DeFi — A Buzzword Or A Working Technology【Vol.2】
A New Mechanism For Seed Funding Fully Protects Your Investment (powered by DeFi)
Welcome back DeFi enthusiasts!
In this article we continue talking further about Decentralized Finance and its quite significant achievements. As in the previous one, we are in the search of whether DeFi is just another trendy word gathering attention and investment or it really offers technical solutions for existing problems.
One of the biggest issues not only in crypto but in the traditional finance as well, turns out to be the startup funding. Some will argue here that this kind of investment could never be safe enough and it cannot guarantee you ROI. It is true that to put capital into an early business is a high risk investment, which you do of your own free will, but DeFi now provides a way to minimize the risk of losing your money.
This new funding mechanism is called PIP (Public Interest Projects) and it was briefly explained by Vitalik at two of the latest major conferences — the Ethereal Tel Aviv Summit and the Korea blockchain week.
But before diving into it, let’s first have a quick look at the good old ways of funding a project and outline their weaknesses.
- IPO
The Initial Public Offering takes place when a company goes public and starts selling shares in order to inflate fresh money into its further development — whether to attract the talent they couldn’t afford before or to cope with financial difficulties. On one hand, an IPO provides a good level of transparency because by filing the S-1 form, the company exposes its internal workings and data such as revenue, growth, number of employees, net loss, etc.
On the other hand, an IPO is a very complicated and prolonged process but moreover, it is very very expensive. The company should pay hefty transaction costs such as underwriter fees, legal fees, registration, financial advisory services and so on.
One example of successful IPO belongs to General Motors. The company was operating in bankruptcy before it triggered an IPO in 2010 and managed to raise more than $20 billion roughly.
2. ICO
The Initial Coin Offering is a more direct way to raise funds from supporters and fans, which avoids all the unnecessary paperwork and IPO bureaucracy. This type of crowdfunding is associated mainly with cryptocurrencies. Companies create their own cryptocurrency and sell it directly to investors for the first time before the project is officially launched. The difference here is that you do not buy a piece of the actual company but rather invest in the utility of the product. Users can then either spend the digital tokens on the company platform for specific service or sell them later on exchanges at much higher price and make a decent profit.
The problem here is that, since the token holders do not own any shares of the company at all, the company has no real obligation to the holders to deliver on its promises. This is how the big scams of 2017 were born and many people got cheated by crypto projects which failed to deliver.
One of the most successful ICOs of all time is Ethereum. The ICO was launched in 2014 with a price of around USD 0.31 and raised close to USD 18 million in only 42 days. The all time high of Ethereum is $1,417 in January 2018, making it one of the world’s most valuable cryptocurrency projects ever.
3. IEO
The Initial Exchange Offering aims to solve the trust problem and stop the scams by using an exchange as a middleman. Thereby the investors don’t send money directly to the project but rather buy the tokens from the exchange platform. The exchange reputation is now in question — if the project fails to deliver or get away with the money, the marketplace will get dirty. This makes the exchange do a strict due diligence before launching the IEO by checking the project’s whitepaper, members and goals. The exchange can step out of the deal at anytime, if it finds something shady.
The problem with the IEO comes from the centralized nature of the exchanges, which can easily censor who is allowed to participate, manipulate the token’s price or manipulate the whole sale by fake volumes.
One good example of IEO belongs to BitTorrent. The file-sharing platform, conducted an IEO on Binance exchange in January 2019 and managed to raise US$7.2 million.
4. IDEO
The Initial Decentralized Exchange Offering, as the name implies, takes place on Decentralized Exchanges and benefits from all the advantages of the decentralized trading. There are no price manipulation, no excessive fees for using the exchange platform, no filtering of participants, no KYC and AML procedures. Unfortunately, DEXs are still struggling to achieve adoption amongst users (due to lack of liquidity and complicated user interface), despite their brilliant decentralized system. This is why, it is hard to make a successful IDEO.
5. PIP
The Public Interest Project is a completely new concept which minimizes entirely the risk to lose your investment due to scams, failures or any other malicious actions taken by the project you have invested in. To make this possible, PIP stands on DeFi platforms like Compound, Dharma and Uniswap. The concept was created by two blockchain developers — Justin Lee and Krasimir Raykov.
Here is how it works:
- the new project, which is in search of funding, creates a smart contract that is connected to Compound (we assume that the smart contract is correctly built and its source code can always be checked).
- only the amount of money aggregated by the interest in Compound is sent to the project as a funding
- the smart contract sends back to the investor an equivalent amount of the project’s native token
- the project or any market maker can initiate a market on Uniswap for the token to create a pool of liquidity for the investors to trade with, which can affect positively the price of the token.
Let’s play out an example.
Alice, Bob, and Carol decide to pool their assets to fund Project XYZ and in return will receive XYZ tokens. Alice sends 200,000 DAI, Bob sends 300,000 DAI, and Carol sends 500,000 DAI for a total of 1,000,000 DAI in the PIP smart contract.
Assume that:
- the interest rate (APR) is 10%
- the interest and the project tokens are paid daily
- the price of XYZ token is $0.5 USD and DAI is $1.00 USD
As a result:
- projects are funded fully onchain. Since the funds are not raised at once (in a short ICO campaign) but throughout the time, this will stimulate the project to prove itself by continue building. The investors can remove or add more assets to the PIP contract at anytime depending on their assessment of the project’s development.
- PIP removes the risk for the investor to lose his money because funds are only coming from the interest on his capital. In the worst-case scenario, the investor can only lose the interest while his capital is fully protected.
- PIP is a completely decentralized funding mechanism which is open to anyone who wants to participate
- It excludes the need of middleman and centralized exchanges to provide liquidity. The project can simply create their own Uniswap market.
Check the details here:
https://file.globalupload.io/nEL7kCrIqQ.pdf ;
https://ethresear.ch/t/public-interest-projects-a-fully-onchain-risk-minimized-seed-funding-mechanism/5977 ;
https://github.com/kraikov/pip-seed-funding-mvp
To sum up, PIP is a new and way more secure mechanism of seed funding, which becomes possible thanks to all the latest innovations in DeFi. This is one example of how the currently forming DeFi ecosystem can self-regulate and self-correct in order to achieve full transparency and decentralization.
Since this series of articles is written in a time when DeFi is still in its early stage of development, we are discussing here concepts that are yet to be practically proved. We are living in interesting times of financial and technological disruption. This give us the privilege to observe whether DeFi will turn out to be just another buzzword or will prove as a successful technology. See you next time!
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