Automated Market Makers, Liquidity Pools and Automating Interest
Banks offer far more services than simply being an account. They make money off loaning money to others in the form of interest. By placing money into a bank account, the bank can then use that money to lend to others. By lending to others they charge an interest amount greater than what they pay for holding money and then profit off the difference. In short, the money you deposit in a bank account is made to create more money for the bank which gets delivered back to you in the form of interest.
In the current system this requires vast amounts of accounting systems. Being able to view when exactly people opened accounts, how much they have invested and ultimately how the money in the system produces more money. You can imagine the overhead required for this as accountants and finance experts are needed to ensure money is both being protected (FDIC) but also that money continues to yield profits on an ongoing basis.
Liquidity pools and automated market makers are the answer to traditional finance’s moving of assets for profit. Instead of the overhead of hiring traders and book keeper’s, though, it’s all automated. Once your money is deposited into an account or wallet it is then used as liquidity to execute additional trades.
Whereas traditional finance must factor the overhead of employees into the equation, this method does not. The result is that instead of fractions of a percent of interest in traditional accounts, your money can work as much as 100% interest depending on asset usage. Additionally, due to bookkeeping being done on the blockchain, accounts are always up to date which results in the ability for interest to be paid daily vs monthly or yearly in traditional finance.
This is where you can see both the amazing benefits of blockchain but also where the hesitancy lies. Due to automation, the need for accountants and finance professionals goes away. The large systems that traditional finance relies on also become extinct with amortized debt needing to be written off, there’s few incentive for change into the new systems outside of the drastically reduced operating costs.
This is, again, where regulation needs to step in at the primary blockchain layers. Because of the vast automation, rules such as consumer protections in the form of FDIC come into play. There always needs to be enough money within liquidity pools for consumers to withdraw their initial deposits. Today, this requires vast reporting standards and, again, teams of accountants to calculate and ensure compliance. In the blockchain realm, though, this will be programmed into algorithms. As part of the regulatory acceptance process of a blockchain being available to citizens, it must prove these safeguards while also ensuring the ability for new laws to change requirements. When a new law is passed each blockchain should be allotted a given constraint towards compliance which will incentivize proper coding architecture.
The boon for consumers is clear, though. With interest rates this high many can rely on a single account for retirement savings and negate the need for further services. Liquidity pools or the brands running their own assets then remain fully focused on increasing what assets can interoperate between which facilitate these automated trades. The ones which do best will be low overhead resulting in higher interest rates.
Think Chase Freedom or Citi Premier, both are two separate credit cards offering different cash back rewards and benefits. In the blockchain realm, theoretically each “credit card” would be its own asset and likewise have its own liquidity pool or interest rate for being a part of its network. However, instead of interest working against you, the liquidity pool enables interest to work for you.
DeFi in its current state relies on over collateralization of assets to determine your creditworthiness. In many cases this would represent 200%. So if you had $100 you’re entitled to up to $200 of credit. Again, thanks to real time accounting standards, adding or subtracting your account could affect your limit immediately in the form of the asset’s balance within your account.
As the technology advances credit blockchains would be able to utilize open source technologies to better adjust the collateralization multiplier. As a managed service this could leverage the government ID to scan all assets for more accurate readings. Opening additional credit lines which would be flagged on your ID account for instance may result in a lowered multiplier.
What happens when you spend from your credit account is currently theoretical but leverages many concepts such as token-omics. As merchants would want their own cash assets to accrue interest from liquidity pools, the merchant ideally would want cash (primary blockchain) payment, However, because there are no longer intermediaries, a merchant could potentially miss a sale if a consumer wishes to pay via credit. It’s at this stage that the consumer’s account balance would shift to the merchant’s.
Because the consumer has now received the purchased goods it’s now on the merchant to receive payment via the protocol (creditor). The merchant, now having the credit asset, will not be able to accrue interest on it. It’s in essence now accounts receivable.
However, the credited account would be accruing its own interest within the protocol. The credited asset’s interest would transition into the primary blockchain’s merchant account daily, again, thanks to blockchain’s self updating nature and a shared government ID.
As it does so the credited asset also flows back into the consumer’s credit account at the same rate interest is accrued. The merchant would then be able to start accruing it’s own interest once on the primary chain immediately.
Thanks to blockchain’s transactional records, the credited asset in the merchant’s case could still be utilized as payment, though. In this case a merchant may pay for goods using the credit balance. Because the credit balance is, again, linked to the government ID, its primary blockchain interest payout will always be relative to its total credited account balance which will continue to shrink as interest is paid. In essence the creditor’s assets act as an interest bearing bond yielding its interest rate relative to the initial credited asset’s principal.
Because credit asset usage may some day reflect a credit multiplier in real time, consumers would be able to purchase up to their credit limit back. These funds would then be sent not to the protocol (credit asset) but to the merchant directly resulting in the merchant’s credited account balance to zero out (for that transaction). In the case of a merchant account spending the asset before it fully yields, the blockchain would remember the initial transaction principal so that the transaction’s payment would instantly turn to the primary blockchain’s dollar amount regardless of where it was located. A merchant of a merchant in this case may see their credited account transition into their primary account quicker.
In this scenario, credit asset providers would still be running a business and likewise be looking to profit. Their primary account balance would be pegged to the sum of all their outstanding credited account balance plus additional capital (talked about later). Thanks to automated market makers, this lump sum of money would be yielding, again, anywhere from 1–100% on a daily basis as assets automatically seek to balance each other,
Their overhead target would then be maximizing interest yield while simultaneously offering merchants compelling daily interest rate returns for using their service. This is where competition will emerge as merchants will want their accounts receivables to turn into interest bearing accounts as quickly as possible.
A protocol, creditor, with a low interest rate may not be desirable for a merchant so the merchant chooses to not support it. The causality then being reduced primary blockchain yields for that given creditor and likewise less profitable business.
Staying small and nimble, not large and monolithic then will drive profitable creditors in the future.