Benzinga 04

Emergent enterprises in Decentralized Finance

Decentralized finance (DeFi) leverages blockchain technology to offer financial services, such as borrowing, lending, and trading, without the need for traditional financial intermediaries like banks. However, entering the world of cryptocurrency still requires a point of contact with the traditional banking system, as you need to purchase Bitcoin or Ethereum using fiat currency.

Platforms like Ethereum enable numerous applications to benefit from blockchain technology. Some of the most successful DeFi projects include MakerDAO, which operates on the Ethereum blockchain. It allows users to generate DAI, a stablecoin tied to the US dollar, by securing other cryptocurrencies as collateral.

Another example is Uniswap, a decentralized exchange (DEX) that facilitates the automated trading of DeFi tokens without requiring an order book. Additionally, there are various lending platforms, such as Aave and Compound, where users can lend and borrow different cryptocurrencies.

Many DeFi projects employ blockchain technology as an automated escrow system. Here, decentralization refers to the fact that the network nodes supporting the blockchain are independent and equal in relation to the network protocol, meaning no single node holds more importance than the others.

This concept of decentralization, as originally outlined in Bitcoin's white paper, is foundational. However, Ethereum's Decentralized Virtual Machine and similar blockchains introduce new possibilities that broaden the scope of decentralization beyond merely validating transactions.

These platforms facilitate complex interactions among independent and unrelated actors who do not require a central organization to function.

To illustrate this point, consider Seasonal Tokens, a project that implements the economic principles found in Bitcoin’s design but operates on the Ethereum network. This project comprises four ERC20 tokens—Spring, Summer, Autumn, and Winter—each managed by its own independent smart contract. These contracts do not interact; their primary distinction lies in the names of the tokens and the timing of their mining supply halvings.

The operation of these smart contracts began in September 2021. Nine months into the operation, the mining supply of the Spring token was halved. This process was sequentially repeated every nine months with the other tokens: Summer, Autumn, and Winter. Following this pattern, the mining supply for each token is scheduled to halve every three years. However, these halvings are staggered so that every nine months, one of the token's supplies is reduced. This staggered schedule is the sole connection between these four smart contracts; otherwise, they function independently.

Interestingly, when the price movements of the four tokens are observed on the same graph, a pattern of oscillation around each other emerges. This pattern is not explicitly programmed into the smart contracts. How, then, does this synchronized behavior occur?

Despite their name, a smart contract is more akin to a jukebox—it remains inactive until someone inserts a coin and selects a song. The smart contract underpins the token's functionality, managing and executing all operations related to it, including issuance, transfer mechanics, and balance tracking. However, these functions are only executed when a person (or another smart contract) requests them and pays the associated gas fees.

An analogy might help illustrate how this complex behavior emerges from simple instructions encoded in smart contracts.

Consider the relationship between flowers and bees. Bees facilitate pollination by transferring pollen from one flower to another, but their primary motivation is not pollination; they are simply gathering food for the hive. This relationship demonstrates how different parties, acting in their own interests, can collectively fulfill a broader purpose.

Similarly, the four smart contracts attract various actors, none of whom are specifically aiming to create price oscillations. It is likely that most are primarily interested in making money. These actors might engage in different activities such as mining tokens, trading them, providing liquidity to decentralized markets, or capitalizing on price fluctuations and arbitrage opportunities. The random and uncoordinated actions of all these participants ultimately result in the observed price oscillations of the tokens.

This closed ecosystem of four cryptocurrencies offers additional advantages over single-token systems. In other proof of work cryptocurrencies, when the mining supply is halved, mining often becomes unprofitable overnight, forcing many miners to cease operations.

In the Seasonal Tokens system, miners can redirect their efforts to the other three tokens, which typically leads to an increased supply of these tokens. Traders, anticipating this shift, might invest in the token whose supply was just reduced. The resulting scarcity of that token tends to drive its price up relative to the others.

By adapting in this way, traders inadvertently support the mining economy, effectively subsidizing the production of the momentarily unprofitable token. This collaboration occurs spontaneously, with each participant acting in their own interest, yet collectively benefiting the system.

This scenario illustrates how, beyond the decentralization seen in transaction verification on networks, other subtle forms of decentralization can emerge purely from economic principles, without any need for formal governance or central planning. Thus, the Seasonal Tokens model exemplifies a powerful synergy between technology and economic strategy, fostering a self-sustaining and adaptive financial ecosystem.