born with a concept of,
“We don’t need any intermediate fees to banks and exchanges, right?”
This is literally possible because the blockchain’s data tampering resistance can guarantee this reliability and security.
So, instead of the existing financial companies, DEX =“Decentralized Exchange” came out.
DEX allows direct transactions between individuals without going through financial institutions such as UFJ and Coincheck.
2. Axie Infinity Case Study
Axie before the appearance of DEX
Take Axie Infinity as an example. It recently announced its own DEX “katana”.
Previously, when we wanted to buy Axie with the SLP we earned, we had to follow the following steps:
1. Withdraw SLP to Ronin wallet (=Claim)
2. Send money from Ronin wallet to Binance
3. Convert it to ETH in Binance
4. Return to the Ronin wallet again
5. Buy Axie at WETH (*)
(* Token that upgrades (wraps) the standard of ETH itself and makes it usable on the standard of ERC-20)
Binance was a bottleneck because it took time and money (gas fee)like this.
Appearance of DEX “katana”
However, with DEX “katana,” we can follow simpler steps as follows:
- Transfer SLP to Ronin Wallet (Claim)
- Convert SLP to WETH there
- Buy Axie right away
As Binance disappeared (*), fees and man-hours were reduced, and convenience increased at once. So when DEX “katana” appeared it was like, “Yo! I’ve been waiting for you”.
(* Before the RON network was established in Binance, there was a higher fee (gas fee).)
What you can do with katana
Katana can also convert to $-USDC (1 US dollar = 1USDC), which always stays at the same price as US dollars. (It’s called stablecoin.)
USDC also works with Visa, and it means that if you convert your earned SLP to USDC, you can use it for credit card payment as it is.
It feels like the distance between virtual currency and legal tender has shrunk at once.
If “katana” corresponds to Japanese Yen stablecoin $-JPYC, we can convert it to Japanese Yen and transfer it to PayPay or Rakuten Pay. So we can complete Japanese Yen payments with SLP in the future!
Now, Play to Earn has a high hurdle of “moving between wallets and exchanges,” but DeFi has been taking away this problem gradually.
3. What is yield farming?
In DEX, high liquidity (≒ ease of trading) is important.
Without enough virtual currencies on the exchange, we cannot exchange our money even if we say, “Hey, can you exchange my money?”
Therefore, “katana” has created a system to return the virtual currency to lenders for increasing liquidity with a swap fee.
Users use SLP and WETH, or AXS and WETH to create a seed called “LP tokens.”
If you plant this seed, the swap fee will be returned in a virtual currency called RON.
In other words,
- Once you get the seeds of SLP / WETH / AXS
- And plant the seeds in the katana network
- You can harvest fruits called “RON”
This system is called “yield farming.” In this model, we can get interest rates and commissions in return once we deposit a specific virtual currency to contribute to liquidity
“Staking” means depositing the currency on the network (=planting seeds).
DeFi has expanded at a stretch with yield farming and staking.
From PoW to PoS
Virtual currencies have been PoW (Proof of Work). , The more work(=mining) we do, the more we can get paid. This has led to a sharp rise in gas prices.
If this turns into PoS (Proof of Stake) and the system changes to paying according to the total amount of staking, the gas bill will be cheaper and the liquidity will increase.
When the start of staking of AXS was announced this October, AXS, which had been in the 8,000 yen range back then, jumped to the 15,000 yen range.
YGG is a guild that has been teaming up with Axie from the beginning. YGG menbers bought AXS at a fairly low price, so their assets might have jumped extremely.
YGG tweeted, “I staked 189,953 AXS and received 1310 AXS within one day.”
With the seeds of 2.82 billion yen at the rate back then, the fruit of 19.46 million yen (yield about 0.7%) was obtained in one day.
“Where will the next big wave come?” LGG also pay attention.
4. “Smart contract” that supports DeFi
It’s been a long story, but it is smart contracts (automatic transactions) that support these DeFi.
It is a mechanism that the contract is automatically executed based on the preset program.
“Katana” was created by Sky Mavis, but “Katana” itself moves automatically without the hands of the administrator.
In the past, banks once entrusted an asset from a user and lent it to another person or managed it.
However, Sky Mavis just prepared a box called “katana” and does not keep assets from users.
The operation of the exchange is driven by the program and the staking of the participants.
5. DEX vs CEX
Now some people may feel that the centralized exchange (CEX as opposed to DEX) is evil, but DEX also has its weak points. Both of them have advantages and disadvantages.
Looking at CEX’s Coinbase investing and supporting the DeFi field considerably, I think that CEX and DEX will probably evolve in a way that complements each other.
DeFi has a strong speculative side at the moment.
However, the realization of interpersonal transactions in “finance” has great significance, and it should be implemented and deployed in many fields in the future.
If it is used in the Metaverse, a lot of interesting things will happen.
I’m very excited from now on!
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