Understanding finance and DeFi1: Explore what problems finance and DeFi are solving

Finance is very complex, and people have many misunderstandings about it. It has great advantages and very bad shortcomings.

DeFi (decentralized finance) is more complex, with more prominent advantages and disadvantages. The world's love and hatred for it are several times that of traditional finance.

Traditional finance has developed for hundreds of years and accumulated a wealth of knowledge.

DeFi can’t be found10In the past year, I have been studying traditional finance, trying to understand DeFi and give some scientific explanations to DeFi.

On this topic, I want to write a series of articles using the knowledge of traditional finance and the practice of DeFi.

I have a vague outline for the time being, but I have never been satisfied with it. The delay in starting to write it makes me even more dissatisfied with myself. Just get started and write wherever you go.

Sorry if the writing is not good, and thank you for reading.

The ultimate goal of traditional finance.

From the perspective of financial development, I have read a lot about debt, shares, accounting systems, and supervision, etc. Finance should be dedicated to solving a capitalism The underlying problem is the principal-agent problem caused by the separation of ownership and management rights.

The core of this principal-agent problem is information asymmetry. Finance is equipped with a series of mining of this information, as well as incentive and punishment mechanisms.

Debt is the separation of the ownership and use rights of money, and the money is transferred from the hands of the creditor to the hands of the borrower. This can also be seen as a principal-agent problem, where the creditor entrusts the money to the borrower. This process is bound to produce information asymmetry.

In finance, complex methods have been devised to coordinate principal agents for matters such as debt. Including banks, bond systems, supporting laws and enforcement.

Stocks are easier to understand. Stocks are certificates of the principal-agent relationship between shareholders and the people who actually operate the company.

Similarly, finance has designed complex and messy mechanisms for things like stocks. Including investment banks, exchanges, accounting, etc.

Currency is essentially a kind of debt. The current consensus in economics on the origin of money is that money originates from debt.

Modern credit currency is a direct debt, a bond issued by the country, and it is the kind of debt that will never be repaid. As long as everyone believes that the country will not collapse, it will Debt can be issued forever.

The government generally issues currency by issuing treasury bonds, and then the central bank directly buys the treasury bonds and generates a sum of cash in the government's account.

The special debt of legal currency is of course also a set of principal-agent problems, such as how to limit inflation, ensure employment, fair distribution, etc.

Similarly, many mechanisms have been designed around the fiat currency financial system, especially the central bank, as well as complex concepts such as reserve ratios.

The above paragraphs are what I see as a highly abstract financial world, which means that finance is probably about playing with these things and solving these problems.

DeFi, decentralized finance, is a branch of financial innovation. I think DeFi is still trying to solve the principal-agent problem of separation of asset ownership and management rights.

The specific application scenarios of DeFi are also debt and stocks.

Cryptocurrency itself can be interpreted as either a debt or a stock. For example, BTC and ETH are stocks, while USDT and Dai are bonds.

Many tools have been born in the DeFi world to realize the principal-agent problem caused by the separation of asset ownership and management rights.

DeFi’s biggest solution is to eliminate the separation of asset ownership and management rights.

Blockchain asset ownership can generally be interpreted as private key ownership, and operating these assets mainly relies on various smart contracts. The prerequisite for smart contracts to manage and control assets is that they will not deprive original users of digital currencies of their ownership rights. That is, when users entrust assets to smart contracts, they will not lose control of their private keys.

Of course, this highly abstract description is ideal. The writing, updating and operation of smart contracts also require people to do it, which will also generate asset ownership. and separation of operating rights.

DeFi, a financial technology, makes risks and returns very clear. For example, traditional financial banks may take several years to deal with bad debts, but banks in DeFi (lending protocols such as aave) only need to deal with bad debts in one block15seconds. Because in DeFi, whose assets, whose risks, and whose profits are all determined in real time and can be settled in real time.

This is that DeFi is a true private property right that eliminates the principal-agent problem as much as possible.

Another idea of ​​DeFi is extreme transparency. Everyone knows where the coins are, the total amount of coins, and how the coins are distributed. Yes, completely transparent.

This kind of transparency can greatly alleviate the information gap in the agency process, which is one of the biggest problems in traditional finance.

Faced with the same principal agent problem, in contrast, DeFi relies on blockchain and smart contracts through technical solutions to provide a more A transparent, efficient, trustless financial system.