Benzinga 04

Emergent enterprises in Decentralized Finance

Decentralized finance utilizes blockchain technology to provide financial services such as borrowing, lending, and trading without the need for traditional financial intermediaries like banks. Still, entering the world of cryptocurrency requires a point of contact with the traditional banking system, as you have to buy Bitcoin or Ethereum with fiat.

But technologies like Ethereum make it possible for many other applications to benefit from the blockchain technology, some of the most successful DeFi projects include MakerDAO which runs on the Ethereum blockchain. It allows users to generate DAI, a stablecoin pegged to the US dollar, by locking up other cryptocurrencies as collateral.

Or Uniswap, A decentralized exchange (DEX) that allows for the automated trading of DeFi tokens without an order book. There are also various lending platforms like Aave and Compound where users can lend and borrow different cryptocurrencies.

Many DeFi projects use blockchain technology as an automated escrow system. Decentralization here refers to the fact that the nodes of the network supporting the blockchain are independent, and equal in relation to the network protocol, in the sense that no particular node is more important than others.

This is the original meaning of decentralization when we read about it in Bitcoin's white paper. However, Ethereum's Decentralized Virtual Machine, and other blockchains of the same category open new possibilities that expand the meaning of Decentralization besides the validation of transactions.

Complex interactions emerge among independent and unrelated actors that need no central organization to function.

To illustrate this point, let us consider Seasonal Tokens, a set of four tokens implementing the same economic principles embedded in Bitcoin's design, but running on the Ethereum network.

The four ERC20 Tokens are created and operated by four independent smart contracts.They do not talk to each other, and they are identical except for the name of the tokens: Spring, Summer, Autumn and Winter. And for the dates in which the mining supply will be cut in half.

The smart contracts started operating on September 2021, nine months later the Spring mining supply was cut in half. Nine months later Summer's mining supply was halved. Nine months after that Autumns mining supply was halved, and nine months after that the Winter token mining supply was cut in half.

The halving of mining supply for each token will occur every 3 years. But their halving are staggered so that every 9 months one of the tokens mining supply will be halved.This is the only relation between these four smart contracts. They are totally independent.

But if we look at the price action of the four tokens on the same graph we can see that a pattern emerges, the prices are oscillating around each other. This is not coded anywhere in the smart contracts, so how does this happen?

In spite of their name, a smart contract is more like a jukebox, it sits there doing nothing unless somebody puts a coin in the sloth an asks for a song. The smart contract supports the functionality of the token and actively manages and executes all operations associated with it, which includes the token's issuance, transfer mechanics, and balance tracking. But all these functions are executed only if a person (or another smart contract) asks for it and pays the gas fees associated with operating the function.

Maybe an analogy will be useful understanding how this complex behavior emerges from simple instructions in the smart contracts.

If we think of the relationship between flowers and bees, we see that bees are working for the flowers by carrying the pollen from one flower to another. However, the bees are not interested at all in pollinaing the flowers, all they care about is to collect food for the hive. It is a relationship where all parts act on their own interest but nonetheless the collective interest is fulfilled.

In similar fashion, the four smart contracts attract the attention of many actors, none of them is interested in forming those price oscillations. It is safe to say that most of them only want to make money.

Some actors can make money by mining the tokens. Others can make money by trading tokens, others by providing liquidity to the decentralized markets. Others make money by exploiting price fluctuations, others by exploiting price differences on different markets. The random and uncorrelated action of all these actors results ultimately in the price oscillations we see in the relative prices.

Consi

Bitcoin's technological break trough was to successfully implement the blockchain as an automated escrow system where people can exchange digital assets without the need to trust a third party.

The problem with electronic transactions is that if two persons want to exchange digital assets they have to trust each other. For example if Alice and Bob want to exchange documents, Alice may send the document to Bob,but Bob may decide not to send his document. The only way to solve this problem is the use of an escrow system, where both Alice and Bob trust a third party to keep the documents until both parties fulfill their obligation. The escrow receives Alice's and Bob's documents, and delivers the documents only if the two documents were handed in.