We have been thinking about how the DeFi field has evolved recently and how to follow the broader trends in the technology industry.
If you read Ben Thompson’s Stratechery blog, his aggregation theory defines the difference between platform companies and “aggregators”.
There are some platform companies, such as Shopify or Substack, which provide some APIs or technologies to allow third parties to connect with end users. Substack connects writers and readers, and then draws a 10% share from income. Shopify connects merchants and buyers, and then charges merchants a monthly subscription fee to provide its technology, while providing optional value-added services (payment, credit lines, etc.).
But in the end, it is up to the author or merchant to acquire users and distribute themselves.
Aggregators are companies like Google or Facebook that build an intermediary relationship between third parties and users. This is a bit too simple, but Facebook and Google have a lot of user information, and use this information to let the company spend a lot of advertising money on them. In many cases, media companies or travel companies do not have customer relationships, they must publish by paying Google and Facebook.
If you plan to travel to Tokyo, you might start searching on Google instead of directly searching on Expedia. Therefore, Expedia spent US$6.03 billion in “sales and marketing” expenses in 2019, mainly on Google advertising.
In the field of CeFi cryptocurrencies, Binance is probably the “aggregator” most similar to Facebook or Google. Binance has more than 15,000,000 users and a very large cryptocurrency market, and thus obtains a lot of value (USD) from suppliers (projects that want to log on to the Binance platform).
The project team (supplier) is willing to pay fees to Binance in several ways: including the cost of listing on the exchange, a certain percentage of their IEO fundraising, and advertising (airdrops and gifts). The team is willing to pay Binance all these expenses because they cannot achieve such extensive publicity and promotion on their own. Listing on Binance also adds legitimacy to the project, because users generally believe that Binance conducted a detailed investigation before supporting a certain project.
Binance’s strong position in the cryptocurrency field, as well as its brand, users and maturity, allow them to get a very large market share even if they bring their products to the market later than their competitors. Binance often lists tokens after other exchanges, enters the perpetual futures market late, and has only recently started offering options (although it is unilateral). In any case, Binance’s products have attracted many users.
In order to apply the aggregation theory to DeFi, we first look at the current DeFi situation:
- Agreement (third party): Compound, dYdX, Maker/DSR, CurveFi, Uniswap, Compound, dYdX
- Platform: Zerion, InstaDapp, Argent
- And a new class of aggregators: Ray, CurveFi, 1inch.exchange, dex.blue, unspent.io
An old metaphor is that DeFi is still in the “early Internet era.” No one has done all the meaningful aggregation of services. For example, Compound has more users directly connected to their agreement than any platform or aggregation service.
Current aggregators don’t exactly meet Ben Thompson’s definition, but if you really think about it, you can spy on some clues about how they get there.
opportunity
We believe that current neutral and UI/UX-focused platforms such as Zerion, InstaDapp, Argent, or a brand new company that provides a simplified DeFi experience interface, have the opportunity to become a mature aggregator in this process.
The current aggregators are not so easy to use, because unlike the aggregators in the technology industry, they have only aggregated suppliers so far and have not successfully aggregated users.
To some extent, crypto wallets are now playing this role. For example, Trust Wallet can be used to hold your assets, and it also provides limited trading functions, which can be used to pledge assets and connect with other applications through Wallet Connect. But as far as we know, they did not make money.
The first platform to become the’THE DeFi platform’ will monopolize the entire market. Metamask is a typical example, it illustrates what happens when a sufficiently good tool appears earlier than other tools and becomes a recognized brand. Almost all DeFi products use MetaMask first. If there is no “Log in with MetaMask” option on your website, then this can be regarded as a sign that the project is immature.
We propose several ways how the DeFi project becomes an aggregator:
Path one:
A platform can be transformed into a “trust market” or DeFi financial opportunities (DeFi financial opportunities) application store. The platform connects users with any number of financial opportunities and provides some security audits of the protocols they support. For users, this means that the platform does its best to verify whether the code is legal and passed the review.
Amazon has a similar approach for third-party merchants. Amazon will charge merchant partners for each transaction and monthly subscription fee to be able to sell on the Amazon platform.
Admittedly, it will be difficult for the platform to charge monthly subscription fees from “merchants” (agreements or products) (such as how can you charge Compound?), but this can be done in other ways.
Perhaps new products (before complete decentralization?) can be charged for official support (just like the previous Binance example). There are many new DeFi applications that are competing for users’ attention. Getting support on the platform with the most users may be of great value to a new team in terms of marketing.
Another company that does this is Salesforce. Salesforce acquires users and then provides a way for other companies to integrate their company’s services into Salesforce through AppExchange. Through AppExchange, Salesforce charges a one-time listing fee (used to pay for security review fees), and then extracts a certain percentage of revenue from subscriptions generated through its platform.
A DeFi aggregator with a huge user base will be in a perfect position, it can provide DeFi protocol API and SDK to integrate with it.
Path two:
The above proposal introduces a question about size. Will DeFi have as many applications as Amazon or Salesforce? This is unlikely. For a platform, the way to deal with such problems is to propose a “free value-added” model.
For retail investors, the platform can use the intermediary smart contract between the user and the actual agreement to extract from the interest generated, or charge a small amount of base point fees on the transaction. For users, this is equivalent to “convenience fee”.
In conjunction with this, the platform can provide a “professional” version of the tool (such as $500/month), without charging a “convenience fee”, with more features and more scalability (for example, professional users New products can be integrated through the platform UI, etc.).
This professional tool can be more similar to a tool like Prime Brokerage (institutional brokerage business), tailored for institutional clients. The term Prime brokerage is difficult to define, but in the traditional financial field, it generally refers to the one-stop integrated financial services provided by banks for hedge funds. The service scope includes leveraged lending transactions or short selling, transaction execution, cash management, fundraising introduction, consulting services, etc.
In CeFi cryptocurrency, people are very excited about the establishment of Prime Brokerage (such as Tagomi), but most of them have not succeeded because:
- In the traditional market, without a prime broker, it is almost impossible for hedge funds to raise funds from institutional investors, but this is not the case in the crypto market, so the overall demand is low.
- Some of the head companies in the cryptocurrency are actually taking advantage of the early advantages of the exchange infrastructure, so the fund hopes to directly interface with all platforms
- Prime brokers are not yet able to provide customers with loan services (for many people, this is the most important function).
- Even if Prime Broker provides a margin in their native user interface, the funds still need to provide a separate collateral for each exchange (that is, the collateral provided on Huobi is not recognized on OKEx).
The role that DeFi aggregators can play here is to place loans (starting with Compound or Aave) next to trading opportunities. In reality, this means that market makers borrow on one platform and then loan out on another platform (similar to CeFi’s Prime Brokers), but in practice, this may look more like a traditional prime The unified transaction experience of brokerage.
Aggregators may also consider launching their own CeFi or P2P lending opportunities, which will make it easier to obtain spreads. It is still possible to take a method like Amazon and use the AmazonBasics series to create your own versions of the most successful products.
Eventually, one of the platforms will achieve complete vertical integration of services, which will enter a “winner take all” situation. The platform will simplify the user’s process and accumulate most of the value for their platform in this process.
What are the upsides?
The benefit of these platform aggregators is that it will help bring more audiences to DeFi. The cost of participation for the first time using DeFi is very high. Even for those who have been in the cryptocurrency industry for a long time, these platforms are difficult to get started.
The new aggregator has a beautiful user interface, users do not need to care about those trivial details, which can introduce new users to DeFi, similar to what Coinbase did with cryptocurrency at the end of 2017.
Many people are frightened by tedious operations when they first contact DeFi and want to actually try it. You can imagine a generally smart person, seeing the dollar in their hands on Twitter can get 8% of the income. So immediately opened DeFi_Product, but found that he first needed to convert the US dollar into a stablecoin elsewhere, and then he also needed to establish a wallet on a different website before he could actually use his own dollar on DeFi_Product.
DeFi has a lot of room for product improvement, and it is valuable to improve at the platform/aggregator level, because this way the product can continue to focus on technological improvement and security.
What are the potential risks?
Everything has risks. If you are using Instadapp, and Instadapp uses dex.blue to execute transactions on Uniswap, you may be separated from the actual transaction by three layers (and multiple smart contracts). More abstract simplification makes it less likely that users will actually understand what they are using. This cover of security can be dangerous in an emerging industry that is still vulnerable to hackers. When developing a protocol against hackers, simplicity is king.
The further away users and their funds are, the greater the possibility of a security breach. In addition, when more and more things are connected to each other, the aggregator’s review of the entire ecosystem becomes more and more difficult. The BZX hacking incident is a good example, which reveals what happens when multiple parts of DeFi are mixed together.
Image source: “The Simpsons-Nuclear Scene” recreated by Deribit (Fox Broadcasting Company)
In a 1inch transaction, the funds from DAI to USDT transactions usually flow like this:
- User sends DAI to 1inch
- 1inch sends DAI to curve.fi pool 1.
- Curve.fi Pool 1 is deposited into DAI in iearn.finance.
- iearn.financial withdraws USDT to curve.fi pool 2.
- Curve.fi Pool 2 sends USDT to 1inch.
- 1inch sends USDT to users
There are two consequences of the above process that need attention:
First, if someone hacks into iearn.financial, he may transfer ERC20 tokens from users who have approved the 1inch smart contract to steal funds. This is because 1inch has approved curve.fi and curve. fi again approved iearn.financial. However, these users may not even know the existence of iearn.financial!
Second, in the current form of Ethereum, the cost of gas makes the cost of aggregation very high. For example, this 1-inch transaction has a fee of nearly $10. It may be worthwhile to trade thousands of dollars, but it is not cost-effective for people who trade small amounts. Now, the gas cost of using a combination of 1inch and CurveFi to exchange DAI/USDT is approximately 6 times that of direct conversion from Uniswap ($5.13 vs. $0.855).
to sum up
The silver lining of DeFi aggregators is that they will be able to provide a better user experience in many ways and make it easier to achieve profitability by becoming more centralized. But in most cases, this is contrary to the original intention of these teams to start building these projects. Finding a balance between establishing a sustainable business model and maintaining decentralization will be one of the most interesting things in the next few years.