The 2 Fundamental Flaws in Current DeFi Projects

Smart Trade Networks
Smart Trade Networks
12 min readApr 25, 2021

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All DeFi projects fall into 3 categories:

  1. The Intentional Scam
    These types of projects last only a few weeks, they generally have a few social media posts. They are launched by anonymous actors. People get excited by the promise of getting rich overnight. Unless you are “in the know” on when to buy and sell, the odds are you will lose out. And generally people are left with the feeling of daylight robbery.
  2. The Un-intentional Scam
    The leaders of these projects have a long term view, they are transparent, they are professional and utilize good marketing practices but the projects end up failing because the price drops. The leaders had the right intentions but they are not aware of how the DeFi industry works. For example investors are happy to move their funds out of the project and jump on the next DeFi project selling sizzle. This results in their native token suffering large price drops, generally to almost zero and the leaders find themselves unable to fund the time and skills required to continue development of their promised platform.
  3. Externally Funded Projects
    The leaders of these projects don’t sell the sizzle, they are well funded from external funds before they hit the DeFi space and generally only sell a small % of the value in the platform as a way to gain adoption. They bring out concepts that are truly revolutionary and their price grows powerfully over time with very little marketing effort. They generally bring out a step change in innovation that disrupts the market. However they are still missing 2 crucial components.

Hence the writing of this article:

DeFi Flaw 1: DeFi is not backed by real assets

None of the DeFi projects are backed or secured by the real value/assets that allows humans to get their basic needs met, which is actually what secures the adoption of a project or new platform. Not having anything behind the project in the way of assets, makes the risk to the investor very high.

What is real value or assets?

Traditional accounting sees assets as housing/property and food and to put this into a more holistic short perspective. It’s the things that allow us to live: like food, water, shelter…. etc.

Traditionally investors feel safe with asset backed investments, for example property. With technology, property can now mean livestock, feed for livestock and much more.

You could almost think Maslow’s hierarchy of needs…

In Maslow’s hierarchy of needs, you can see the essential foundation layer is: breathing, food, water, sex, sleep, homeostasis, excretion. I’m of the opinion DeFi projects loosely fall into the Self-actualisation and Esteem category…

People are currently buying into “what they perceive” as “a good team”, “solid leadership” creativity, sometimes morality and generally hope.

Moving on…

DeFi Flaw 2: The Investor is not Protected

How many times have you seen a DeFi project launch with all the promise of the world, only to see three weeks later the entire market cap of the project bottom out?

This happens because there are no traditional assets that underpin the future promise of the project (specifically the assets representing the bottom layer of Maslow’s hierarchy of needs). This results in uncertainty when the leadership team goes silent. If the team doesn’t respond to just one question within a reasonable amount of time the entire community can spiral into a frenzy and a panic sell off can trigger.

The world is in transition, blending fiat value with real value needs a blend of traditional, physical, tangible assets and the future promise of the digital assets realised once the platform launches. In other words the world is not quite ready to recognise higher level digitally represented assets until the foundational assets are able to be cryptographically backed by the physical tangible assets, like property or food.

How do we protect the investor?

The investor needs a failsafe, whereby if the project fails the underlying assets being used to create new assets through transformation of the underlying assets can be sold off and funds recovered generally through forced liquidation or the fund manager decides to pull the plug and recover losses to pay back the initial investors…

Think of this as how the bank has a mortgage on your house. If everything goes wrong they may not get all their money back but probably will, it protects the lender / investor.

Sure maybe the investor does not get back 100% of their money but if the underpinning assets sold off make at least 50% of the initially invested funds then that is fair enough. Better than current DeFi investments where if the project fails you are most likely to lose all your funds. I’ve been there… And if you have made it this far into this article, I’m sure you have too.

Although there are better post-blockchain technologies emerging It’s clear the bulk of DeFi value is currently captured in the ERC20 protocol.

This begs the question… How do we connect the ERC20 pattern/protocol via cryptographically backed real world tangible assets? Read on to find out… But first…

Blending Asset Securitisation with DeFi

In order to give each ERC20 token a baseline value, we want the DeFi ERC20 world to represent the bottom layer of Maslow’s hierarchy of needs. If we can re-represent the assets that support basic human needs using traditional asset securitisation in the Ethereum space then this will allow cryptographic proofs required to underpin assets further up Maslow’s hierarchy of needs.

It’s not a new concept, but it certainly is, in the emerging DeFi world, and it’s what accountants and lawyers look for when they value things. Accountants cannot legally advise on investments, they will always be cautious with their clients (reputational risk). BUT if you can create conditions that clearly satisfy their usual needs, i.e. security over assets, it will go a long way to encouraging adoption of something new. The average joe seems to look up to their accountant and accountants seem to command the general view of what is stable, safe and a good investment. If we want the DeFi space to become safer and achieve the next pocket of adoption it makes sense to blend traditional asset thinking into the future of DeFi products. There is nothing worse than an accountant saying that is a risky investment so lets give these DeFi instruments the features they are looking for in a safe investment and at the same time it will improve current DeFi offers instead of resorting to weird scarcity based/diminishing smart contract games.

Tracking Assets

Adopting asset securitisation requires the Ethereum blockchain to also track assets. In order to track assets each asset needs to be identified, which requires more smart contracts to keep a record of the assets, including the current state of the assets. But how can we trust the assets are there? This requires the assets to be tracked on a blockchain with oversight on the moving and changing hands.

Oversight on Registration and Tracking of Assets

We can’t simply trust one person to say their assets are there, we need proof, we need photos, we need an uneditable log of the current condition of the assets… In other words we need to track the assets using a blockchain database that protects against non-repudiation.

Connecting Tracked Assets to an ERC20 Investment Token

On top of that we need to cryptographically connect the assets to the investment token such that when someone owns the ERC20 token they can click through and see how many assets are backing their token and see the current state and location of the assets. That way if the market goes into a panic sell off, the price won’t drop to zero because people can see there are real assets backing the value of their investment token.

Ethereum is too expensive to track assets on the public chain

The only issue with all of this is that Ethereum is expensive and running an asset register on the public chain tracking current location, state and who has custody of the assets would rack up an ETH transaction bill more than the value of the assets themselves.

So we really need to track the assets on a blockchain database that is not as expensive as the Ethereum public chain. Which is why we built the Smart Trade Network (STN). The Smart Trade Network is a side chain to Ethereum, where we can enjoy the security of the blockchain capacities however not have to pay for the large transaction costs required to track 1000’s of assets to back a project.

And the cool thing is, if you are holding an asset backed investment token you too would have an interest to run a node for the our asset register side chain and you are welcome to run a node using these instructions: http://54.206.103.22:8000/#geth

Current ERC20 Wallets don’t support querying 2 blockchain networks at the same time.

As I mentioned earlier most DeFi value sits in Ethereum or wrapped in ERC20 tokens on Ethereum. So it makes sense to have investors invest on the public chain.

It’s too expensive to have the assets registered and tracked on the public chain. So it makes sense to do all asset tracking on the Ethereum side chain.

We need to upgrade ERC20 web wallets to talk to 2 blockchains at the same time.

Partnering with Smart Trade Networks

MetaMorph is proud to partner with the Smart Trade Networks. The Smart Trade networks have a number of projects launching. One of their sub projects is BeefLedger, “tracking cattle from farm to plate”.

BeefLedger is trying to bring full transparency to the beef supply chain so meat eaters and non-meat eaters are informed on how cattle are treated with the hope to bring more appreciation to what it means to eat animals and the impact it has on our environment.

It’s one of the first implementations of asset backed ERC20 tokens and has been chosen because:

  1. Smart Trade Networks is on a mission to incentivise food producers to achieve ecological best practices and sustain regenerative practices.
  2. It’s easy for investors to understand the cattle supply chain and the assets that back them.
  3. Smart Trade Networks is also working on a carbon trading program in partnership with BeefLedger to create CO2 certification assets for companies to purchase under regulation to offset their carbon emissions.

Side-chain MultiSig Asset Register

When it comes to tracking assets there is an incentive for asset managers to create fake assets in order to get more finance. We’ve mitigated this by only allowing parties to sign off on registering assets via a multisig wallet as in the picture above. This requires the actor putting their reputation on the line and individually verifying the assets are real and only if they know they are real will they sign off.

If they sign off on assets that are not real they will naturally be banned from signing on assets in the Smart Trade Network because nobody will believe their claims. We are doing this first with the ERC20 token STN5. Anyone who holds STN5 can be approved to sign off on the realisation of new assets into the system, if you have seen enough proof of the assets being real.

Now that we have oversight on the assets and have minimised the ability for projects too fake they have assets how do we make use of this asset register.

Multichain WebPage Wallet

The Smart Trade Network have pioneered a way for public chain ERC20 tokens sitting in the DeFi space to be cryptographically backed by ERC721 assets managed on the Smart Trade Network Ethereum Side Chain.

Introducing the Multi Block WebPage Wallet that talks to Ethereum mainchain and also reads Metadata on ERC20 contracts that points to the Smart Trade Network and the Assets represented by ERC721.

We’ve made use of asset groupings inspired by ERC998.

ERC998 Asset Groupings

What is the ERC998 standard?
The 998 grouping is a way for ERC721 assets to be grouped and even given transfer rights to another contract if needed.

SupplyChain Finance in the Cattle Industry Replacing the Banks

Take for instance the blockchain BeefLedger asset register. BeefLedger deals with supply chain finance of the cattle industry. It’s actually very expensive for a farmer to grow edible cattle and get them all the way to the abattoir, there are a lot of costs in just feeding and moving cows.

A farmer can be up for hundreds of thousands of dollars in costs just to “acquire and feed cattle”, not to mention the costs of land and water. A farmer would traditionally need to go to the bank in order to get short term finance.

The bank would require security over the cattle, meaning the bank would require legal rights to take the cattle and sell the cattle, in the ‘off chance’ something went wrong and the bank wanted to recover money from the short term finance deal.

Mainstream lenders — both bank and non-bank — charge between 9–14% on the finance. Small to medium sized business Cashflow finance can cost anywhere between 14.95% and 24.95%. This can cripple a business from investing in the activities that can make it a more sustainable and socially and ecologically responsible enterprise. Now thanks to the smart trade networks decentralised asset register backing ERC20 tokens we can bring these high end opportunities to the DiFi space, and cut into what has traditionally only been available to the rich and banks.

Backing ERC20 Token with ERC721 Assets Explained Using Cattle

Let’s say farmer Joe is happy to share profits from his cattle if the DeFi space helped him fatten up his cattle ready to be delivered to the butchers. Farmer Joe calculated he needed an extra 100k to take his 50 cattle and transfer them to the feedlot, fatten them up, pay for all their health checks and then send them to the abattoir where they would then be transferred to butchers. This is described in the image below.

He has secured the deals with the butches and restaurants however he has cash flow issues. How can he pay for the new feed, get the health checks and transport costs?

If he provides a way for his assets to be tracked by investors who put the cash up, and for the investors to have the legal right to recover initial investment by selling the cows should something happen in the process. Then he could essentially sell security in the DeFi space where privileged crypto investors could get access.

In order to protect the DeFi investors the assets would be registered on the Smart Trade Network blockchain asset register. The assets would all be given unique identities which would be saved in the ERC721 contract.

Cryptographically connecting an ERC20 token on the public chain to assets on another chain is relatively simple.

  1. Assets are registered on the side chain using ERC721.
  2. The 721 contract will have a contact address.
  3. We then create a grouping of assets using EIP998 methodology. The 998 contract is deployed and references a group of ERC721 unique identifiers.
  4. The 998 and 721 contracts and provider details of the side chain are added as unchangeable metadata on the ERC20 investment token main chain.

That way everyone can verify for themselves the assets that back the token and Multi-chain web wallet can also read the ERC20 contract metadata to then query the assets on the side chain.

Early DeFi Adopter VIP Access Only

The Smart Trade Network has several DeFi community partners.

These partners and their investors have been busy growing the space to make DeFi funding possible.

We want to pay tributes to those who made the DeFi industry possible and make these opportunities only available to those who took the early risks and who are already heavily invested in DeFi projects and infrastructure.

We believe those most invested in the space should be the ones that get VIP access to these evolved low risk asset backed investments.

The first asset backed investment is the Regeneration Series (RG). You can read more about STN5 Security Token here.

The STN5 explainer website isn’t live yet however if you like what we are doing you can learn more about STN5 at dexTools.io

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