Decentralized Finance

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Abstract DeFi, short, for Decentralized Finance represents a system that harnesses the power of blockchain technology. It eliminates the involvement of intermediaries. Allows for lending, borrowing and asset transfers on the blockchain.This study centers around a DeFi platform that simplifies crypto tokens staking and borrowing processes. Users have the opportunity to join a banking system where they can earn interest by lending their assets and loans using collateral.To ensure fairness and automate calculations this platform utilizes contracts removing the influence of authorities. It operates on the Ethereum blockchain ensuring asset transfers and facilitating peer to peer transactions. In conclusion DeFi revolutionizes how we access services by making them transparent, efficient and accessible, to all. This research delves into a DeFi platform aiming to enhance these qualities contributing to the evolution of DeFis landscape.

Keywords Blockchain, Smart contract,Oracle,Decentralized Exchange,Liquidity Pool

1. Introduction The financial landscape was revolutionized by the introduction of technology starting with Bitcoin in 2009[1]. Blockchain is a ledger that cannot be altered and is visible, to all network participants while being tamper proof. It offers advantages, including security due to the extensive computational resources required to modify the chain transparent transaction histories accessible to everyone and user anonymity protected by private and public keys. By operating in a manner blockchain eliminates the need, for an authority and automates financial processes reducing human involvement.

The issue lies in finance systems where banks and institutions exert control and impose fees on transactions eroding control over assets. The 2008 financial crisis demonstrated the dangers of this system as greed and mismanagement contributed to an economic downturn. While large corporations thrived ordinary citizens suffered, revealing the unfairness of the system.

This research aims to introduce a model of managing assets using automated systems and computer algorithms. The objective is to establish a finance platform based on Ethereum that allows users to earn interest by staking assets and borrow currency with collateral from an independent liquidity pool governed by smart contracts. This project seeks to empower individuals by providing them with secure and transparent options that address the shortcomings of centralized finance.

2. Background and Related Works 2.1 Decentralized Finance Decentralized finance[2] is a relatively new technological advancement that has gained significant popularity over the past decade. Several DeFi platforms have emerged over the years that have been able to bring billions of dollars worth of capital into the decentralized market. The total market capitalization has already crossed 90 billion dollars and is increasing steadily.

Among many available platforms of transactions, more than half of the capitalization value is accounted for by the top five DeFi projects [3]. These existing DeFi projects are the most valuable literature for us to complete this project.

2.2 Related Work Curve Finance (2020) and Compound (2018) are two of the biggest decentralized exchange platforms that are in operation at present. Both of these money market protocols are based on Ethereum and allow super-efficient stablecoin trading. The liquidity in Curve[4] is split across seven ‘curve pools’ where each pool mints its particular ERC-20 token to liquidity providers which can then be exchanged for many different assets. It is known for allowing users to trade with very little slippage and low fees.Compound[5], on the other hand, is famous for allowing users to take out overcollateralized loans. In this platform, users can borrow up to 75 percent of the initial collateral amount. The interest starts to accrue immediately and continues throughout the loan duration; then the name ‘Compound’. The assets in this protocol are represented in terms of C-tokens.

3. Methodology 3.1 Block Diagram Lenders contribute their assets to a shared pool of liquidity which helps create connections, between people who want to deposit money and those who need to borrow it. Lenders earn interest on the assets they provide until they choose to withdraw them. Borrowers on the hand offer their cryptocurrency assets as collateral, which determines how much they can borrow— less than the total value of their collateral in the market. The systems algorithms take into account exchange rates to calculate the loan amount at the current interest rate. Borrowers are responsible for paying interest. The rates are adjusted automatically to maintain a balance between supply and demand. The DeFi protocol oversees all transactions ensuring automated lending and

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Decentralized Finance

can be liquidated. The borrower may initiate this process. It may happen automatically due to market conditions. Measures are in place to prevent any redundancy and ensure tracking of borrowing history. Loans can be repaid to release the collateral.

If a loan is considered bad it will trigger the liquidation process as explained further in the report which discusses its implications, for both borrowers and the protocol.

borrowing processes, for its users.

3.2 Staking Function The staking feature, in a DeFi protocol allows users to lend their assets to a liquidity pool in exchange for earning interest.

The interest rates vary depending on the supply and demand dynamics. Each individual who participates in staking is assigned an identification number. Has a specific wallet address associated with them. These details include the amount they have staked and the interest they have earned far. When users lend their assets it contributes to the pool, which is then utilized for providing loans.

Interest is periodically added to the pool. Unlike banks DeFi rates are flexible. Do not automatically compound due to short term lending arrangements. To ensure accuracy in calculating interest redundancy is prevented. Users have the option to withdraw their assets either in just the accrued interest, with the withdrawn assets being sent to their designated wallet address. Any unused structures related to stakers can be. Cleaned during system updates.

3.4 Use case Diagram Use Case diagram shows the users, admin, the DeFi protocol and the blockchain as the various actors that contribute in the operation of the overall system by passing the functional requests and processing them to obtain the desired results.

3.3 Borrowing Function The borrowing feature of the DeFi protocol enables users to borrow USDC from the liquidity pool with interest rates compared to what stakers receive. To be eligible, for borrowing users need to provide collateral in Ethereum or ETH assets. The maximum amount that can be borrowed depends on the ”Rate of ETH ” which reflects the value of Ethereum in relation to USDC in the exchange market. We obtain real-time Ethereum price data from the Chainlink[6] Oracle, ensuring accurate and up-to-date information for our DeFi protocol. This ensures that there is collateral than the amount borrowed. Borrowers are assigned IDs or keys similar to stakers containing information like the borrowed amount, timestamp, total interest due and collateral deposited for loan security. In case a borrower defaults on their loan or if there are market fluctuations their collateral

3.5 Liquidity Pool The liquidity pool acts as the element of the DeFi protocol. It serves as a repository, for USDC assets. Provides funds for lending to borrowers. Think of it as a representation of the assets at any given time. The pool grows when stakers deposit USDC expanding the funds and shrinks when borrowers withdraw USDC in exchange for Ethereum collateral reducing the assets.

Likewise when borrowers repay their loans they return the borrowed USDC to the pool increasing the tokens. Stakers have the option to withdraw their assets whenever they want which decreases the amount in the pool.It’s important to note that these fund movements don’t require actions. Borrowers are not 2

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obligated to withdraw loans after staking them. Stakers do not have to wait for borrowers to repay before withdrawing their assets. Although stakers and borrowers impact the liquidity pool their actions are not dependent on each other; they can make choices independently based on their preferences.The pool plays a role in maintaining a balance, between the supply and demand of USDC tokens within the protocol. This equilibrium helps establish interest rates and prevents situations caused by excessive activity from either stakers or borrowers.

value of the borrowed assets due to market changes. This helps manage risks. The process involves some automation, where administrators initiate liquidation. The system automatically identifies accounts that qualify for it based on factors like interest.

During liquidation the collateral assets are sold at market prices through Uniswap[7]. Any obtained USDC is added back to the liquidity pool to recover losses incurred by borrowers. This proactive approach along with using assets like Ethereum and USDC enhances stability within the protocol. Reduces risks associated with asset value fluctuations, in the dynamic crypto market.

4. Experiments and Result This section describes the detailed procedure of deploying and testing the smart contract and the web application designed for transactions of USDC and Goreli ETH using Metamask.

4.1 Smart Contract deployment and testing One smart contract was developed on the Ethereum testnet and following unit tests were conducted to ensure its proper implementation.

4.1.1 Connection to the Wallet (MetaMask)

The test included establishing a secure connection with the MetaMask network by encouraging the users to input their credentials in order to make use of the services accessible through the web application.

3.6 Intrest Mechanism The functionality related to interest plays a role, in the operation of the liquidity pool. Borrowers are responsible for paying interest into a shared pool (interest pool) while stakers receive their interest from the pool. This interest pool helps maintain balance in the liquidity pool. When more borrowers join it increases the interest making staking more attractive. On the hand if there is an influx of stakers it reduces individual interest earnings. The interest rates for both stakers and borrowers are not fixed and can vary based on market conditions changes in supply and demand and other factors.Stakers interest is determined by the rates offered to existing stakers. Is distributed at intervals aligned with blockchain block creation. This method helps stabilize fluctuations in interest rates. May result in patterns without any intervention.Borrowers experience interest rates over time ensuring consistency in their loan payments.

However stakers interest earnings are proportional to their share of assets being staked. This allows for distribution of earnings, among all stakeholders. Helps maintain a balanced supply demand ratio within the protocol.

4.1.2 Transfer of funds

Various forms of transaction involving the Goreli ETH and the USDC assets were verified to be accurate and secure. These transactions involved the users and the smart contract’s liquidity pools as the interacting parties.

4.1.3 Calculations

Several calculations that needed to be performed by the smart contract for the proper functioning of the system were evaluated and verified to be consistent with the expected results. These tests verified the accuracy of the interest rate calculation, interest amount calculations, and also evaluations of conditions that were subject to triggering liquidation clauses.

4.2 Borrowing of USDC assets The borrowing transaction involved the transfer of Goreli ETH from the Ethereum wallet of the borrower to the liquidity pool of the smart contract and in return transfer of USDC assets from the liquidity pool to the Ethereum wallet of the borrowing party.

This transaction supplied the collateral Ethereum to the finance protocol while also generating a means for the usage of the USDC assets staked by the lenders.

3.7 Assets liquidation Liquidation is a safety measure, within the DeFi protocol. It is triggered under conditions, one of which’s when a borrower fails to repay their loan or interest on time. This helps protect lenders and ensures that the funds are recovered. Another situation that may lead to liquidation is if the value of the assets falls below the 3

Decentralized Finance

4.4 Interest Rate Calculation The calculation of interest rate offered to the staking users is dynamically calculated using real-time asset valuation data accessed from the interest pool. The smart contract periodically performs the calculations with the use of the latest data from the interest pool to update the interest rate to be used to perform transactions with borrowers and stakers.

4.5 Interest Amount Calculation The calculation of the interest amount happens in two distinct, yet interrelated portions: • Interest Amount charged from the borrowers The smart contract calculates the interest amount to be charged to each of the borrowers using the dynamic interest rate obtained from the interest pool data. The interest amount thus paid by the borrowers is added to the interest pool, also maintained by the same smart contract, which then becomes the source of interest amount to be paid to the staking users.

• Interest Amount paid to the lenders The smart contract calculates the ratio of USDC assets skated by each staking user to the total USDC assets staked in the platform. Then, the calculation of interest earned by each lender is performed using the ratio same ratio. The smart contract pays out the calculated amount of interest to the lenders using the assets collected in the Interest Pool.

4.3 Staking USDC assets The staking function allows the users of the web application to lend their USDC assets to the liquidity pool to earn a certain amount of interest in return for the lent assets. This feature allows the protocol to collect the required USDC assets to populate the liquidity pool and initiate transactions with the stakers.

4.6 Withdrawal of assets The users, either lenders or borrowers, can withdraw their assets from the liquidity pool by initiating various events in the protocol.

The lenders can simply choose to withdraw their due interest or the whole principal sum at any time. The borrowers, on the other hand, can withdraw their collateral assets by repaying the total sum of USDC borrowed plus the due interest amount.

4.7 Liquidation of assets Liquidation of assets is a major feature of the smart contract to ensure the fiscal security of the lenders as well as the stability of the platform itself. The smart contract is designed to undertake 4

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the liquidation functions automatically by periodically evaluating the conditions stipulated in the smart contract. This liquidation can be performed on two separate occasions:

the distribution of interest established a trustworthy system for the crypto owners to use and earn from their assets. Integrating a wider variety of crypto assets in the platform and enabling their transactions can further enhance this system by attracting more users and increasing the transaction volume through the application.

• If the amount of outstanding due interest for a specific borrower exceeds the threshold percentage (50) of the borrowed amount.

References

• If the net value of the borrowed asset depreciates in the global market causing it to approach a threshold level that could cause loss to the platform even upon its full repayment.

[1] Caleb Silver. Over 10 years later, lessons from the financial crisis.

[2] Antier Solutions. Understanding the business scope for defi, Dec 2020.

[3] Milko Trajcevski.

Top 5 defi projects by market capitalization, Mar 2021.

[4] PYMNTS.com. Pymnts defi series: What are the top defi platforms?, Dec 2021.

[5] Robert Leshner and Geoffrey Hayes. Compound: The money market protocol, Feb 2019.

[6] Chainlink. How chainlink price feeds secure the defi ecosystem, April 2022.

[7] Hayden Adams, Noah Zinsmeister, and Dan Robinson.

Uniswap v2 core, Mar 2020.

5. Conclusion An interactive web application provides a platform for crypto owners to access the services of the smart contract including transfer of funds, staking and borrowing of crypto assets. The deployment of the smart contract and the web application, the use of the MetaMask wallet and the implementation of the contract in the Ethereum blockchain provided a secure platform for users to trade their assets over the internet. A fully transparent and automated system to dynamically calculate the interest rates and

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