What happens when collateral becomes liquid?
While the past year was a tough one for the public crypto markets, talented and dedicated teams spent it heads down, shipping what appear to be some of the building blocks of a truly open financial system. As a result, while 2017 was the year of the ICO and 2018 was the year of continued massive private token sales, 2019 is shaping up to be the year of Open Finance.
Most significantly, Maker, which launched at the tail end of 2017, has created a system for minting a USD-denominated stablecoin (DAI) using Collateralized Debt Positions (CDPs). The system has performed incredibly well, with DAI smoothly retaining the dollar peg and CDPs sucking up >2% of all ETH, during a year in which ETH declined as much as 94% from its all-time high.
Maker isn’t the only way to borrow or lend cryptoassets. Dharma allows users to request or offer loans for any ERC20 (fungible) or ERC721 (nonfungible) asset, dYdX enables derivatives and long/short margin trades, and Compound offers money market borrowing/lending for ETH, DAI, and a handful of other tokens.
Decentralized exchange (DEX) protocols (e.g., 0x, Kyber), are now functional, as are 3rd party exchanges and interfaces to access them (e.g., Radar Relay, Easwap), allowing non-custodial trading to become a viable reality, though liquidity is still somewhat lacking across the board. In November, a new completely on-chain DEX launched that makes it possible to provide liquidity and earn fees automatically using basically the same approach as Bancor, but simplified to remove the unnecessary token. Hello, Uniswap!
We now have (almost) fully decentralized options for borrowing, lending, and trading cryptoassets, creating derivatives around any asset or event, and even a USD-denominated stablecoin that allows risk-off positions and greatly improved UX without ever needing to directly touch that dirty, dirty fiat.
One of the core tenets of Open Finance is that of permissionlessness. But if there are no gatekeepers, then how can we be sure that a borrower won’t default on a loan or that a derivative will pay out as intended?
In a nutshell: collateral is posted as a form of insurance for the other participants in the system, so that you can be trusted to take certain actions without anything else being known about who you are, where you live, how competent you are, and so forth. If your actions ever come close to harming the system, you are automatically booted out and some or all of your collateral is handed over to more responsible parties.
In the Maker system, in order to borrow dollars in DAI, you must lock more than 150% of the equivalent value in ETH in a CDP. If your collateral ratio ever drops below 150%, a “Watcher” will step in, and *POOF* — your collateral is liquidated at a 13% penalty to repay your loan. Compound and Dharma employ similar structures to ensure lenders don’t need to be worried that borrowers won’t repay their loans.
Naturally, builders and participants in the Open Finance ecosystem have tended to think of assets used as collateral as just that: assets in use as collateral. Those assets may eventually be released and used for other purposes once a loan is repaid, but for now, their raison d’être is to be collateral.
But what if it doesn’t have to be that way?
There are currently over 2 million ETH locked in Maker CDPs, generating around 78 million DAI. That means at current prices, more than half the ETH in CDPs isn’t even technically required for collateral. It is a completely dead, unproductive asset.
Sowmay Jain, founder of InstaDApp, recently proposed automating the process of sweeping excess ETH out of CDPs and into Compound’s money market protocol to earn interest (the process of moving ETH back to the CDP as needed would also be automated, of course). That is a great first step and one that is relatively straightforward to implement by integrating the Maker and Compound protocols as they exist today.
But what about the rest of the ETH that is sitting in the CDPs, ensuring that they meet the minimum 150% collateral requirement? Why couldn’t that also be sitting in a Compound money market, available for others to borrow and earning the current 0.27% APR?
While a single unit of ETH can’t literally be in two places at once (one of the primary breakthroughs of Bitcoin was in solving the “double-spending problem”), there’s no reason why deposits into Compound couldn’t be made through a “deposit token” contract, which issues an equivalent number of “Compound ETH” or cETH (or cDAI, cREP, etc) ERC20 tokens. These cETH tokens would always be redeemable 1:1 for ETH in Compound. Ryan Sean Adams points out the same approach could be used in the future by staking pools with staked ETH.
Given this reliable, transparent backing, once Multi-Collateral Dai is shipped, it’s not hard to imagine that cETH could be added as a supported collateral type for Maker. Especially with speculation that much Maker activity today is driven by ETH holders who are looking to go long with leverage, it makes sense that there would also be demand for earning interest on the ETH that sits as collateral.
cETH is a fairly basic example of liquid collateral, but what if liquid collateral was actually used to provide… liquidity?
Uniswap is a fully on-chain decentralized exchange. Rather than maintain an order book, Uniswap uses liquidity pools and an automated market maker to determine the price at which an asset can be traded. If you want to supply liquidity to the exchange and earn a proportional share of the 0.3% fee charged on every trade between a given asset pair, you just deposit an equivalent amount of ETH and the relevant ERC20 token. (If you want a deeper explanation of Uniswap, check out Cyrus Younessi’s excellent overview.)
The ETH/DAI pair is currently the second deepest liquidity pool on Uniswap. Both assets are also available on Compound. It would be great for anyone providing ETH/DAI liquidity on Uniswap to also earn interest on their assets by having them simultaneously available on Compound for borrowing. Again, the cETH-type trick would work here for half the equation (cDAI), but it feels like there’s potential to do a more direct integration or re-writing of the two protocols to make this possible.
A different trick with Uniswap that definitely works is using the liquidity pair itself as collateral (e.g., ETH/DAI, as opposed to each of the assets in that pair, ETH and DAI). What does that mean? Well, although most Ethereum wallets don’t show them by default, whenever you deposit liquidity into a Uniswap pool, your share of that pool is actually represented by ERC20 tokens.
Any system willing to accept as collateral both assets in an ETH/XYZ pair should also be willing to accept the corresponding Uniswap pool shares as collateral. Uniswap’s automated market maker function ensures that the combined value of the ETH/XYZ pool share will never drop more than either of those two assets. In fact, all else equal, the value of the ETH/XYZ pool shares will rise over time, based on earnings from trading fees being added to the liquidity pool.
I predict we’ll see Uniswap pool shares used as collateral for millions of dollars in loans in months, not years.
Anyone familiar with the world of prime brokerage services will immediately recognize the process described in the preceding sections as forms of rehypothecation: a lender taking an asset posted as collateral by a borrower, and using that same asset as collateral to take out another loan. Except in this case, we may see collateralized collateral collateralizing collateralized collateral… and so on and so forth. Oy.
This creates a daisy-chain situation: if there’s a failure at any link along the chain, all of the assets further down the chain will also fail, but anything further up (i.e., closer to the original underlying collateral) should be fine.
However, it’s extremely unlikely this chain of collateralization would be created in a neatly serialized fashion. All available evidence suggests that financial engineers will slice, lever, mix, and sling every imaginable asset in every imaginable combination to create new products they can sell to each other or the unwashed masses. It will probably end up looking more like this:
Is this really any worse than the legacy financial system? Probably not. Technically, this would all be publicly viewable and auditable, rather than hidden behind a series of closed doors and incomprehensible legal contracts. We should be able to devise systems to track and quantify risk when everything is linked together via public ledgers and immutable automated contracts. We should be able to self regulate, put in place reasonable standards, and refuse to interact with contracts/protocols that don’t demand conservative margins and ensure the collateralization chain doesn’t go more than a couple layers deep.
But given what we know of human nature, do you really think we’ll show restraint when the possibility exists to earn an extra point of yield or pay a slightly lower rate on a loan?
There is something undeniably compelling about all of this. If assets can be allocated for multiple purposes simultaneously, we should see more liquidity, lower cost of borrowing, and more effective allocation of capital. Most of the builders I’ve met working on Open Finance protocols and applications are not looking for ways to wring a few extra bips (basis points, not Bitcoin Improvement Proposals… sorry) out of the system; they’re trying to build the tools that will ultimately make every imaginable financial asset, service, and tool available via open source software on the phone of every person on the planet. Maybe we’ll never get there, but based on the hyperspeed pace at which this industry is evolving, if this is all a big terrible idea, at least we’re likely to figure that out while it’s still only a few million nerds losing their shirts, rather than causing the entire global financial system to crash and burn.
In the meantime: superfluid collateral, anyone?
Local Authorities Summon Bithumb Chairman Of The Board Over Alleged Fraud
Bithumb’s situation worsens as South Korean authorities have reportedly summoned company Chairman Lee Junh-hoon for alleged fraud regarding the sale of BXA tokens. This comes days after local police raided the exchange for the third time in less than a month.
Three Police Raids For Bithumb In September
September turns out to be a rather unpleasant month for the popular South Korea-based cryptocurrency exchange. As CryptoPotato reported earlier this month, the Intelligent Crime Investigation Unit of the Seoul Police raided the company’s headquarters under allegations for fraud.
Authorities alleged that the exchange sold its native BXA tokens to investors for over $25 million. Bithumb planned to list the token on its platform but reportedly failed to, resulting in a massive loss for investors.
Just five days after the first raid, the police conducted another one on September 7th. A police official purportedly said that authorities aim to secure additional evidence related to already existing allegations against Bithumb Korea and Bithumb Holdings Chairman of the Board – Lee Jung-hoon.
The plot thickened earlier this week when the Seoul Metropolitan Police Agency (SMPA) raided the exchange’s headquarters once again. This time, however, authorities took it a step further. They seized dozens of shares in Bithumb Holdings belonging to Bithumb Korea Director Kim Byung-Gun after receiving approval from the Seoul Central District Court.
Bithumb Chairman Summoned By Local Authorities
Earlier today, the state-run agency Yonhap reported that the SMPA had “summoned” Lee Junh-hoon. Apart from being the Chairman of the Board of Directors of Bithumb Holdings and Bithumb Korea, he is also the beneficial owner of Bithumb.
The report highlighted that BXA coin investors had sued both Lee Junh-hoon and Kim Byong-Gun for the financial losses suffered from the token sale. The authorities have also accused Junh-hoon of violating the Act on Aggravated Punishment for Specific Economic Crimes by fleeing South Korea.
Interestingly, while the investigation against Junh-hoon is ongoing, authorities haven’t conducted one against BK Group Chairman Kim Byung-Gun, despite both being accused of the alleged fraud.
Beware: Fake Uniswap (UNI) Token Giveaways Already Roaming the Internet
Cryptocurrency fake giveaway scams continue to emerge frequently, and the latest example involves the popular DEX protocol Uniswap. Just a day following the UNI token release, scammers began promoting fake UNI giveaways by impersonating Uniswap’s creator – Hayden Adams.
Fake UNI Giveaways On YouTube
As CryptoPotato reported yesterday, the popular decentralized token swap platform launched its long-anticipated native token called UNI. The announcement was accompanied by news that Uniswap will airdrop 15% of UNI’s total supply to users who had used it before September 1st. Naturally, this free token rush raised the community’s attention rather rapidly.
However, it appears that scammers were also keeping a close eye. It didn’t take long, and only a day after the UNI launch, unknown fraudsters initiated a fake UNI giveaway on the most widely-used video-sharing platform – YouTube.
In this case, the scammers created a fake Uniswap YouTube channel that supposedly has over 400,000 subscribers. They also launched a live video displaying 40,000 live viewers with the protocol’s creator – Hayden Adams.
Lastly, the classic scam is completed by offering to double all UNI tokens sent to a specific address. Meaning, that if users send 250 UNI to their address, the fraudsters promise to send back 500 UNI tokens.
Although it sounds like easy money, a more in-depth look reveals several issues and points out that it’s a classic scam. The YouTube channel has only two videos – both carrying the same fraudulent live stream, but the Google-owned platform has taken down the first one.
Additionally, the videos contain the same repeating old interview with Adams, where he says nothing about giving free UNI tokens. Last but not least, victims that fall for this scam and actually send coins to the provided addresses will not receive anything in return.
Growing Problem But Where’s The Solution?
Similar fake giveaways are a growing threat for the cryptocurrency field, its image, and, most importantly – users. Although they sound too good to be true, scammers continue doing them on several social media platforms, but mostly on YouTube.
This is where the main problem lies. The Google-owned platform has been previously criticized and even sued for not putting enough effort into fighting the scams. However, YouTube is frequently warning and banning legit cryptocurrency content creators as its logarithm fails to notice the differences.
Another social media giant Twitter also went through something similar recently. Attackers gained control over 130 accounts of famous individuals and companies and initiated a fake Bitcoin giveaway. Although Twitter stayed up front with the users and updated its security protocols, the platform was exploited once again a month later.
In any case, while social media platforms struggle to find the most appropriate solution, users need to be more cautious and vigilant. A general rule of thumb suggests that if something sounds too good to be true, it usually is. Also, there’s no such thing as free lunch.
Uniswap Activity Sends Ethereum Gas Fees Sky High
The issue of high Ethereum gas prices isn’t going away anytime soon. Just last month, total daily fees on the Ethereum network managed to reach an all-time high of $8.6 million.
Following a brief respite from high charges, the latest data from coinmetrics.io, for August 31, 2020, shows an alarming trend back towards that all-time high. Total daily fees for the end of last month reached $8.2 million.
Considering the activity that has taken place since then, it would be no surprise if the all-time high gets topped in the near future.
Ethereum daily gas fees. (Source: coinmetrics.io)
In line with expectations, this is a pattern repeated for average transaction fees. This time, the latest data shows average transaction fees hit $11.61 yesterday. While some way away from the all-time high of $14.58, set on September 2, 2020, it’s still an unacceptable part of the ERC-20 ecosystem.
More pressing than that, the situation poses serious questions about the sustainability of the Ethereum network.
Uniswap Airdrop Seen as a Kind Act of Generosity
Many blamed the mania surrounding DeFi for the high charges. In particular, the network activity that arose from the glut of newly launched tokens during that period.
With that in mind, things took a turn for the worse on Wednesday when decentralized exchange Uniswap surprised the community with the launch of their new $UNI governance token.
The firm has allocated 150 million tokens for distribution by airdrop. Each address that interacted with the Uniswap V1 & V2 protocol, before September 1, is eligible to claim 400 $UNI.
“Uniswap owes its success to the thousands of community members that have joined its journey over the past two years. These early community members will naturally serve as responsible stewards of Uniswap.”
The move was widely seen as a generous act on the part of Uniswap. Many praised the team for sharing their financial success with early adopters.
Amazon never gave you AMZN for buying books
Google never gave you GOOG for doing searches
Facebook never gave you FB for setting up a profile
Uniswap is giving you UNI for contributing liquidity
That’s the difference
— Ryan Sean Adams – rsa.eth 🏴 (@RyanSAdams) September 17, 2020
What’s more, it had the effect of stealing thunder from rival DEX Sushiswap, who was, up until that point, back on the ascendency following a change in management.
Following a deep selloff on the launch, the price of $UNI recovered. At the present time, one $UNI is priced at $5.16.
Uniswap 30 minute chart with volume. (Source: UNIUSDT on tradingview.com)
Uniswap Contracts Dominant Ethereum Network Activity
Despite Uniswap’s act of generosity, the effect on gas fees has been catastrophic.
Uniswap contracts account for four of the top 10 gas guzzlers on the Ethereum network. This includes the top spot, where the Uniswap V2 contract accounted for almost a quarter of the total gas used in the last 24-hours.
Top 10 gas guzzling contracts on the Ethereum network. (Source: etherscan.io)
The upshot of this situation is a terrible and costly experience for Ethereum users. Aside from high charges, many have vented their frustrations over stuck transactions, even having paid for the fast option.
This Uniswap thing has taught me…
Ethereum is awful to use for day to day transactions. I still have transactions ‘queued’ even though I have paid for ‘fast’ gas lol
I’m not meant for this DeFi craze. Just give me SIMPLE!
— They Call Me Jongo “I ♥️ CTP & HIVE 🐝” (@Jon_G_Olson) September 17, 2020
Solutions such as using layer 2 protocols, or waiting for ETH 2.0, doesn’t fit with the way the majority of people use the Ethereum network now. With that in mind, how long can Ethereum carry on like this?
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