Cheers to Chai, the Newest Interest-Bearing Token

Also, PoS vs. DeFi debate and crypto credit report.


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Now, here’s what’s going on in decentralized finance,

  • First there was Dai, and now there’s Chai
  • Does decentralized finance cannibalize proof-of-stake?
  • Report shows DeFi derivatives and new addresses exploded in Q3

Chai Lets You Earn Interest on Your Dai

I read somewhere that DeFi sounds more and more like magical potions than finance and I loled. It’s certainly true in the case of Chai, a wrapper which allows Dai holders to easily start earning interest on their stablecoin.

To understand how this works, first take a step back to remember that Dai is MakerDAO’s dollar-pegged stablecoin. In MakerDAO’s recently upgraded system, holders of Dai can earn interest –the so-called Dai Savings Rate– by locking up their Dai in a MakerDAO smart contract. Users can withdraw their Dai plus interest at any time. Now, Chai is a wrapper which allows traders to earn interest by exchanging Dai for Chai, without having to lock up their tokens.

This potentially allows Chai tokens to be further used in other platforms –if this happens then you could have a situation where you could lend out and earn interest on a token that’s already earning interest (which sounds a bit too close to the financial engineering schemes of past crises). It also allows users to hold tokens directly in their wallet, rather than in MakerDAO or other applications’ smart contracts.

Dai holders also have the option of lending their stablecoin on Compound Finance, DDEX or others apps, and earn interest that way. The difference with locking Dai in Maker and exchanging it for Chai, is that there’s lending risk –borrowers could default, platforms could become insolvent, or some other black swan event. Even with these risks, interest in these platforms is lower than the 2% DSR on Maker and Chai.

This innovation is an example of how this new financial system allows developers to take pieces of other team’s platforms and build around them, to create new and hopefully improved products.

One question here is whether these types of wrappers, which incentivize earning interest outside of the MakerDAO platform, debilitate the system. If the idea behind DSR is to create an incentive for people to hold Dai, then it shouldn’t make much difference if it’s in a Maker smart contract or somewhere else.

Does DeFi Cannibalize PoS?

There’s a risk that decentralized finance will cannibalize proof-of-stake as its platforms offer higher returns than becoming a validator, Haseeb Qureshi of Dragonfly Capital wrote in a blog post.

Proof of stake is a consensus algorithm like proof of work, which relies on network participants to stake tokens, rather than spend high amounts of energy, to validate transactions. A PoS system is secure when there are lots of coins actively staked for the network. An attacked could accumulate a large amount of the staked capital, but that’s “hard and expensive.” An alternative could be to lure stakers into withdrawing their coins and take over the much cheaper network. And how to lure them? With the juicier yield offered by platforms running on the very same network.

Tarun Chitra from Gauntlet modeled what that would look like in a chain with a deflationary monetary policy, like bitcoin’s, and showed that over time, the percentage of tokens staked would migrate to lending platforms as block rewards decrease. An attacker could take advantage of this process by paying an even better rate in lending markets and then taking over the “barren staking market,” Haseeb writes.

If true, this type of attack could be a potential threat to Ethereum.

While it’s an interesting point, Eric Conner of EthHub calculates it would be very expensive to pull off, as in $267k-a-day expensive. Check out his thread.

Something else to consider, with the ability to have derivatives such as tokens representing staked ETH, traders may be able to both stake their ETH, and lend it out to gain interest. Also, Ethereum’s monetary policy is deflationary, but flexible enough to adjust issuance so that validators continue earning block rewards. And finally, there’s also traders’ risk profiles. Some may be willing to earn a lower yield in exchange for the safer option of staking ETH rather than lending it out.

Report Shows DeFi Explosion in the Third Quarter

Graychain published a Crypto Credit Report for the third quarter, focusing on DeFi. To me these are the most interesting take aways:

  • DeFi accounts for 16 percent of crypto debt, and 24 percent of interest generated
  • The entire industry has a loan-to-value ratio of 52 percent, which means it’s far from over-levered
  • New DeFi addresses soared by 1,589 percent thanks in part to Coinbase campaign

Thanks for reading dear subscribers!! Feedback, comments, shares are always appreciated :)