[Parker] The secret behind a one million percent interest
[Parker's Crypto Story] The DeFi annual interest rate craze seems to have hit its peak and is entering a lull. This is only because of the side effects of unsustainable projects designed solely to drive up the yield and governance tokens. As a testament to this, most of the total value locked or TVLs of Ethereum-based DeFis were occupied by traditional powers such as Aave, Maker, and Uniswap as of September 15. This is quite different from the news that speculators are flocking to Sushiswap, kimchi, and hot dogs. Why is this trend happening in the DeFi ecosystem right now? The answer is in the unique annual percentage rate mechanism that is different from conventional finance. #The MM Model of traditional finance and DeFi DeFi does not use the simple interest model, but uses an entirely different transaction method than conventional finance. In the world of traditional finance, market makers are used to reducing the market spread, or the gap between the lowest selling price and the highest buying price. There are also market makers in centralized cryptocurrency exchange. They provide liquidity to the market by receiving benefits such as a reduction over market taker. The more smoothly this market maker system is applied, the more likely buyers and sellers close deals at the desired price. Existing finance uses market makers to solve the problem of slippage, or the price gap between buyers and sellers, the Defi ecosystem is struggling with. On the other hand, the Auto Market Maker (AMM) of DeFi is automatically performed by code and formulas. Before AMM was born, the DeFi ecosystem focused on simple deposits, securities and DEX, or Decentralized Exchanges. A DeFi project called Uniswap brings this AMM model to a turning point. Unlike the market maker system, AMM only serves as a simple liquidity provider (LP) for people. If the LP injects liquidity into the pool for a particular pair of transactions, it will be compensated 0.3 percent of the fee. While doing so, AMM uses a formula called X*Y=K to build ecosystems. It's a system that's completely different from traditional finance. #The principle behind a one million percent interest rate Since then, the DeFi industry has achieved explosive growth by introducing a separate compensation token payment system for those who supply liquidity according to designated interest rates. Uniswapp's spin-off project, commonly called as the "food swap," drew attention both inside and outside the industry as news broke that annual percentage rates had temporarily surpassed the 1 million mark. How could this happen? Sushi-swap, one of the first type of food swaps, said "the exact value is unknown because annual percentage rate varies based on commission and usage." GrowPi's co-founder Mu Jong-woo said, "for Sushi-swap or Kimchi Finance, the annual percentage rate is determined based on the token price." "The reason these projects showed abnormal annual percentage rate earlier was because the value of the token was high despite liquidity pool funds being extremely low," said Mu. In the end, there wasn't much of a principle behind the high interest rate. However, since the food swap also uses Uniswapp's AMM, its interest rate changes depending on the size of the liquidity pool and token price. The surprising incident was a result of someone applying the concept of a governance token.