Babbitt Column | The integration trend of banking and securities business from DeFi

Since June, the digital assets locked in Compound and Uniswap, two of the most representative applications in DeFi, have seen rapid growth. These two DeFi applications have been so popular in the market recently, what enlightenment can it give us?

Compound is a mortgage application. Any user with idle digital assets can put their idle assets into Compound's pool for other users to borrow. The borrower needs to pledge another asset to lend the digital asset he wants.

Compound automatically monitors the pledged assets according to pre-determined rules. When the market value of the pledged assets drops to a critical point, the Compound smart contract will automatically send a margin call notification to the user. If the user fails to cover the position in time, Compound will automatically execute the contract to sell the pledged assets to prevent the lender's asset loss. The above process is completely automatically executed based on the rules determined in the smart contract and does not require any human intervention.

We can see from the above figure that before mid-June of this year, the amount of assets pledged in Compound remained stable.

It has been skyrocketing since mid-June. This is because the Compound team issued the governance token of this DeFi application. Any user who lends assets in Compound and any user who borrows assets can obtain these governance tokens based on the amount of assets they have locked and the amount of assets they have loaned. In order to obtain these governance tokens, speculative forces in the market have locked a large amount of digital assets in Compound.

Uniswap is an automated market-making application. Any user can use Uniswap on Ethereum to establish a trading pair between any two digital assets and provide initial liquidity. Any other user can trade against this trading pair asset pool. The commission required for each transaction is returned to this liquidity pool. The more trading volume, the more income this liquidity pool will generate. After this initial liquidity pool is established, other users can continue to provide more asset liquidity to this liquidity pool. If some providers withdraw the assets they provide, they will be able to obtain the corresponding commission income earned by this liquidity pool based on the proportion of the liquidity they provide in the total flow.

As we can see from the above figure, Uniswap also experienced explosive growth in June. I think one of the main reasons is that the increase in the amount of liquid assets generated in Compound has led to more digital assets flowing into Uniswap. Speculators earn interest income by providing liquidity. Obviously, the interest earned from Uniswap will exceed the interest income obtained by mortgaging assets in Compound. Therefore, a large amount of speculative funds in the market began to arbitrage between these two DeFi applications.

From the rapid growth of the above two DeFi applications, we can see the business scenarios that are likely to appear in the future digital financial ecosystem. The future digital financial ecosystem must be based on distributed accounting technology. On such financial market infrastructure, more DeFi applications will be developed. The current Compound and Uniswap are developed and run on Ethereum. Similarly, various DeFi applications in the future will be developed on the same blockchain, and the applications will affect each other.

In the current financial market, lending and borrowing can take place in both the banking market and the securities industry. Since the two markets operate on the support of different systems, users cannot use their assets efficiently. Similarly, trading is also carried out in the banking market and the securities market. However, they usually trade different financial products. In short, lending and trading are currently carried out in both the banking and securities industries.

In the future digital financial ecosystem, all financial businesses will be conducted on the same financial market infrastructure. Users can directly conduct their lending business on this infrastructure. The difference from the current DeFi application is that in the future, digital currency will be mainly used as the basic value transaction medium. Users use digital currency to conduct various financial businesses. Therefore, the main lending method should be to lend digital currency by mortgaging the digital assets they own. However, this lending process can be completed in the DeFi way. After lending digital currency, users can directly use these digital currencies for payment transfers or transactions.

Similarly, the same trading mechanism as Uniswap can be easily generated on the same financial market infrastructure. As we have seen in the operating mechanism of Uniswap, it is very easy to generate pairing transactions between any two digital assets. Therefore, the trading market can also effectively price various digital assets.

I have mentioned before that in the future of digital finance, direct peer-to-peer transactions and centralized matching transactions will coexist. Due to the characteristics of emerging digital financial products, peer-to-peer transactions will increasingly become a major transaction method. DeFi applications such as Uniswap are a new transaction method in addition to the current order book-based transaction method. The pricing of digital assets will therefore be more accurate.

Since the above lending and trading businesses use the same financial market infrastructure and trading media, digital financial products are generated and circulated in the same way, and financial businesses are all automatically conducted using DeFi, the distinction between the banking and securities industries in the current financial market is not obvious, and there will be a trend of integration.