High level overview of p2p-DeFi Protocols for the Cardano Settlement Layer.
P2P-DeFi Protocols seek to establish the basic building blocks of p2p finance on Cardano. It is a family of open Plutus protocols that share common design patterns, chiefly centered around radical permissionlessness, simplicity, and composability. By taking full advantage of the protocol architectures enabled by the eUTxO paradigm, p2p-DeFi protocols can achieve an unprecedented level of scale, with both high security and high availability guarantees. The protocols work synergistically with one another, enabling the formation of a truly independent and complex economy on Cardano.
Distributed ledger technologies have long sought to provide an alternative financial platform for the disenfranchised or unbanked peoples of the world. Throughout the years, much progress has been made. However, the current DeFi paradigm is still heavily reliant on the legacy financial system for critical pieces of infrastructure, namely fiat on/off ramps, pricing information, and identity management. To be a viable alternative, DeFi must further decouple from these bottlenecks, and establish its own endogenous infrastructure.
Current DeFi dApps have a number of drawbacks:
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Most DeFi dApps rely on a permissioned set of batchers/arbitragers/aggregators for liquidity. Although a well designed dApp does not place user funds at risk of being outright stolen, the dApp cannot guarantee high availability, since permissioned actors are at a high risk of denial-of-service (DOS) attacks. This is doubly true for dApps that rely on oracles for external info feeds, where DOS and oracle collusion/corruption are major attack vectors.
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Governance of these actors is a complex and nuanced topic: who decides who gets to be a batcher or oracle provider? How are they compensated? If the answers to these questions are DAOs and dApp tokens, respectively, doesn't this mean that over time, as the permissioned actors profit, they gain increasing control of the DAO, until they become their own overseers? Furthermore, since dApps currently require users to go through batchers, composability with other dApps must be implemented manually, which is outside of user control. Governance quickly gets messy, and may result in a variety of regulatory issues down the line. It should be minimized wherever possible.
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Current dApps charge relatively high fees because they need to compensate permissioned actors for their resources and incentivize liquidity via "dApp Token" yield farming. This raises concerns about long-term sustainability; Plutus is already expressive enough to handle complex DeFi logic, permissionlessly. New cryptocurrencies may be useful for specialized sidechains/L2s, but are not necessary for CSL-level protocols.
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Many DeFi dApps sacrifice full delegation control, especially in the case of liquidity pools. The more delegation control is decoupled from the ADA owners, the more distorted Ouroboros' game theory becomes. It is difficult to predict the extent of this distortion, so minimizing it is of paramount importance.
If mature DeFi protocols really do offer an alternative to the legacy financial system, they will likely be perceived as a threat by those in positions of power. Therefore, DeFi protocols must not only be scalable, but must also be resilient to high-resource attacks by state-level actors.
These considerations are glaringly similar to the blockchain trilemma; security, availability, and throughput must all be uncompromisable priorities of an alternative financial system. Taking inspiration from Cardano, the trilemma is addressed through the following principles:
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Radical Permissionlessness - there are no permissioned or specially provisioned actors. All protocol participants, including large market-makers/batchers, are treated equally and permissionlessly. The only way to profit is to make profitable trades.
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Minimum Viable Expressiveness - protocols are simple, predictable, and are never subject to external off-chain variables, such as fiat-denominated prices. Due to their simplicity, they offer up to an order of magnitude lower fees than existing DeFi dApps, do not require superfluous dApp Tokens, and are highly composable.
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Proportional P2P Scaling - total throughput/liquidity scales in proportion to the number of users. The more users there are, the deeper the liquidity, the higher the throughput.
Note p2p-DeFi protocols are similar to Hydra, in that they are ledger-wide, Plutus-enabled extensions of the CSL, albeit with a focus on finance.
Some of the design patterns shared by all p2p-DeFi protocols, and a discussion of their advantages over the status quo.
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Unique User Addresses - p2p-DeFi users deploy and interact with each others' script addresses. Each user creates at least one unique address, composed of identical payment credentials (mediated by a global reference script, per protocol), and unique user-mediated staking credentials. Owner-related actions (i.e. simple withdrawal) are "overloaded" to the user's staking credential, so assets are never stolen. Users always maintain full delegation authority over their addresses.
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Beacon Tokens - All p2p-DeFi protocols coordinate their spending policies with the minting policies of specialized NFTs, dubbed "Beacon Tokens". These tokens serve two primary functions:
- Mediating protocol logic.
- "Tagging" specific TXs, Addresses, or UTxOs, and categorizing them such that they stand out among a sea of on-chain data.
Beacon Tokens are highly generalizable, and can be very expressive when used in combination with each other. They are used extensively in all p2p-DeFi protocols.
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Permissionless Indexing - All p2p-DeFi protocols have at least one Beacon Token that shares identical queryable properties with all other Beacon Tokens of the same protocol. As a result, users can locate relevant addresses and/or UTxOs using existing off-chain indexers, such as Blockfrost, Koios, local db-sync, e.t.c. No specialized indexers/routers necessary.
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No Oracles - Protocols that rely on off-chain information feeds are subject to the integrity of the underlying oracle network. This raises many difficult questions about security, availability, governance, and greatly increases the attack surface. Instead, p2p-DeFi protocols forgo reliance on oracles, in favor of endogenous price discovery.
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No Superfluous "dApp" Tokens - protocols do not require any new fungible tokens. There is no yield farming, no "bootstrapping rewards", no specialized incentive structures. There are never any permissioned batchers, DAOs, or otherwise central entities. ADA is all that this is needed for minUTxO and TX fees. Instead, protocols align demand with market forces to incentivize participation.
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Full Custody - users always maintain complete spending and delegation control over their assets. The only exception is when locking is required to enforce protocol logic, which restricts spending (but never restricts staking).
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Script Staking Credentials - since owner-related actions of script addresses are overloaded to the staking credentials, users can secure their addresses either with a simple stake key or a more complex stake script (Native or Plutus). Users are empowered to secure their addresses via complex access control schemes.
Note In the case of a simple stake key, a regular signature from the stake key will suffice. In the case of a script however, the staking script must be executed (i.e. withdraw 0 ADA from rewards) in the same TX. This means stake address registration is not necessary when using simple stake keys, but is necessary when using staking scripts.
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P2P Concurrency - all user interactions are fully p2p and occur to and from each others' unique addresses, so there must be at least one UTxO for every user of the protocol. Throughput scales with the number of users.
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Frontend/Backend Agnosticism & Interoperability - since all protocols are ultimately just on-chain minting and spending policies, they are frontend-agnostic. They can be integrated in a wide variety of frontends, such as light wallets, simple webpages, or fully custom stacks.
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Emergent Liquidity - Instead of placing orders "against" specialized market-makers, liquidity aggregates naturally from high user volume. Over time, sophisticated traders using bespoke systems/algorithms will arise, becoming de-facto market makers.
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Zero Slippage - All assets are priced purely in relation to other on-chain assets. Slippage is impossible, since transaction validity depends only on exact fulfillment of individual users' terms, and no external variables.
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Censorship Resistance - thanks to frontend agnosticism, ultralow attack surface, and the atomized nature of user interactions, p2p-DeFi protocols offer the highest level of censorship resistance of any DeFi architecture.
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Democratic Upgradability - since addresses are unique, users choose if/when to use new contracts/protocols, at their own discretion. Doing so does not bifurcate liquidity, since the protocols are interoperable across versions. All users share the same global reference script(s), per protocol.
A simple, scalable, p2p-exchange protocol. Users create unique scripts and Beacon Tokens for every swap-pair, so all available pairs are easily queryable. Swaps are highly composable - any transaction can have inputs from swap addresses, provided they have an appropriate output back to the swap address. Using Aiken, the latest version of the protocol can support 10+ swaps composed in a single transaction. Liquidity arises naturally from the incentive for arbitragers to find the most profitable "path" through a sea of open swap-pairs. Users maintain full delegation control at all times.
- Cardano-Swaps protocol - 1.5 ADA transaction fee for a single transaction that fulfills 14 swaps. Zero slippage, no impermanent loss. Composable with other dApps. Full staking support.
- Minswap - a minimum of 2 ADA transaction fee for a single currency conversion[1]. Interoperability with other dApps depends on manual approval/support. Impermanent Loss. Restricted staking support (for LP providers).
A p2p-lending/borrowing protocol with trustlessly negotiable and repayable loans, an on-chain credit-history, compounding interest, and trade-able bonds. Lenders and borrowers negotiate loan terms via a "two-way UTxO handshake". Borrowers can repay loans incrementally, and reclaim their collateral proportionally. Compounding interest and/or recurring minimum payments can be enforced by requiring the borrower to periodically "evolve" their Active Loan UTxO. Lenders may sell their credit in the form of a Bond NFT, which also serves as a Beacon to query the location of the borrower's Loan UTxO.
- Cardano-Loans Protocol - All loan terms are negotiable: what assets can be used as collateral (including NFTs), length of the loan, asset(s) to be loaned out, interest rate (compounding or non-compounding), repayment periodicity (with support for minimum payments). All assets, even ones that don't exist yet, are supported. Composable with others dApps. Full staking support.
- Liqwid - Only DJED, ADA, SHEN, and iUSD are currently supported[2]. Adding support for more assets requires a governance action and trust that the maintainers will implement the requested support. Lack of loan negotiability. Liquidation risk. Low composability with other dApps. Restricted staking support[3].
A p2p protocol for writing and buying American-style covered options contracts. Spreads of contracts of varying parameters can be written against a single UTxO, and buyers can select which to purchase. Upon paying the premium, the buyer mints an "Exercise" Token that lets them exercise the contract up until expiry. The Exercise Token can be sold on a secondary market, just like traditional options contracts. The option writer/seller cannot reclaim the underlying asset(s) until after expiry, but maintains delegation control the whole time.
Currently, there are no options protocols on Cardano.
A secondary marketplace for buying/selling NFTs, fully p2p. Works in conjunction with Cardano-Loans and Cardano-Options for seamlessly creating an aftermarket for bonds and options contracts. Here is an example of the composability possible when using these protocols together.
Note Trade-able Loans/Bonds are still a WIP.
p2p-DeFi Protocols have a ways to go before they are ready for mass adoption. Here are some roadmap items:
Currently, all p2p-DeFi protocols (except for Cardano-Swaps) are written in IOG's PlutusTx language. Although this is a good choice for prototyping, auditing, and maintaining code, it is relatively resource-intensive. With current node parameters, some features are bottlenecked by script execution limits. Newer, more resource-efficient languages like Aiken offer more headroom for additional features and throughput. Aiken implementations for the protocols are currently in development. To express the promise of switching to Aiken, here are the before and after benchmarks for Cardano-Swaps:
| Language | Maximum Number of Swaps | Tx Fee |
|---|---|---|
| PlutusTx | 4 | 1.5 ADA |
| Aiken | 14 | 1.5 ADA |
Similar improvements are expected for the other protocols.
p2p-DeFi protocols are more than the sum of their parts. They are not just standalone dApps, but are an ecosystem of protocols that explore a new design paradigm. Concepts like Beacon Tokens need to be fleshed out and standardized across the community, perhaps in the form of CIPs. Processes for agreeing on the authorship and location of UTxOs containing shared reference scripts must be established. Here is a proposed solution. At minimum, each protocol should undergo an external audit prior to wide adoption.
p2p-DeFi protocols are purely p2p, so bootstrapping users and building liquidity may be challenging. However, there are some large key players that can help catalyze the process. Existing DEXes and lending/borrowing protocols with their own "dApp tokens" are especially interesting, since they may be able to offer additional profit-sharing rewards to token holders in a kind of "decentralized market maker" model.
All p2p-DeFi protocols employ a standardized JSON schema that allows for straightforward integration into existing frontends, like wallets and explorers. The UX/UI afforded by these integrations is essential from a usability perspective. Outreach to such providers is ongoing.
The growth of p2p-DeFi protocols depends on community involvement. Collaboration on Github, Funding from Catalyst, or Twitter discussions are all great contribution vectors. Additional community resources like video demos, tutorials, and a website are being worked on.
For the judges' consideration:
Due to the nature of this project, there is no straightforward way to profit from a VC perspective; there are no tokens, no equity, it is just a family of open protocols. However, it lays the foundation for greatly increasing use and utility of the Cardano blockchain. All ADA holders (especially whales like Emurgo) stand to profit from increased value of Cardano as a whole.
Furthermore, this project creates a platform for others to build on. Traders, creditors/lenders, or more exotic entities like DAO-managed hedge funds can all use these protocols to profit for themselves and their investors.
Since this project is not a typical VC project, here is an alternative funding plan, in order of importance:
- $20,000 first place grant goes directly to developers.
- Funding independent security audits for the protocols (approximately $10,000 each)
- Any additional funds could be invested in startups focusing on algorithmic trading and/or lending using these protocols.