So what is Binance Smart Chain? How is it different from Ethereum? And what is CeDeFi all about? You’ll find answers to these questions in this article. 

First, let’s see how Binance Smart Chain came into existence. 

Binance Chain 

In April 2018, Binance – one of the biggest cryptocurrency exchanges, decided to launch their own blockchain – Binance Chain. 

The main idea behind Binance Chain was to create a high-speed blockchain able to support large transaction throughput.

To achieve this, the team behind Binance Chain chose the Tendermint consensus model with instant finality and instead of supporting multiple applications, decided to focus on its primary app – Binance DEX.

With DeFi on Ethereum flourishing and Binance DEX not getting as much traction as expected, Binance very quickly realised that the main feature missing from Binance Chain was the ability to run smart contracts and allowing other teams to deploy their own applications. 

At this point, Binance made an interesting decision. Instead of trying to add smart contract capabilities to Binance Chain and sacrificing its performance, they decided to launch another chain in parallel to Binance Chain and this is where Binance Smart Chain comes into play. 

Binance Smart Chain 

Binance Smart Chain launched in September 2020 and in contrast with Binance Chain, was fully programmable and supported smart contracts out of the box. 

If you’d like to better understand what smart contracts are and why they are so important you can check this article here. 

Creating a completely new smart contract platform from scratch requires years of work and research. Instead of doing that, Binance decided to leverage users’ and developers’ familiarity with Ethereum and forked Ethereum’s go client – geth. 

Of course, forking Ethereum without making any changes wouldn’t make much sense, so Binance decided to optimise the new chain for low fees and higher transaction throughput by sacrificing decentralization and censorship-resistance properties of the network. 

This was achieved by replacing Ethereum’s Proof-of-Work consensus model with the Proof-of-Staked-Authority model and tweaking a few other parameters such as the block time and the gas limit per block. 

Before we jump into the details of Binance Smart Chain, let’s see why some properties of the network had to be sacrificed in the first place. We can understand this better by revisiting the famous Scalability Trilemma. 

Scalability Trilemma 

The Scalability Trilemma is a useful model, introduced by Vitalik Buterin, that helps with visualising what trade-offs have to be made when it comes to different blockchain architectures. 

Each blockchain has 3 core properties: security, scalability and decentralization that cannot be achieved simultaneously. So in order to significantly improve one of these properties the other ones have to be sacrificed.

Sharding is an attempt at solving this challenge at the base layer by splitting a blockchain into multiple smaller chains – “shards”. Sharding is one of the scaling approaches chosen by Ethereum and it’s one of the elements of the Eth2 upgrade. 

Unfortunately, sharding by itself cannot fully solve the trilemma and even sharded blockchains wouldn’t be able to process hundreds of thousands or even millions of transactions per second without sacrificing decentralization and security.  

This is also why the Ethereum community decided to use Layer 2 solutions that can dramatically increase the scalability of a blockchain without sacrificing other properties. 

It shouldn’t come as a big surprise that there were a lot of other projects popping up that, despite The Scalability Trilemma, decided to scale up by sacrificing the other 2 properties. One of the most notable examples was EOS.

This is also the approach that Binance Smart Chain decided to go with. 

Architecture 

Binance Smart Chain, instead of using a Proof-of-Work (PoW) or a Proof-of-Stake (PoS) consensus mechanism, uses a Proof-Of-Staked-Authority (PoSA) model. 

In this model, all transactions are validated by a set of nodes called validators. A validator can be either active or inactive. The number of active validators is limited to 21 and only active validators are eligible to validate transactions. 

Active validators are determined by ranking all validators based on the amount of BNB tokens they hold. The top 21 validators with the highest amount of BNB become active and take turns validating blocks. This is determined once per day and the set of all validators is stored separately on Binance Chain.

Besides staking BNB tokens themselves, validators can also encourage BNB holders to delegate their BNB tokens to them in order to receive a share of the validator’s transaction fees. 

On this note, all transaction fees on Binance Smart Chain are paid in BNB which is the native token of the chain, in a similar way to how ETH is native to the Ethereum blockchain. 

In contrast to Ethereum and Bitcoin, there are no block subsidy rewards on Binance Smart Chain. This means that the validators only receive the transaction fees paid in BNB and there is no other fixed reward per block. 

Although the PoSA consensus model allows for achieving a short block time and lower fees, it does so at a cost of decentralization and security of the network. 

First of all, a user cannot just start validating the state of the blockchain in a similar way as they can do it in Bitcoin or Ethereum. 

On top of this, even if a user could just join the network in a permissionless way and start validating transactions, they wouldn’t be able to do it for a very long time on consumer-grade hardware as the state on Binance Smart Chain grows at a much higher rate than the Ethereum’s state.

Now, let’s see how the PoSA-based model allowed the Binance Smart Chain team to change the block time and the block gas limit.

The block time was reduced from around 13s on Ethereum to around 3s on Binance Smart Chain. This allows for higher transaction throughput and faster confirmation time, at a cost of having to store more data. 

If implemented on Ethereum, it would also increase the number of orphaned blocks as there would not be enough time to propagate valid blocks across the network from multiple different geographic locations.

When it comes to Binance Smart Chain, however, this is not a problem as validators just take turns validating blocks. 

Block gas limit is another important parameter that we discussed in our article about the gas fees. This parameter basically decides how many transactions can fit into one single block. On Ethereum, miners have to come to a consensus and decide what value they want to set it to. 

Increasing the block gas limit, similarly to reducing the block time, increases the amount of data produced by the blockchain which makes it harder for individual users to run their own nodes. 

Again, this is not a problem on Binance Smart Chain as the 21 validators can just run their nodes on institutional-grade hardware when the state of the blockchain grows beyond what can be handled by consumer-grade hardware. 

At the time of writing this article, the gas limit per block is set to 12.5M gas on Ethereum and 30M on Binance Smart Chain. 

By knowing both the block time and the gas limit per block we can quickly calculate that the amount of data on Binance Smart Chain increases roughly at a 10-times faster rate than the state on the Ethereum blockchain. 

Currently, with an average block size of 40,000 bytes, Binance Smart Chain grows by around 1.15 GB per day which is around 420 GB per year. After a couple of years, this of course eliminates most of the consumer-grade hardware. 

Now as we understand a bit more about the Binance Smart Chain architecture, let’s see what CeDeFi is all about. 

CeDeFi

As we know, DeFi stands for decentralized finance. CeFi is the opposite of DeFi and as we can probably guess stands for centralized finance. CeDeFi is a term coined by the CEO of Binance that basically describes a mixed solution between centralized and decentralized finance which Binance Smart Chain is a good example of. 

So what are the benefits of such a solution? 

CeDeFi allows users to get a feel for using DeFi without paying high transaction fees. Low fees encourage users to play with multiple different DeFi protocols such as decentralized exchanges, lending protocols, liquidity aggregators, yield farming tools and others.

On top of this, CeDeFi makes users familiar with common DeFi tools like Metamask and block explorers. 

It also allows new teams to deploy their smart contracts for a fraction of a cost when compared to what they would have to pay on the Ethereum blockchain. This way they can easily test and get feedback on their projects. Testing within an ecosystem with actual economic incentives usually works much better than just testing on a testnet. 

Binance Smart Chain and CeDeFi have recently started gaining a lot of popularity. This is mainly driven by the high transaction cost on Ethereum that priced out some of the users.

As we know, Binance Smart Chain is a fork of Ethereum and therefore allows for running exactly the same smart contracts like the ones on Ethereum. 

This allowed the network to quickly bootstrap its ecosystem by essentially either reusing or forking all popular Ethereum services and applications.

Users can connect to Binance Smart Chain based dApps by switching their network in Metamask. They can look up their transactions on bscscan.com which is pretty much a copy of etherscan.com. They can trade on Pancakeswap – a fork of Uniswap. They can lend and borrow on Venus – a fork of Compound and yield farm via Autofarm – a protocol that resembles Yearn Finance. 

Binance Smart Chain, similarly to Ethereum, also allows for creating new tokens using their BEP-20 standard – Ethereum’s ERC-20 counterpart.

Some Ethereum-based projects also quickly saw the opportunity for expanding their reach to Binance Smart Chain, at a minimal cost. 1Inch – a liquidity aggregator – has recently decided to also launch on Binance Smart Chain.

Summary

It’s clearly visible that Binance Smart Chain was able to make quite a lot of traction and attract a decent number of users and trading volume in a very short amount of time. 

A decision to fork Ethereum and allow users and developers to interact with DeFi tools and protocols they are already familiar with was quite clever. 

The timing was also extremely good. The popularity of Ethereum combined with most Ethereum scaling solutions still in progress and a roaring bull market resulted in high transaction fees that priced out smaller users and forced them to find a different option if they still wanted to participate in DeFi.

On top of this, Binance was able to leverage its position as one of the top cryptocurrency exchanges and make it easy for its millions of users to easily withdraw BNB and other tokens directly to Binance Smart Chain. 

The main question to ask here is if this is a short term growth caused only by high transaction fees on Ethereum or a longer-term user acquisition? 

At this point, it’s hard to say, but two main things pointing at the former are Ethereum’s layer 2 scaling solutions and the Eth2 scaling roadmap. 

Both of these can dramatically reduce the transaction fees on Ethereum without sacrificing other properties like security and decentralization. 

We can already get a feel for it with Matic (a.k.a. Polygon) and Loopring attracting more and more users and trading volume. This trend should only keep escalating with other layer 2 solutions getting more traction and new ones like Optimism fully launching in a matter of weeks. 

With millions of new users entering the cryptocurrency space, it’s also extremely important to make sure they are aware of the differences between DeFi and CeDeFi and are able to make their own decisions. 

At the end of the day, we have to ask ourselves the question. What’s the main point of using a blockchain if it’s not fully decentralized and permissionless? Auditability? Maybe, but is this really the main value proposition of the whole cryptocurrency space?

It will clearly be interesting to see how DeFi and CeDeFi play out. 

So what do you think about Binance Smart Chain? Does CeDeFi have a future? 

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

So what exactly is gas? Why are transaction fees so high at the moment? And what are some of the ways to make the transaction cost lower? You’ll find answers to these questions in this article. 

Let’s start with what gas actually is. 

What Is Gas 

Gas is a unit used for measuring the amount of computational effort required to perform specific actions on the Ethereum blockchain.

The name itself hasn’t been chosen by accident. Similarly to gasoline fueling a car and allowing it to drive, gas on the Ethereum network fuels transactions and allows them to perform different operations. 

Every operation on the Ethereum blockchain, or to be precise on the Ethereum Virtual Machine (EVM), has an associated gas cost. For example: adding 2 numbers costs 3 gas; getting the balance of an account – 400 gas; sending a transaction – 21,000 gas. 

Smart contracts usually consist of multiple operations that together can cost even hundreds of thousands of gas.

What is interesting is that the gas cost by itself doesn’t tell us how much we have to pay for a particular transaction. To calculate the transaction fee we have to multiply the gas cost by gas price. 

The gas price is measured in gwei – a smaller unit than ether where 1 gwei equals 0.000000001 ETH. We can think about it as a major and a minor unit similarly to dollars and cents. 

As an example, let’s say we want to send a simple Ethereum transaction and the ETH price is at $1,800. Most of the popular Ethereum wallets such as Metamask estimate necessary gas prices and allow us to choose between fast, medium and slow transaction confirmation speed. Let’s assume that the wallet estimated the gas price to be set to 100 gwei if we want to have a chance of having our transaction confirmed within the next minute. 

We can now quickly calculate that we have to pay $3.78 for such a transaction. We multiply the gas cost for sending a transaction – 21,000 gas – and the gas price – 100 gwei. This is equal to 2,100,000 gwei which is 0.0021 ETH. At the ETH price of $1,800, this gives us $3.78. 

ETH Price And Gas

It’s worth mentioning that gas is only an abstract unit that exists only inside the EVM and the user always pays for their transactions in ETH.

The main reason for having a separate unit for measuring computational effort is to decouple it from the price of ETH. 

This means that the increase in the ETH price should not change the cost of transactions. If the network activity stays the same and the price goes up we should see the gas price going down, so the final transaction cost measured in ETH stays the same in dollar value. 

Saying this, a price increase of ETH is very often correlated with an increase in the activity on the Ethereum network – something that indeed increases the cost of transactions. 

Now, let’s see how exactly an increase in network activity causes the transaction cost to go up. 

To start with – all transactions sent to the Ethereum network land in the mempool. This is a place where all pending transactions are waiting for the miners to pick them up and include them in the next Ethereum block. 

Miners are incentivised to pick up transactions with the highest gas price first as they are basically doing a fixed unit of work for a better price. 

Miners are also limited to how many transactions they can include in one single block. This is determined by the maximum gas limit per block. At the time of writing this article, this limit is set to 12.5M gas. 

As a quick example, let’s assume there are only simple ETH transactions in the mempool each one costing 21,000 gas. A miner can include ~595 such transactions (12.5M/21K). If there are, let’s say, 1,000 pending transactions in the mempool, the miner would choose transactions by sorting all pending transactions by the gas price and choosing 595 most profitable ones. 

The current fee model is based on a simple auction mechanism and the users who want to have their transaction picked up by miners first have to essentially outbid other people for the space in a block. This in turn drives the gas prices up, especially at times when a lot of users have urgent transactions that they want to confirm. 

Why Do We Need Gas

To wrap up the gas explanation, it’s also important to understand why gas has to exist in the first place. EVM as a Turing-complete machine allows for executing any arbitrary code. Although this is one of the main reasons that makes Ethereum so powerful it also makes it vulnerable to the halting problem. The halting problem is the problem of determining, from a description of an arbitrary computer program and an input, whether the program will finish running, or continue to run forever.

Without gas, a user could execute a program that never stops, either by making a mistake in their code or just by being malicious. To prevent this, Ethereum introduced a gas cost associated with each operation that would prevent a program from running forever and bringing the whole network to the grinding halt. 

Besides the gas price, each transaction also has a gas limit that has to be equal or higher to the anticipated amount of computation needed for successfully executing a particular transaction. 

EVM, before executing each operation within a transaction, checks if there is enough gas left for that operation. In case there is not enough gas left, the whole transaction is reverted with “out of gas” exception and all state changes are rolled back. The user would still pay the transaction fee for the amount of work that has been done by the miner even if the transaction fails. This is again to avoid attacks on the network. 

If the transaction consumes less gas than initially anticipated the remaining amount of gas is converted to ETH and refunded to the sender. 

It’s also really important that all operations on Ethereum have the correct gas cost in relation to each other; otherwise, that could be another attack vector. One of such attacks took place in 2016 and resulted in a hard fork that repriced certain low-level operations. 

Now, as we know a bit more about gas, let’s have a look at the recent period of high transaction fees and a few solutions that can lower the transaction cost now and in the future. 

High Fees on Ethereum

With record volumes on decentralised exchanges, the highest total value locked on defi lending platforms, multiple yield farming opportunities available, and minting more and more NFTs – the Ethereum network is as busy as ever. 

This popularity results in high demand for block space which in turn results in high transaction cost. 

It’s not uncommon anymore to pay more than $10 for a simple ERC20 transfer or $50-100 for a Uniswap transaction. This, of course, is not ideal as it makes it really hard for smaller players to participate in the Ethereum ecosystem. 

Fortunately, there are multiple solutions either already available or being actively worked on. Let’s go through some of the most important ones. 

Layer 2 Scaling and Eth2

Layer 2 scaling is a collective term for solutions that help with increasing the capabilities of the main Ethereum chain – Layer 1 – by handling transactions off-chain. Besides improving transaction speed and transaction throughput, layer 2 solutions can greatly reduce the transaction fees. 

Loopring is a good example of a decentralized exchange built on Layer 2 that is getting more and more popular. The exchange has recently hit $200M in total value locked and over $10M in daily trading volume.

Another project – Matic – that was recently rebranded to Polygon also hit over $200M in TVL on their Plasma+POS chain. 

A more general-purpose solution – Optimism – that is based on optimistic rollups is also being rolled out. This is important as it will allow DeFi smart contracts to interact with each other in a similar way to how they interact on Layer 1. 

One of the missing pieces that can increase the adoption of Layer 2 solutions even further is direct onboarding to Layer 2. This could decrease the cost of transactions even further as users would be able to transfer their ETH directly from an exchange to a Layer 2 solution like Loopring. 

If you want to learn more about Layer 2 Scaling check out this article here. 

Besides Layer 2 scaling, another solution that can decrease the transaction cost, in the long run, is Eth2 which introduces sharding and Proof-Of-Stake. You can learn more about these concepts here. 

EIP-1559

EIP-1559 is another solution for optimising the transaction cost. 

Although the proposal will not have a direct effect on lowering the transaction cost, it will allow for optimising the fee model by smoothing fee spikes and limiting the number of overpaid transactions. This will make transaction fees more predictable.

From the timeline perspective, it looks like EIP 1559 could be implemented in early 2021. 

Here is a separate article that explains EIP-1559 in depth. 

Optimising Gas Usage

Besides using Layer 2 scaling solutions and waiting for other improvements, there are a few other tricks that can help us with lowering our transaction cost on Layer 1. 

First of all, if we don’t have any urgent transactions, we can try to find times of the day when the gas prices are the lowest. 

Besides this, we should always double-check the gas cost estimated by our wallet with a separate reliable source such as https://ethgasstation.info/. 

Another trick, used by 1Inch exchange, allows for lowering transaction fees with CHI tokens. These tokens must be burned alongside the primary operation, which allows for reducing the total amount of gas spent in a transaction.

This can be achieved by leveraging an EVM mechanism that refunds gas when storage space is freed. When CHI tokens are minted, dummy smart contracts on the Ethereum network are created. Burning CHI destroys these contracts and results in a gas refund. 

Other Chains 

So how about other chains besides Ethereum? 

There is no doubt that the recent period of high transaction fees on Ethereum resulted in a few other chains capturing a meaningful amount of users and volume.

At this point, it’s hard to say how much of this will be a short-term play versus a longer-term user acquisition. 

Saying this, we have to keep in mind that some of these chains are not fully decentralized and permissionless. This basically creates a fake DeFi ecosystem that may be fun to play with but is actually not that much different from using a centralized exchange. 

So what do you think about gas and high transaction fees? What is your favourite way of lowering it? 

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

So what is The Graph Protocol all about? Why do some people call it the Google of Blockchains? And what is the use case for the GRT token? You’ll find answers to these questions in this article. 

Let’s start with what The Graph actually is. 

Introduction

The Graph is an indexing protocol for querying blockchain data that enables the creation of fully decentralized applications. 

The project was started in late 2017 by a trio of software engineers who were frustrated by the lack of tooling in the Ethereum ecosystem which made building decentralized applications hard. After a few years of work and a lot of iterations, The Graph went live in Dec 2020.

The Graph, as one of the infrastructure protocols, can be quite tricky to grasp, so before we jump into the details, let’s try to understand what indexing – the main concept behind The Graph – actually is.

Indexing

Indexing, in essence, allows for reducing the time required to find a particular piece of information. A real-life example is an index in a book. Instead of going through the whole book page by page to find a concept we’re looking for, we can find it much quicker in the index, which is sorted alphabetically and it contains a reference to the actual page in a book. 

Similarly, in computer science, database indexes are used to achieve the same goal – cutting the search time. Instead of scanning the whole database table multiple times to provide data to an SQL query – indexes can dramatically speed up queries by providing quick access to relevant rows in a table. 

When it comes to blockchains such as Ethereum, indexing is super important. To understand why this is the case, let’s see how a typical blockchain is built. 

A typical blockchain consists of blocks that contain transactions. Blocks are connected to their adjacent blocks and provide a linear immutable history of what happened on the blockchain to date. 

Because of this design, a naive approach for searching for a particular piece of data, such as a transaction, would be to start with Block 1 and search for a transaction across all transactions in that block. If the data is not found we move to Block 2 and continue our search. 

As you can imagine this process would be highly inefficient. This is also why every popular blockchain explorer, such as Etherscan, built their own service for reading all the data on the blockchain and storing it in a database in a way that allows for quick retrieval of data.

These kinds of services are very often called ingestion services as they basically consume all the data and transform it into a queriable format. 

Although this approach usually works fine, it requires trusting the company that provides the data – this is not ideal for building fully decentralized and permissionless applications. 

On top of that, all private crypto companies that don’t want to trust other APIs have to build their own ingestion service which creates a lot of redundant work. 

This is also why a decentralized query protocol for blockchains was needed and this is where The Graph comes into play. 

The Graph 

The Graph aims at becoming one of the main core infrastructure projects necessary for building fully decentralized applications. It focuses on decentralizing the query and API layer of decentralized web (Web3) by removing a tradeoff that dApp developers have to make today: whether to build an app that is performant or truly decentralized.

The protocol allows for querying different networks such as Ethereum or IPFS by using a query language – GraphQL. GraphQL allows for specifying which fields we’re interested in and what search criteria we would like to apply. 

Queriable data is organised in the form of subgraphs. One decentralized application can make use of one or multiple subgraphs. One subgraph can also consist of other subgraphs and provide a consolidated view of data that the application may be interested in. 

The Graph provides an explorer that makes it easy to find subgraphs of the most popular protocols such as Uniswap, Compound, Balancer or ENS. 

Uniswap subgraph provides access to a lot of useful data, for example, the total volume across all trading pairs since the protocol was launched, volume data per trading pair and data about particular tokens or transactions. 

Now, let’s jump into the architecture of The Graph Protocol. 

The Graph Architecture

The easiest way to explain this is to focus on different network participants first. 

Let’s start with Indexers. 

Indexers are the node operators of The Graph. They can join the network by staking the GRT tokens and running a Graph node. Their main function is to index relevant subgraphs. Indexers earn rewards for indexing subgraphs and fees for serving queries on those subgraphs. They also set prices for their services. To keep prices in check each Indexer competes with other Indexers, on top of ensuring the highest quality of their data. This basically creates a marketplace for the services provided by Indexers. 

Consumers query Indexers and pay them for providing data from different subgraphs. Consumers can be either end-users, other web services or middleware.

Curators are other important network participants. They use their GRT tokens to signal what subgraphs are worth indexing. Curators can be either developers that want to make sure their subgraph is indexed by Indexers or end-users that find a particular subgraph valuable and worth indexing. Curators are financially incentivised as they receive rewards that are proportional to how popular a particular subgraph becomes. 

Delegators are yet another network participant. They stake their GRT on behalf of Indexers in order to earn a portion of Indexers’ rewards and fees. Delegators don’t have to run a Graph Node. 

Last but not least are Fishermen and Arbitrators. They become useful in case of a dispute that can happen, for example, when an Indexer provides incorrect data to the Consumer. 

Now, let’s see how the network participants cooperate in order to create a trustless and decentralized system. 

Let’s say a new decentralized exchange has launched and the team behind the project wants to allow other applications for easy access to the exchange’s historical volume and other data points.

To encourage Indexers to index the new subgraph, a Curator has to step in and signal that the new subgraph is worth indexing. 

Here we have 2 options. If the new exchange was a highly anticipated project with a lot of potential, an already existing Curator would most likely step in and use their GRT tokens to signal the usefulness of the new subgraph. If the subgraph becomes popular, the curator would financially benefit from their signalling. In the case that the new exchange is not highly anticipated, the developers behind the project can become Curators themselves and use their GRT to encourage Indexers. 

Once this happens, the Indexers can step in and start indexing the subgraph. This process can take a few hours or even a few days depending on how much data has to be indexed. 

Once indexing is completed, the Consumers can start querying the subgraph. Each query issued by the consumers requires payment in GRT that is handled by the query engine. The query engine also acts as a trading engine, making decisions such as which Indexers to do business with. 

To make this process smoother, The Graph uses payment channels between the Consumer and the Indexer. If the Indexer provides incorrect results a dispute process can be initiated. 

If you’d like to dive deeper into the architecture behind The Graph protocol, you can check this link here.

Now, time to discuss the GRT token. 

The GRT Token

GRT is a utility token that plays an important role in The Graph Network design. As we mentioned earlier GRT is used by Curators to signal subgraphs that are worth indexing. On top of this, it’s staked by Indexers to keep their incentives in check. Besides that, people who own GRT tokens, but don’t want to be Indexers and run the GRT node, can become Delegators and earn a portion of Indexers reward. And also, Consumers pay for their queries in GRT.

The Graph had an initial supply of 10 billion GRT tokens and new token issuance at 3% annually that is used for paying the indexing rewards.

There is also a token burning mechanism that is expected to start at ~1% of total protocol query fees. 

The Graph protocol had a huge interest from VCs, with plenty of big names including Coinbase Ventures participating in their initial offering. 

Future

The Graph core team aims at decentralizing the protocol further by launching on-chain governance – The Graph Council – in the future.

The protocol that is currently deployed to Ethereum mainnet only supports indexing Ethereum, but multi-blockchain support is one of the areas for further research. 

The Graph is already used by other popular projects such as Uniswap, Synthetix, Decentraland and Aragon. 

It looks like The Graph could be one of the missing puzzles in the effort of increasing the decentralization of dApps. 

Some people went as far as calling The Graph the Google Of Blockchains, pointing at similarities between indexing websites by Google and indexing blockchains and decentralized applications by The Graph. 

If this analogy is correct, and The Graph indeed becomes a go-to protocol for indexing web3, it has a lot of potential to grow. 

So what do you think about The Graph? Will it become a core piece of infrastructure in the decentralized world? 

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

So what exactly is quadratic funding all about? How can it magnify the funding of public goods? And what are public goods in the first place? You’ll find answers to these questions in this article.

You can also consider supporting us on Gitcoin, which leverages the power of  quadratic funding described in this article, more on our grant later. 

Okay, let’s get started! 

Public Goods

Quadratic Funding is the mathematically optimal way to fund public goods in a democratic community where the number of contributors matters more than the actual amount funded. 

Let’s start with what public goods actually are. 

In economics, a public good is a good that is both non-excludable and non-rivalrous, so individuals cannot be excluded from use, and use by one individual does not reduce availability to others. A public good can also be used simultaneously by more than one person. 

To illustrate the difference between public goods and other goods such as common, private or club goods, let’s have a look at a few examples. 

All goods can be classified by their excludability and by their rivalry.

Okay, so let’s start with excludable and rivalrous goods. This intersection represents private goods such as food, clothes, cars and other consumer goods. Bread, for example, is a scarce resource which can cause people to compete for it. A person will be excluded from obtaining bread if they are not willing to pay for it. 

When it comes to goods that are excludable and non-rivalrous, we end up with club goods such as cinemas, private parks or satellite tv. Another example is a noncongested toll road which excludes people who don’t want to pay for it, but it’s not a rival good since one person’s use of the road does not reduce its usefulness for the others.

So how about non-excludable goods that are rivalrous in nature? This intersection represents common goods such as fish, timber or coal. Everyone has access to these resources but there is an inherent competition when it comes to collecting them due to potential overuse or congestion.  

Now for the non-excludable and non-rivalrous goods. This is where public goods come into play. Some of the examples are clean air, infrastructure and privacy. We don’t have to compete for them and we cannot be excluded from them, either by being priced out or not belonging to a specific group of people. 

Let’s have a look at some examples of public goods that can benefit from quadratic funding 

• Open-source projects – projects and protocols built on publicly accessible infrastructure such as the Internet or the Ethereum blockchain, or useful libraries that can facilitate work of other software developers. 
• Free education – education available to everyone, for example, a newsletter, a podcast or a Youtube channel on decentralized finance 
• Free services – ethical hacking – finding vulnerabilities in open source projects

Okay, so now as we have a better picture of how quadratic funding can be utilised, let’s dive deeper into quadratic funding itself.  

Quadratic Funding 

Quadratic funding is a concept that extends ideas from quadratic voting to a funding mechanism. Both concepts were widely discussed by Vitalik Buterin in his blog posts and a paper that he co-authored together with Zoë Hitzig and Glen Weyl. 

At the core of Quadratic funding is its matching pool. 

A matching pool is a pool of money that is provided by the matching partners. Matching partners are companies, individuals or even protocols supporting public goods projects. 

The funds collected in the matching pool are used to magnify the individual contributions to different projects. 

To understand the concept of quadratic funding better, let’s go through a quick example. 

Imagine that we have $10,000 in a matching pool that was provided by our matching partners and we have 3 projects participating in a funding round. 

• Project A got $1,000 in funding from 5 contributors ($200 each).
• Project B also received $1,000 but from 2 contributors ($500 each).
• Project C received the same amount – $1,000 – from 20 contributors ($50 each). 

Let’s have a look at the matched amounts to see the power of quadratic funding.

Matched amounts are calculated by using the quadratic funding formula where the amount received by the project is proportional to the square of the sum of the square roots of contributions received. 

The first project got an additional $1851.85 which is an extra ~185% on top of the contributed amount. Project B received only a match of $740.74 which is around 74% of the total contributions. Now here comes the magic, Project C received a whopping $7407.41 of matched funding, which is 740% of the initial amount contributed. 

Of course, in the real world scenario, a project would most likely receive multiple different contributions with different amounts, for example, $1, $5, $20 etc, but the principle stays the same – more contributions = higher the matched amount. 

Incentives 

Quadratic funding also creates amazing incentives for smaller contributors over the bigger ones a.k.a whales. An individual supporting a project would see diminishing returns on bigger contributions, with the small contributions getting the highest matches percentage-wise. 

As an example, imagine that our project C received its next contribution. 

If the 21st supporter contributes another:

• $1 – their $1 is matched by $26.97 which is almost 2700% – 27x of the contributed amount 
• $5 – would be matched by $59.8 – around 1200% – 12x of the contributed amount 
• $20 – would be matched by $117.77 ~ 590%
• $100 – would be matched by $253.68 which is 253% of the contributed amount.  

As we mentioned earlier, this model creates really strong incentives for individuals to contribute even small amounts. If you want to see how matching works for a different number of projects, different matching amounts and different amounts contributed, you can play with a calculator here. 

Speaking about small amounts, if you’d like to support this channel and free DeFi education check out our Grant on Gitcoin. On the Grant Page you can learn more about how this channel started, our goals and a few ideas for the contributed funds. At the time of writing this article, a $1 contribution would result in 12 extra dollars from the matching pool.  

Interacting with Gitcoin is as easy as using Uniswap. You can connect your wallet, choose grants that you want to support and contribute ETH or any ERC-20 token such as DAI or USDT.

You can find a link to our grant here.

Projects

Quadratic funding, although quite a new concept, is already making a big change. There’s been over $2M distributed to public goods.

There is a growing number of projects that make quadratic funding possible such as Gitcoin Grants, Downtown Stimulus and clr.fund, with Gitcoin Grants leading the charge. 

If you’re interested in supporting public goods make sure to visit their websites and also remember that in quadratic funding, every contribution matters – even the smallest amounts! 

So what do you think about quadratic funding? Do you think it will be a default method for funding public goods in the future?

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

So have you ever been wondering how lending and borrowing works in DeFi? How are the supply and borrow rates determined? And what is the main difference between the most popular lending protocols such as Compound and Aave? We’ll answer all of these questions in this article. 

What is Lending and Borrowing

Let’s start with what lending and borrowing is. 

Lending and borrowing is one of the most important element of any financial system. Most people at some point in their life are exposed to borrowing, usually by taking a student loan, a car loan or a mortgage. 

The whole concept is quite simple. Lenders a.k.a. depositors provide funds to borrowers in return for interest on their deposit. Borrowers or loan takers are willing to pay interest on the amount they borrowed in exchange for having a lump sum of money available immediately.

Traditionally, lending and borrowing is facilitated by a financial institution such as a bank or a peer-to-peer lender. 

When it comes to short term lending & borrowing, the area of traditional finance that specializes in it is called the money market. The money market provides access to multiple instruments such as CDs (certificates of deposits), Repos (repurchase-agreements), Treasury Bills and others. 

Lending and Borrowing in Crypto 

In the cryptocurrency space, lending and borrowing is accessible either through DeFi protocols such as Aave or Compound or by CeFi companies, for instance, BlockFi or Celsius.

CeFi or centralized finance operates in a very similar way to how banks operate. This is also why sometimes we call these companies “crypto banks”. BlockFi, for example, takes custody over deposited assets and lends them out to either institutional players such as market makers or hedge funds or to the other users of their platform.

Although the centralized lending model works just fine, it is susceptible to the same problems as centralized crypto exchanges – mainly losing customer deposits by either being hacked or other forms of negligence (bad loans, insider job etc.). 

You can also argue that the CeFi model basically goes against one of the main value propositions of cryptocurrencies – self-custody of your assets. 

This is also where DeFi lending comes into play. 

Lending and Borrowing in DeFi

DeFi lending allows users to become lenders or borrowers in a completely decentralized and permissionless way while maintaining full custody over their coins. 

DeFi lending is based on smart contracts that run on open blockchains, predominantly Ethereum. This is also why DeFi lending, in contrast to CeFi lending, is accessible to everyone without a need of providing your personal details or trusting someone else to hold your funds. 

Aave and Compound are two main lending protocols available in DeFi. Both of the protocols work by creating money markets for particular tokens such as ETH, stable coins like DAI and USDC or other tokens like LINK or wrapped BTC.

Users, who want to become lenders, supply their tokens to a particular money market and start receiving interest on their tokens according to the current supply APY. 

The supplied tokens are sent to a smart contract and become available for other users to borrow. In exchange for the supplied tokens, the smart contract issues other tokens that represent the supplied tokens plus interest. These tokens are called cTokens in Compound and aTokens in Aave and they can be redeemed for the underlying tokens. We’ll dive deeper into their mechanics later in this article. 

It’s also worth mentioning that in DeFi, at the moment, pretty much all of the loans are overcollateralized. This means that a user who wants to borrow funds has to supply tokens in the form of collateral that is worth more than the actual loan that they want to take. 

At this point, you may ask the question – what’s the point of taking a loan if you have to supply tokens that are worth more than the actual amount of the loan taken. Why wouldn’t someone just sell their tokens in the first place? 

There are quite a few reasons for this. Mainly, the users don’t want to sell their tokens but they need funds to cover unexpected expenses. Other reasons include avoiding or delaying paying capital gain taxes on their tokens or using borrowed funds to increase their leverage in a certain position. 

So, is there a limit on how much can be borrowed? 

Yes. The amount that can be borrowed depends on 2 main factors. 

The first one – how much funds are available to be borrowed in a particular market. This is usually not a problem in active markets unless someone is trying to borrow a really big amount of tokens.

The second one – what is the collateral factor of supplied tokens. Collateral factor determines how much can be borrowed based on the quality of the collateral. DAI and ETH, for example, have a collateral factor of 75% on Compound. This means that up to 75% of the value of the supplied DAI or ETH can be used to borrow other tokens. 

If a user decides to borrow funds, the value of the borrowed amount must always stay lower than the value of their collateral times its collateral factor. If this condition holds there is no limit on how long a user can borrow funds for.

If the value of the collateral falls below the required collateral level, the user would have their collateral liquidated in order for the protocol to repay the borrowed amount.

The interest that lenders receive and the interest, that borrowers have to pay are determined by the ratio between supplied and borrowed tokens in a particular market. 

The interest that is paid by borrowers is the interest earned by lenders, so the borrow APY is higher than the supply APY in a particular market.

The interest APYs are calculated per Ethereum block. Calculating APYs per block means that DeFi lending provides variable interest rates that can change quite dramatically depending on the lending and borrowing demand for particular tokens. 

This is also where one of the biggest differences between Compound and Aave comes in. Although both protocols offer variable supply and borrow APYs, Aave also offers stable borrow APY. Stable APY is fixed in a short-term, but it can change in the long-term to accommodate changes in the supply/demand ratio between tokens. 

On top of stable APY, Aave also offers flash loans where users can borrow funds with no upfront collateral for a very short period of time – one Ethereum transaction. More on the flash loans here. 

To better understand how the DeFi lending protocols work, let’s dive into an example.

How Does It Work

Let’s dive deeper into the mechanics of Compound and cTokens. 

In our example, a user deposits 10 ETH into Compound. In exchange for 10 ETH, Compound issues cTokens in this case cETH. 

How many cETH tokens will the user receive? This depends on the current exchange rate for a particular market, in this case, ETH. When a new market is created the exchange rate between cTokens and underlying tokens is set to 0.02. This is an arbitrary number, but we can assume that each market starts at 0.02. We can also assume that this exchange rate can only increase with each Ethereum block. 

If the user supplied 10 ETH when the market was just created they would’ve received 10/0.02=500 cETH. Because the ETH market has been operating for a while we can assume that the exchange rate is already higher. Let’s say it is 0.021. 

This means that the user would receive 10/0.021=~476.19 cETH. If the user decided to immediately redeem their ETH, they should receive roughly the same amount as it was deposited, which is around 10 ETH. 

Now, here is when the magic happens. The user holds their cETH.  This is just another ERC20 token and can be sent anywhere. The main difference is that cETH is necessary to redeem the underlying ETH from Compound. On top of that, cETH keeps accumulating interest, even if it is sent from the original wallet that initiated the deposit to another wallet. 

With each Ethereum block, the exchange rate would increase. The rate of the increase depends on the supply APY which is determined by the ratio of supplied/borrowed capital. 

In our example, let’s say that the exchange rate from cETH to ETH increases by 0.0000000002 with each block. Assuming that the rate of increase stays the same for a month we can easily calculate the interest that can be made during that time. 

Let’s say on average we have 4 blocks per minute. This gives us the following numbers.

0.0000000002*4*60*24*30=0.00003456. Now we can add this number to the previous exchange rate. 0.021+0.00003456=0.02103456. 

If the user decides to redeem their ETH they would receive 476.19*0.0213456=~10.0165 ETH. So the user just made 0.0165 ETH in a month which is around 0.16% return on their ETH. It’s worth noting that the original amount of cETH that the user received hasn’t changed at all and only the change in the exchange rate allowed the user to redeem more ETH than was initially deposited. 

Aave uses a similar model with interest being accumulated every single block. The main difference is that aTokens’ value is pegged to the value of the underlying token at a 1:1 ratio. The interest is distributed to aToken holders directly by continuously increasing their wallet balance. aToken holders can also decide to redirect their stream of interest payments to another Ethereum address.

When it comes to borrowing, users lock their cTokens or aTokens as collateral and borrow other tokens. Collateral earns interest, but users cannot redeem or transfer assets while they are being used as collateral. 

As we mentioned earlier the amount that can be borrowed is determined by the collateral factor of the supplied assets. There is also a smart contract that looks at all the collateral across user’s account and calculates how much can be safely borrowed without getting liquidated immediately. To determine the value of collateral Compound uses its own price feed that takes prices from several highly liquid exchanges. Aave on the other hand relies on Chainlink and falls back to their own price feed if necessary. 

If a user decides to repay the borrowed amount and unlock their collateral, they also have to repay the accrued interest on their borrowed assets. The amount of accrued interest is determined by the borrow APY and it is also increased automatically with each Ethereum block. 

Risks

DeFi lending, although reducing a lot of risks associated with centralized finance, comes with its own risks.

Mainly the ever-present smart contract risks, but also quickly changing APYs. For example, during the last yield farming craze, the borrow APY on the BAT token went up to over 40%. This could cause unaware users who were not tracking Compound interest rates daily to get liquidated by having to repay more than expected in the same period of time. 

So what do you think about lending and borrowing in DeFi? What is your favourite platform? 

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

So is Yield Farming dead? Are there any good farming opportunities left? And when are 1000% APYs coming back? We’ll answer all of these questions in this article. 

Yield Farming & Liquidity Mining

Before we jump into the main topic, let’s quickly recap what yield farming actually is. 

Yield Farming, in essence, is a way of trying to maximise a rate of return on capital by leveraging different DeFi protocols. Yield farmers try to chase the highest yield by switching between multiple different strategies. If the strategy doesn’t work anymore or if there is a better strategy available the yield farmers move their funds around. 

Liquidity mining plays a big role in yield farming to such an extent that sometimes these two concepts are used interchangeably. Liquidity mining is a process of distributing extra tokens to the users of a protocol, for example, Compound distributing COMP tokens to lenders and borrowers on their platform or Uniswap distributing UNI tokens to their liquidity providers. 

If you haven’t read it yet, I’d recommend reading my other article on Yield Farming to understand these concepts even better.

Where is the yield coming from? 

To answer our main questions, we have to first understand where the farming yield is coming from.

There are a few options where the yield can be generated in defi.

The first one is lending. You can lend your coins on platforms such as Compound or Aave and receive usually a single-digit APY on your assets. You can also use Yearn Finance to automate switching between lending protocols with the highest APY. 

The next one is providing liquidity to liquidity pools. You can supply your coins to platforms such as Uniswap, Balancer or Curve and start generating extra money by collecting fees on trades going through the pool. This usually also yields a single-digit APY on your assets. You also need to make sure you understand what impermanent loss is. 

Now, it’s time for the most lucrative way of generating a yield on your assets in decentralized finance – the previously mentioned liquidity mining. 

Liquidity mining is the biggest enabler of high yields in yield farming. This is because the extra tokens that are received can be instantly sold for profit, boosting the APYs. 

Let’s take Uniswap’s UNI token liquidity mining program as an example that currently yields 23% in their ETH-DAI liquidity pool. Yield farmers can supply their ETH and DAI to a liquidity pool and start receiving UNI tokens that can be later sold for, let’s say, ETH or a stable coin, greatly improving their APY generated from the liquidity pool fees. 

Liquidity mining was previously able to bring crazy high APYs. Even as high as 2500% in Sushi or Yam farming. 

So why was that even possible before? 

The answer is fairly simple – there was a high demand for the tokens that were being distributed.  

To illustrate this, let’s have a look at a quick example. 

Project A, a fork of another well-known project, creates a new token – token A and distributes it via liquidity mining. After the initial hype, people quickly realise that Project A doesn’t bring much value to the decentralized finance space and start selling their tokens A rapidly. 

If this happens the yield on Project A’s liquidity mining program collapses as the farmers can only sell their tokens for a very little amount of money. 

Project B, on the other hand, is a well-known project that just started its liquidity mining program by distributing token B. Token B is in demand as investors believe in a long term value proposition of Project B and they think that token B will appreciate in value over time.

In this case, high demand from investors is met with high supply caused by yield farmers selling their token B. 

Market Sentiment

On top of the viability of a project, a general market sentiment also plays a huge role. In a down-trending market, the demand for all the tokens decreases. This, of course, means less demand for the tokens that are being distributed by liquidity mining, hence lower APYs. 

So if liquidity mining requires a constant flow of new capital, you may ask a question – is this some kind of a ponzi scheme? 

Not really, liquidity mining just reacts to the natural supply and demand of the tokens, similarly to the token prices. 

Bear Market -> higher supply than demand -> lower prices -> lower yields 

Bull Market -> higher demand than supply -> higher prices -> higher yields 

On top of that, good projects may be reluctant to even start their liquidity mining programs when the market sentiment is negative, so there are fewer opportunities available. This is kind of similar to companies not doing their IPOs during a recession. 

Is Yield Farming Dead

Okay, so let’s answer our main question here – is yield farming dead? 

Probably, you already know the answer to this question by now. 

No, yield farming is not dead, it just goes through the same cycles as the whole crypto market. 

The fact that yield farming is not dead, doesn’t guarantee the craziness of farming food tokens with 1000% APY coming back. In fact, we can see new projects iterating on the concept of liquidity mining and trying to improve different aspects of it.

Most projects that want to distribute their tokens have to find an optimal way of doing so without flooding the market with tokens and causing a constant selling pressure. This is important even in an up-trending market.

One way of reducing the selling pressure is to introduce additional vesting of the newly distributed tokens. 

Opportunities Left 

So are there any opportunities left in a down-trending market? 

Yes, there are still some good projects going through their liquidity mining program. The yield, although not as high as it used to be, can still be much higher than the yield generated by just lending your tokens. 

Uniswap’s UNI token liquidity mining program, with over $2B of total value locked, is probably the safest option at the moment. 

It offers between 12-24% APY, depending on the liquidity pool. 

SushiSwap still offers between 25% and as high as 400% APY, depending on the pool. 

Index Coop is another interesting example with 60% on ETH-DPI Uniswap LP tokens. DPI is a DeFi Pulse Index that represents 11 top defi tokens, so if you’re bullish on both ETH and DeFi this could be a good option for you. 

There is also a lot of other fairly popular, but more risky options such as Pickle, Core or Ampl. In these projects, the highest APY is usually generated by participating in a pool that requires holding their corresponding token, also known as Pool 2. The main risk here is impermanent loss, especially in a down-trending market. 

For example, although you can get 168% APY on the PICKLE/ETH pair, you are additionally exposed to the price of PICKLE. If the price of PICKLE starts going down, you’ll lose some your ETH because you are supplying liquidity to the 50/50 PICKLE/ETH Uniswap pool.

There are also some other interesting options available on layer 2 platforms, such as Honeyswap on xDai. In the future, I’d expect to see more and more liquidity mining programs being launched on layer 2 platforms, with the aim of attracting more users from the base Ethereum layer (layer 1). 

Of course, before participating in any of these yield farming options make sure you do your own due diligence, including assessing smart contract and admin key risks and making sure to understand the impact of impermanent loss on your supplied liquidity. 

So what do you think about the current state of yield farming and its future potential? And what are your favourite liquidity mining programs?

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

So what are NFTs all about? And how can they be used in decentralized finance? You’ll find answers to these questions in this article.

NFTs

Okay, so let’s start with what NFTs actually are. 

NFTs stand for non-fungible tokens and they are one of the types of cryptographic tokens that can represent ownership of digitally scarce goods such as pieces of art or collectibles.  

“Non-fungible” is not a very popular word so let’s see what it really means. 

In economics, fungibility is the characteristic of goods or commodities where each individual unit is interchangeable and indistinguishable from each other. 

Like with most concepts, fungibility is best explained with an example. 

Fiat money such as the US dollar is a good example of something fungible. If Alice has a $5 banknote, she can replace her banknote with Bob’s $5 banknote without this affecting Alice or Bob. 

On the other hand, Alice’s favourite, limited edition basketball card is a good example of something non-fungible. Each card is treated as a collectible and has individual properties. A card with one player doesn’t usually have the same value as a card with another player. On top of that, even when considering 2 exactly the same cards, other factors such as the year of production or how the card is preserved can make a difference. 

An extreme example of something non-fungible is a piece of art. A painting, for example, is usually created as only one original copy. 

Now, as we know what non-fungible actually means let’s see what the most common properties of NFTs are.

Unique – each NFT has different properties that are usually stored in the token’s metadata.

Provably Scarce – there is usually a limited number of NFTs with an extreme example of having only 1 copy, the number of tokens can be verified on the blockchain, hence it’s provability. 

Indivisible – most NFTs cannot be split into smaller denominations, so you cannot buy or transfer a fraction of your NFT.

Similarly to standard tokens, NFTs also guarantee the ownership of the asset, are easily transferable and are fraud-proof.

NFTs on Ethereum – ERC-721 & ERC-1155

Although NFTs can be implemented on any blockchain that supports smart contract programming, the most noticeable examples are ERC-721 and ERC-1155 standards on Ethereum. 

Before we get into the NFT standards, let’s quickly recap what ERC-20 is, as it will be useful for comparison. 

ERC-20 is a well-known standard for creating tokens on the Ethereum blockchain. Some of the examples are stable coins, such as USDT or DAI and DeFi tokens such as LEND, YFI, SNX and UNI. ERC-20 allows for creating fungible tokens. So all of the tokens that were just mentioned are completely indistinguishable and it doesn’t matter if we receive USDT from our friend or from one of the exchanges – the value of each token is still the same (to simplify this explanation, we’re skipping the possibility of receiving tainted tokens that would actually make a difference between tokens making them “less fungible”).

ERC-721 is a common standard for creating non-fungible tokens. ERC-721 allows for creating contracts that can be used to create distinguishable tokens with different properties. A common example of this is the famous CryptoKitties – a game that allows for collecting and breeding virtual kittens. 

ERC-1155 is the next step in creating non-fungible tokens. The standard allows for creating contracts that support both fungible and non-fungible tokens and it was created by Enjin – a project focusing on blockchain-based gaming. In many games such as World of Warcraft, a player can hold both non-fungible items – swords, shields, armours and fungible items such as gold or arrows. This standard allows developers to define both fungible and non-fungible tokens and decide how many of these tokens should exist.

NFT Space

Besides the already mentioned CryptoKitties, there are a few other fairly popular games leveraging the power of NFTs such as Gods Unchained and Decentraland. 

Decentraland is an interesting example as the players are able to buy parcels of digital land that can be later resold or used as advertising space within the game. 

Other examples include marketplaces for digital art such as Rarible, SuperRare and even aggregators of marketplaces – OpenSea. 

Yet another example of something scarce that can be represented as NFTs, are domain names, for example Ethereum Naming Service with .eth extension, and Unstoppable Domains with .crypto extension. 

Some of the NFTs can be extremely costly. The most expensive Crypto Kitty, Dragon, was sold for 600 ETH at the end of 2017, worth around $170k. Scarce domain names such as exchange.eth can be worth upwards of $500k.

NFTs and DeFi

When it comes to DeFi, NFTs can unlock even more potential for decentralized finance. Currently in DeFi, the vast majority of DeFi lending protocols are collateralized. One of the most interesting ideas is to use NFTs as collateral. This means that now you’d be able to supply an NFT representing a piece of art, digital land or even a tokenised real estate, as collateral and borrow money against it. 

This sounds cool, but here is the problem. In our standard lending and borrowing DeFi platforms, such as Compound or Aave, the value of supplied collateral can be easily measured by integrating price oracles. These aggregate prices from multiple liquid sources such as centralized and decentralized exchanges. When it comes to NFTs, the markets for particular tokens are very often illiquid which makes the price discovery process tricky.  

To understand this problem better, imagine that someone buys a rare CryptoKitty for 10 ETH. This NFT is later used as collateral and the borrower draws 1,750 DAI, assuming that 10 ETH is worth $3,500 and this particular NFT has 50% LTV (loan-to-value). After this, if no one else is willing to buy this particular CryptoKitty, we can say that the market for this NFT is illiquid or even non-existent. The only thing we can assume is that the NFT is still worth the same amount as it was last sold for. This is of course not a safe assumption as the value of NFTs can change quite dramatically. 

This is also why some of the projects that offer NFT collateralized loans use a slightly different model of peer-to-peer loans. In this marketplace model, borrowers can offer up NFTs as collateral and lenders can choose which NFT they are willing to accept before initializing a loan. The NFT that is used as collateral is kept in an escrow contract and if the borrower defaults on their loan by not repaying the borrowed amount + interest on time, the NFT is transferred to the lender. This space is really new, but one of the companies that use this model is NFTfi. 

Besides being used as collateral, NFTs can also represent more complex financial products such as insurance, bonds or options. Yinsure from Yearn Finance is a good example of NFT usage in the insurance space. In Yinsure, each insurance contract is represented as an NFT that can be also traded on a secondary market such as Rarible. 

Speaking about Rarible, we have also recently started seeing DeFi-native concepts, such as liquidity mining, being used by the NFT projects. Rarible, for example, started rewarding its users with RARI governance tokens for creating, buying and selling NFTs on their platform.

Summary

With over $100M worth of NFT traded, and $6M just this month, the NFT space is one of the fastest-growing niches in crypto and has huge potential, ranging from digital kittens to complex financial products. 

So what do you think about the future potential of NFTs? Do you know any other good examples where NFTs can be used in DeFi?

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

We’re also participating in Gitcoin Round 7 where every, even the smallest, contribution matters. If you’d like to support us, here is the link.

So what is a vampire attack? And how was SushiSwap able to use a vampire attack to  attract over $1B of liquidity in less than a week? You’ll find answers to these questions in this article.

Before we start, if you’re new to DeFi, you may want to read my other articles on liquidity pools and yield farming first as they cover a lot of basic concepts mentioned in this article.

First of all, let’s see how it all started.

SushiSwap

On the 28th of August in the midst of new DeFi projects popping up pretty much every day, a new project called SushiSwap launched. The project quickly gained more and more traction in the DeFi community as it aimed at directly competing with Uniswap by forking the project and siphoning out liquidity with a process later called a vampire attack. The main goal of the project was to create a community-governed automated market maker and fairly distribute its token – SUSHI.

The concept of a vampire attack, although quite simple, is quite ingenious in its nature as it creates very strong incentives for liquidity providers to migrate their liquidity to a new platform. 

Let’s see what a vampire attack is all about.

Vampire Attack

The first step of a vampire attack is to incentivise liquidity providers of another platform to stake their LP tokens, which represent supplied liquidity, to a new platform. 

In Sushi’s case, Uniswap’s liquidity providers were incentivised to stake their LP tokens on SushiSwap, so they could receive extra rewards paid in the SUSHI token. SushiSwap started with a quite aggressive emission schedule for the SUSHI token – 1,000 SUSHI per Ethereum block distributed to Uniswap’s liquidity providers across multiple different pools such as SNX-ETH, LEND-ETH, YFI-ETH, LINK-ETH. The idea of involving multiple strong defi communities had already been successfully used by Yam and was reused by SushiSwap. 

Once enough liquidity has been attracted to a protocol, the next step of the vampire attack is to migrate staked LP tokens to a new platform. By doing this, a new platform can use the migrated liquidity for their own automated market maker, stealing not only the liquidity but also trading volume and the users of the first platform. 

The liquidity is basically sucked out of the first platform and moved into the second platform, hence the name – vampire attack. 

When it came to Sushi, this is where Sushi’s MasterChef contract came into play. The MasterChef contract, once triggered, was able to migrate LP tokens from Uniswap to Sushiswap, basically stealing Uniswap’s liquidity. Once liquidity had been migrated it could be instantly used for trading on SushiSwap. 

To encourage liquidity providers to participate in the migration, some extra incentives were planned. First of all, the SUSHI liquidity mining program would continue after the migration but with a decreased emission (100 SUSHI per block). On top of that, people who decided to stake their SUSHI tokens instead of selling them would be getting a chunk of trading fees from SushiSwap. 

At the end of a successful vampire attack, a new protocol should in theory capture a significant amount of the original project’s liquidity, users and trading volume.

This is basically how the vampire attack was planned. In practice, there were quite a few unforeseen events happening along the way. Let’s see how the SushiSwap launch actually played out. 

Chef Nomi

SushiSwap, led by an anonymous creator ChefNomi, started attracting a lot of capital straight after the launch. Liquidity providers, attracted by high APYs of between +200-1000%, started moving more and more of their Uniswap’s LP tokens into SushiSwap. A few hours after launching, SushiSwap was reaching $150M in locked value. 

The initial problem of ChefNomi having an admin key to the migration contract was quickly resolved by transferring his admin power to a timelock contract, adding a 48-hour delay to trigger any admin functions. 

Although SushiSwap contracts were launched unaudited, the project attracted several audits from a few notable security companies. ChefNomi also decided to start governance of Sushi where SUSHI-ETH LP tokens could be used for voting. 

The yield farming craze continued. On the 1st of September, Binance announced the listing of SushiSwap and this resulted in the price of SUSHI going as high as $15. A couple of days later and we were talking about over $1B in locked value. On top of that, a couple of security audits were completed with no critical or high severity issues found. 

On the 4th of September, one of the biggest holders of SUSHI SBK, the CEO of FTX and Almeda Research, came out with a future proposal for migrating part of SushiSwap to a new trading platform Serum, built on the Solana blockchain. 

In the meantime, the community voted for an early migration from UniSwap to SushiSwap to incentivise liquidity providers with high token distribution for a few extra days after the migration. 

The next big unexpected event came from ChefNomi himself who sold his entire SUSHI stake, worth around $14M, for ETH on the 5th of September. This was possible because, although SushiSwap didn’t have a pre-mine or an initial team allocation, it had a dev fund where 10% of all the distributed tokens were allocated and which ChefNomi had access to. After the initial attempt to justify his decision as something good for the project, the community lost trust in ChefNomi who later decided to leave the project. 

This led to yet another unexpected event where ChefNomi basically transferred the control of the project to SBF, who decided to be a saviour of Sushi and provide even more incentives to the liquidity providers to stay for the migration with an extra 1 million of SUSHI tokens. On top of that, SBF initialised a transfer of the admin key to a multisig address. 

Migration

The migration of liquidity to the SushiSwap platform was carried out by SBF on the 9th of September. From the peak of $1.2B of locked value, around $840M was left for the migration. Everything went smoothly, with all of the remaining liquidity moved to SushiSwap, allowing trading of the tokens supported by the migration. 

Because of the early migration, there are still a few more days left with a high emission schedule of 1000 SUSHI per block. This will later drop to 100 per block, or even 50 per block if voted in by the community. It remains to be seen if the liquidity stays on SushiSwap after the high reward period is over.

Return of the Chef

Was that the end of unexpected events? Not really, time for yet another plot twist. On the 11th of August, 2 days after the migration, ChefNomi came back, returning $14M worth of ETH to the dev fund and apologising to the community.

Summary

SushiSwap is clearly one of the most polarising projects in the DeFi space. 

I believe that experiments like this are much needed in our nascent industry and they will strengthen the whole ecosystem and make it more resilient in the future.  

So what is your opinion on SushiSwap? Do you think it will keep some of the liquidity after the high reward period is over, becoming one of the standard AMMs in the space?

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

Introduction

So what are Yearn Vaults all about? Also, how does the ETH Vault work under the hood and how can it bring over 60% returns?  We’ll go through all of this in this article.

Yearn Vaults

Okay, one more thing before we start. If you’re new to the Yearn protocol or if you need a quick recap you can check my other article on Yearn and the YFI token here. 

Cool, let’s start with the Vaults. 

Yearn Vaults, in essence, are pools of funds with an associated strategy for maximising returns on the asset in the vault. Vault strategies are more active than just lending out coins like in the standard Yearn protocol. In fact, most vault strategies can do multiple things to maximise the returns. This can involve supplying collateral and borrowing other assets such as stable coins, providing liquidity and collecting trading fees or farming other tokens and selling them for profit. Each vault follows a strategy that is voted in by the Yearn community. 

Yearn Vaults were created as a direct response to yield farming and liquidity mining that made searching for the highest yield much more complex than just switching between different lending protocols. You can learn more about yield farming and liquidity mining here. 

Similarly to the standard Yearn protocol, when tokens are deposited to a vault the user receives their corresponding yTokens that can be redeemed for the underlying tokens.

One of the important rules when it comes to Vaults or Yearn protocol, in general, is the fact that you always withdraw the same asset that was initially deposited. So farmed tokens and accrued fees are sold for the main asset in the vault. The amount that is withdrawn is the initial amount that was put in, plus the pool yield that was earned, minus the fees. 

Not everything that is deposited into a vault is put in a strategy. The vaults differentiate between vault holdings and strategy holdings. Most of the funds are used by an active strategy, but there is also an idle amount that just sits in the vault.

When a user withdrawals from a vault, the funds first come from the idle portion of the vault and there is no withdrawal fee charged. If there are not enough funds in the idle portion of the vault to cover the withdrawal, the funds have to be withdrawn from the strategy which results in a 0.5% fee. 

On top of that, some profit-earning transactions will result in a 5% fee to subsidize the gas costs. For community-made strategies such as the ETH strategy, currently, 10% of this fee goes to the strategy creator. So creating new vault strategies can be a good opportunity for a skilled developer. 

Fees that don’t go to the strategy creator end up in a dedicated treasury contract. If the money in the treasury contract exceeds the $500k threshold, everything over that amount is redirected to the governance staking contract. 

There are currently multiple Yearn Vaults available such as stable coin vaults: DAI, TUSD, USDC, USDT; Curve LP vaults: y, busd, sbtc; Non-stable assets: LINK, YFI, ETH.

ETH Vault

Now, let’s have a look at the Yearn ETH Vault (yETH) to understand the concept of Vault strategies better. 

As we mentioned earlier, a strategy for each Vault is chosen by the community. We’re focusing on the current running strategy for the yETH vault that may and will most likely change over time. 

In the current strategy after a user deposits ETH into the Vault, the ETH is put into a MakerDAO lending platform as collateral. By supplying ETH collateral to MakerDAO the ETH strategy can borrow DAI at 200% collateralization ratio, creating a collateralised debt position (CDP). This means that if 100 ETH was put into the MakerDAO with $500 per ETH, the strategy could borrow up to $25,000 DAI.

Borrowed DAI is then put into the Yearn DAI Vault that uses a strategy that deposits DAI to Curve’s Y pool that is a pool with stable coins consisting of DAI, USDC, USDT and TUSD. Now, because of the current liquidity mining program of the Curve’s CRV token, providing liquidity to the Curve’s pools and locking LP tokens in the Curve Gauge result in getting rewarded with extra CRV tokens, on top of standard trading fees generated by just supplying liquidity to a pool. 

The ETH strategy then periodically sells CRV tokens for ETH and uses the accrued trading fees from the Y liquidity pool to accrue even more interest.

These steps all put together can, at the moment, result in high returns of around 60% on your ETH deposited to the yETH Vault. 

Two days after launching, the yETH Vault had already reached 370,000 ETH locked in the Vault and it became the largest CDPs on MakerDAO. Further deposits to the yETH vault were also temporarily halted to balance between best profits and best risk adjustment.

yETH Vault has a great potential of sucking in more and more ETH and becoming pretty much a black hole for ETH. This should, in theory, increase the price of ETH as more and more ETH is taken out of circulation. 

Is that 60% in the yETH Vault sustainable? Probably not, it all depends on the current liquidity mining programs available. If there are no more programs, like CURVE’s CRV one, available or rather there is no interest in the programs so the farmed tokens are not worth anything, the return on the Vault would go down, most likely to a single-digit or low double-digit APY. 

One of the most important benefits of using Vaults is automating your yield farming. 

Yield farming can be a pretty time-consuming and expensive activity, so if you’re not willing to spend hours searching for the best yield farming opportunity, spend hundreds of dollars in gas fees to move funds around and keep monitoring your collateralization ratio, it is probably better to rely on the Vaults.

Risks

This all sounds pretty cool, but let’s not forget about potential risks. 

Besides our standard DeFi risks such as smart contract bugs and stable coins losing their peg to the dollar, the ETH deposited as collateral on MakerDAO is susceptible to liquidation if the collateralization ratio falls below 150%. 

In our previous example, if the ETH price drops below $375 the collateralization ratio would drop below 150%. If this happens the ETH Vault would have 1 hour to bring the collateralization ratio back to over 150%. The reason for this is that MakerDAO’s Oracle Security Module (OSM) gives the CDP owners 1 hour to put more collateral in before being liquidated. The ETH Vault is directly integrated with this module, so it can react to changes in price ahead of time by bringing back the collateralization ratio to around 200% every time the ETH price drops.

Summary

Yearn Vaults are clearly one of the most interesting new developments in the DeFi space, but like with pretty much everything else in DeFi, before deciding to use a particular protocol always make sure to understand the associated risks. 

So what do you think about Yearn Vaults and the ETH Vault in particular? Do you think it will suck up a lot of circulating ETH causing the price to go up?

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

Introduction

Confused about how Yearn Finance works? And what is the YFI token all about? You’ll find out all of this and more in this article.

Yearn

Okay, let’s start with what Yearn Finance is all about. 

The main element of Yearn Finance is the Yearn protocol. The Yearn protocol, in essence, is a yield optimiser that focuses on maximising DeFi capabilities by automatically switching between different lending protocols. 

Before we explain the mechanism of the protocol itself let’s see how Yearn came into existence. 

In early 2020, the author of Yearn protocol – Andre Cronje, started looking into automating his strategy for choosing the highest paying lending protocol for his stable coins. 

Before the first iteration of the protocol, Andre had to wake up every day and manually check which protocol pays the best APY on that day and consider moving his funds to that protocol. There were always a few options available at a time such as Compound, Aave, Fulcrum or dYdX. This manual work quickly became repetitive and boring, so Andre started coding the first version of the Yearn protocol to automate the whole process of choosing the most optimal strategy for his stable coins.

Mechanics of Yearn

The protocol, in essence, creates a pool for each stable coin. 

By depositing a stable coin to a pool, the user receives their yTokens that are yield-bearing equivalents of the coin that was deposited. For example, if a user deposits DAI, the protocol issues yDAI. The DAI that is pooled together can then be moved between different lending protocols to always maximise the yield. For instance, if Aave offers a better yield on DAI than Compound, the yearn protocol can decide to move all or some of the DAI to Aave. The protocol checks if there is a better yield available at the time a user deposits or withdraws money from the pool, triggering a rebalance of the pool if necessary. 

If a user wants to withdraw their initial DAI + accrued interest they can burn their yDAI and receive the underlying DAI. 

One thing that the protocol always assures is to never swap the initially deposited stable coin to a different stable coin, even if there is a higher yield available. So for example, if a user deposits DAI, the protocol would never swap it to USDC, even if USDC has a higher yield. This is because most users want to withdraw the same stable coins as they initially deposited.

Further Development

After the initial version of the protocol was completed, Andre decided to open it up to more people who were also interested in automating their yield strategies. From the protocol’s perspective, adding more funds to the pool was beneficial as there were more opportunities for triggering rebalances with more deposits and withdrawals taking place. 

After the initial warm welcome by the community, Andre started working on improving the protocol itself. As the money in the pools started growing, some of the previously obvious strategies like moving coins into the highest paying lending protocol stopped working. Now, the protocol had to also anticipate what would happen to the APY if a large amount of funds are moved in, so it would have to also optimise splitting funds between different protocols and choose the most optimal solution. 

At this point, Andre also started working with Curve on the yCRV liquidity pool. yCRV pool contains the following yTokens: yDAI, yUSDC, yUSDT, yTUSD, making it easy to swap between the yTokens without unwrapping them into their underlying tokens.

By depositing stable coins to the yCRV pool, the users can earn trading fees for providing liquidity on top of getting a return on their yield-bearing yTokens.

Liquidity Mining

Up to this point, finding out what the best APY on a given stable coin was fairly easy. This changed dramatically with the introduction of liquidity mining with Compound’s COMP token distribution as a prime example. 

The COMP token distribution was also pretty much the time when all the yield farming hype started. If you need a recap on yield farming and liquidity mining, you can check out this article here. 

COMP farming basically changed the whole landscape of finding the best yield and checking the APY of a deposit was no longer sufficient. To find out the actual yield, you’d have to add up all the extra tokens that were being distributed. Finding the best strategies became more and more complex. 

With all the yield farming craze going on, Andre, together with the yEarn community, started working on another idea – Vaults. yEarn Vaults, in essence, are pools of funds with an associated strategy for maximising returns on the asset in the vault. Vaults strategies are more active than just lending out coins. In fact, most vault strategies can do multiple things to maximise the returns, such as farming other tokens and selling them for profit, providing liquidity or borrowing stable coins. Each vault follows a strategy that is voted in by the yEarn community. 

The full explanation of Vault’s mechanism is outside of the scope of this article, but I’ll write another one that focuses just on this super interesting topic, so make sure you subscribe to this channel to stay in the loop. 

YFI Token

Now, let’s talk about the yearn’s token – YFI.

To further decentralize the yearn protocol and allow other people to make meaningful decisions on the future of the protocol, Andre decided to distribute a governance token to the yearn community. 

The token distribution was focused on having a fair launch and rewarding the yearn community. 

To ensure a fair launch, the YFI token had no pre-mine, no VCs allocation and even no team reward. All the tokens were distributed to the users of the protocol. 

A 9-day long token distribution started with allocating 10,000 YFI tokens to the liquidity providers of the yCRV pool. The LPs had to stake their yCRV LP tokens to receive YFI rewards. Shortly after, 2 more Balancer pools were added, with 10,000 tokens each, totalling 30,000 YFI tokens. 

Regardless of a disclaimer that the YFI token has zero financial value, the money started flowing into the incentivized pools, topping $600M in locked value. Also, the YFI token itself started rapidly appreciating in value. This created additional risk as the author of the protocol was in control of the governance admin key, before the governance went live. This key could potentially be used to create more YFI tokens which would result in collapsing the price of YFI. This was quickly fixed by changing the single admin key to a multisig key, requiring multiple signers from the defi/yearn community. 

The YFI token, as designed, is extensively used in the yearn governance to decide on the future of the protocol with one of the most active and loyal communities in the whole defi space. There is also a lot of speculation on the potential future revenue from the YFI tokens that fuels the price appreciation. The YFI token increased in value from around $6 when it started trading, to over $30,000 per token less than 2 months later. Pretty much a parabolic run. 

Other Services

Although the yearn protocol, and most recently the vaults, are at the core of the yearn.finance ecosystem, there are also other services such as yswap, ytrade, yborrow and yinsure, that are outside of the scope of this video. You can look them up by checking some of the links I’ll put in the description box below.

Summary

Yearn is clearly one of the most interesting protocols in the DeFi space, but like with pretty much everything else in DeFi, before deciding to use a particular protocol always make sure to understand the associated risks. 

So what do you think about Yearn and YFI token? Did you manage to participate in their initial token distribution?

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.