Cao Yin: Economic Crisis Amid the Pandemic Could Be a Crucial Opportunity for the Rise of DeFi

Cao Yin elaborates on the 4 reasons and 5 directions for the rise of DeFi under the pandemic.

Original Title: "Cao Yin: 4 Reasons Why the Epidemic Will Trigger DeFi"
Author: Cao Yin, Managing Director of Digital Renaissance Foundation
Source: BlockBeats

The COVID-19 pandemic is raging globally. Apart from East Asia, the epidemic is still rapidly spreading in various countries. Despite the governments' best efforts, no one knows when the epidemic can be controlled. For most people who have not fallen ill, what is even more terrifying than the virus itself is the severe economic and financial crisis caused by the epidemic, leading us to an uncertain future. Some blockchain practitioners even began to question the meaning of their blockchain careers as their technology seemed unable to help.

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Image: MetaCartel member PeterPan questioning the meaning of blockchain on Twitter and expressing readiness to completely leave the Ethereum community and digital currency

It is not just PeterPan who has such doubts. Under the dual impact of life threats and asset depreciation, the morale of domestic and foreign communities is relatively low. Everyone is asking themselves: What can blockchain really do?

As a DeFi practitioner and investor, I have no doubts at all. I am even full of confidence, not only in humanity's eventual triumph over the epidemic but also in DeFi's ability to help those affected by the crisis. In fact, to be more optimistic, the economic and financial crisis caused by the epidemic will not only not affect DeFi but may even become an important opportunity to trigger its rise.

Let me first analyze the possible consequences of the economic and financial crisis that the epidemic may lead to.

Since the outbreak of the pandemic worldwide, concerns over the global economic slowdown due to the spread of the coronavirus have led corporations and investors to seek the most liquid currency. A wave of indiscriminate selling has swept through the financial markets, with stocks, gold, forex, commodities, bonds from developed and emerging markets all being sold off to exchange for US dollars as a hedge. Despite the emergency rate cut by the Federal Reserve to zero and the initiation of new bond purchasing programs, the US Dollar Index, which reflects the USD exchange rate, has rapidly surged above 100. Other central banks have taken similar measures, but so far, these actions have failed to alleviate liquidity tensions and market panic. The US Dollar Index remains at elevated levels.

In the capital markets, investors are selling off various countries' currency assets to cash out USD as a hedge. Major international currencies like the Pound, Euro, Australian Dollar, Singapore Dollar, Swedish Krona have all depreciated relative to the USD, while currencies of developing countries like Thailand, South Africa, Mexico, Turkey, Egypt have depreciated significantly, indicating investors' concerns about the economies of these countries. Countries relying on external financing may face sudden stops in capital inflows and market disorder, leading them to implement temporary capital flow management measures. For example, the Egyptian government recently started implementing capital control measures, restricting the public from exchanging local currency for USD. Under the pressure of the pandemic, even the IMF, a champion of capital freedom, has shown some flexibility towards sovereign countries' capital control policies. In the new "Integrated Policy Framework" by the IMF, it has been proposed to tolerate temporary restrictions on capital flows by sovereign countries.

Due to concerns about the pandemic's impact on the economy, since early March, over 30 countries including Canada, New Zealand, Australia, the UK, and Egypt have announced interest rate cuts. The Federal Reserve, in particular, has taken a decisive step by cutting rates by 1%, bringing the federal funds rate to a historic low of 0-0.25%. If market liquidity fears persist or to stimulate economic growth post-pandemic, the Federal Reserve and other central banks may even resort to negative interest rates. This will have long-term structural impacts on global capital markets.

Historically, after major disasters and economic crises, investors' risk appetite significantly decreases, leading to a substantial reduction in all types of capital expenditures and non-essential lifestyle expenses for ordinary consumers. The savings rate of the entire society will increase significantly, especially in European and American countries where consumer behavior is expected to undergo a thorough transformation. Many individuals living paycheck to paycheck will have to tighten their belts and shift from a credit card lifestyle to a savings-oriented one, focusing on living within their means.

Previous major financial crises have resulted in numerous financial institutions, including various banks, going bankrupt. After the Asian financial crisis in 1997, a large number of banks in Southeast Asia collapsed, leaving many people's savings wiped out. The current pandemic crisis has severed international supply chains and disrupted trade in goods and services. Post-pandemic, many multinational corporations will reconsider their supply chain strategies, potentially leading to the relocation of production capacities from developing countries back to Europe and the US. This will cause a significant number of bankruptcies in export-oriented countries, further devaluing their currencies and increasing their external debt burdens. Banks will face pressure from both asset and liability sides, with weaker banks facing bankruptcy and resulting in systemic risks.

The consequences of the crisis will severely impact the global economy, especially export-oriented developing countries. However, in the realm of DeFi on the blockchain, due to its unique attributes and functionalities, it will rise as a challenger and potentially overcome the crisis, helping more people to cope with or even overcome the crisis, becoming a "panacea" to tackle the crisis.

During the pandemic, the total supply of various centralized USD stablecoins has surged due to the market's hedging demands. According to statistics, in just March, the market value of various centralized stablecoins increased by approximately $2.1 billion, totaling around $8 billion, and the issuance rate continues to escalate. The increased issuance demand stems from speculative demand for buying BTC at a low point, as well as a significant amount of private hedging demand using various stablecoins to purchase USD through specialized channels. For example, a large number of USD were previously generated as accounts receivable in international trade, helping funds from countries with capital controls to go offshore. Recently, due to the pandemic, international trade disruptions have redirected a small portion of the daily USD circulation demand towards various stablecoins.

Image: Total Issuance of Various Stablecoins

As the supply of stablecoins continues to increase, there is a substantial financial demand for idle centralized USD stablecoins. The majority of these stablecoins are ERC20 tokens issued on Ethereum, such as USDT and USDC, allowing direct lending, interest generation, and trading within existing DeFi protocols. More DeFi protocols are recognizing the financial demand for centralized stablecoins, with mainstream DeFi lending applications like Compound, Lendf, Aave, dydx starting to support various centralized USD stablecoin lending services. Currently, the total amount of centralized stablecoins entering DeFi lending is less than $150 million, but as stablecoin holders realize the liquidity and security advantages of DeFi lending, a significant influx of centralized stablecoins into DeFi lending and financial services is expected in the future.

Image: Various Stablecoin Lending on Lendf

While capital controls are necessary to protect financial stability, they severely affect normal transactions and investment needs of businesses and individuals, especially in countries with less developed financial infrastructure like Egypt and Vietnam. Capital controls prevent citizens from using international financial infrastructure, and local financial infrastructure may be insufficient to provide reliable basic financial services such as cross-border transfers and financial asset trading. However, the borderless and censorship-resistant features of DeFi allow users in regulated countries to conduct cross-border and domestic payments and transactions via DeFi, even enabling them to invest in DeFi synthetic assets to participate in international financial markets.

Image: USDT Trading Options on Tokenlon Decentralized Exchange

Low and zero-interest rate policies in various countries will persist for a considerable period, with negative interest rate policies also being introduced. Many arbitrageurs will choose to perform interest rate arbitrage between bank loans and DeFi deposits, and the high liquidity and security of the DeFi market make such arbitrage strategies almost risk-free. This will attract a significant amount of funds to flow out of banks and enter the DeFi market through stablecoins.

Moreover, post-pandemic, the international capital market will undergo deep restructuring along with international supply chains. The capital control policies of relevant developing countries will continue to escalate. Therefore, in a new era of deglobalization, the interest rate differentials between developing and developed countries will widen, and borderless DeFi will become the best tool for international arbitrage capital to engage in cross-border interest rate arbitrage.

Image: Stablecoin Deposit Balances and Interest Rate Levels in DeFi Lending Applications

Post-pandemic, the already fragile financial systems of developing countries will become even more vulnerable, with the deposits of ordinary citizens in local banks at risk of disappearing at any time. During the pandemic, India's fourth-largest private bank, Yes Bank, declared bankruptcy, endangering the deposits of millions of customers. Similar situations are likely to occur frequently in developing countries. At that time, people in developing countries will realize that keeping money in banks is not safe, while purchasing stablecoins in DeFi is not only secure but also helps hedge against local currency depreciation risks.

Recently, numerous projects have begun offering DeFi deposit and savings services. Starting this year, Dharma has provided a one-stop DeFi service for users in certain countries, offering free deposits and withdrawals, Compound deposit interest, and payments. Users can directly purchase DAI or USDC with bank deposits through the Dharma wallet and then deposit them into Compound. Dharma's service is not only safer and offers higher interest rates than banks but also boasts better UI/UX than banks, making it highly attractive to regular savings users.

It's not just Dharma that sees the opportunity in DeFi savings and payments. The startup project Dipole has introduced stablecoin electricity sales and DeFi savings services for the Southeast Asian distributed solar market. On the OTC platform integrated by Dipole, users directly purchase various stablecoins, including DAI, using local currencies and choose to deposit them into different DeFi lending protocols for interest. For electricity buyers, the stablecoin electricity fees they pay are automatically deposited into DeFi lending for interest, significantly improving the capital utilization efficiency for both buyers and sellers.

Image: Dipole Product Interface

Based on these emerging trends, DeFi projects in the following areas are expected to rise to prominence amid the current crisis.

Provide low-cost, simple services for the easy exchange of stablecoins and fiat currencies, such as Dharma. By integrating third-party deposit services like Wyre, users can directly purchase USDC and DAI with zero cost using a bank card. However, there are still significant gaps in the coverage of Dharma's services, and it does not support purchasing mainstream stablecoins like USDT. Additionally, after depositing, users can only choose Compound for financial management.

Help users manage on-chain stablecoin assets and provide various low-risk floating or fixed interest rate financial services, including lending interest and liquidity interest, such as those offered by mainstream DeFi lending applications. However, the best performer in this category is Lendf from China, offering various stablecoin financial services, including USDT, with stablecoin deposit balances surpassing Compound on Lendf.

Enable users to directly pay the financial assets within DeFi protocols to the contract address of the recipient through convenient methods like QR codes and SMS. For example, Dipole in Southeast Asia provides electricity payment and receipt services.

Realize fund mutual aid between users in a DAO manner, helping informal workers who cannot access credit support and social security to obtain fund mutual aid services akin to insurance. Participants can ensure the correct execution of fund allocation and recovery through a combination of off-chain and on-chain governance, resolving disputes. Mutual aid funds can be directly deposited into DeFi lending protocols for interest, ensuring efficient fund utilization and avoiding issues of mismanagement of mutual aid funds by traditional centralized community mutual aid organizations.

Provide on-chain and off-chain asset liquidation, preservation, and quoting services through a combination of assets for various traditional fixed-income assets like bonds, bank fixed deposits, ABS, offering on-chain collateral discount DeFi services. This helps small and micro-enterprises and developing countries to obtain financing for assets and provides risk-controlled high-yield returns for stablecoins in DeFi. Some DeFi projects have begun exploring similar services, such as RealT, a real estate tokenization project where users can invest in tokenized real estate projects and earn rental income through RealT. However, RealT has not addressed the most critical issues in similar projects, such as ensuring the continuity of off-chain rental cash flow and asset preservation.

Image: RealT's Real Estate Financing Project

Every major crisis destroys certain old industrial ecosystems, giving rise to new paradigms from the ruins. The previous SARS crisis directly fueled the prosperity of the e-commerce industry post-epidemic, while the 2008 financial crisis severely impacted many large financial institutions, providing an opportunity for the growth of internet finance. This current pandemic, with infection and death tolls far exceeding SARS, will lead to economic and financial crises of greater breadth and depth than the 2008 financial crisis. The post-crisis market demands are expected to surpass those of previous crises. DeFi, as the next-generation financial infrastructure built on the next-generation internet, will formally establish itself as mainstream after this unprecedented global pandemic and economic crisis, providing truly inclusive, secure, trustworthy, and fair financial services for people worldwide.

This article is authorized by ChainNews for reprint. Source: ChainNews (ID: chainnewscom)

Further Reading

• Cao Yin: How Should Maker Adjust Monetary and Fiscal Policies Under Liquidity Crisis?

• [Dapp Pocket] DeFi Weekly Report 3/23–3/30

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