Decentralized Finance

by David Stancel

What are the implications of Algorithmic finance?
What are its advantages?
Seed Phrase (Mnemonic Phrase)
What Is It?
A seed phrase is a series of 12-24 random words.
It's the master key to your entire crypto wallet.
  • Generated using BIP-39 standard
  • Words chosen from a predefined list of 2,048 words
How It Works
Your seed phrase mathematically derives all your private keys.
One seed creates infinite addresses across multiple blockchains.
  • Allows wallet recovery on any compatible device
  • Hierarchical deterministic (HD) wallet technology
Security Practices
Never store digitally or take photos of your seed phrase.
Write it down and store it securely offline.
  • Use metal backup solutions for fire/water resistance
  • Consider splitting into multiple locations
Seed Phrase (Mnemonic Phrase)
A seed phrase is a human-readable representation of a cryptographic root key, typically consisting of 12 or 24 words drawn from a predefined wordlist (e.g., BIP39 standard). It serves as the master key from which an entire deterministic wallet structure—including multiple private keys and addresses—can be derived.
In practice:
  • A single seed phrase can generate many wallets across multiple chains.
  • It acts as a backup of identity and access, enabling full recovery of wallet contents even if the original device is lost or destroyed.
PRIVATE KEY
Mathematical Proof
A private key is a long, randomly generated number (usually 256 bits) that provides mathematical proof of ownership over a given blockchain address.
Transaction Signing
It enables the user to sign transactions, proving authorization without revealing the key itself.
Cryptographic Security
Cannot be reversed or guessed due to the strength of elliptic curve cryptography.
- Derived deterministically from the seed phrase using cryptographic functions (e.g., HMAC-SHA512).
- Each private key corresponds to a unique public key and address.
Key Functions:
Authenticate a transaction without third-party approval.
Authorize movement of funds.
Establish identity in decentralized systems.
DeFi CONCEPTS
Key Features of DeFi
Completely Transparent
  • Blockchain
  • Open-Source
Eliminates Middlemen
Direct peer-to-peer transactions without traditional financial intermediaries
Trust-minimizing
Relies on code and cryptography rather than human trust
Open and permissionless
Anyone can access services without approval
Composable
Protocols can be combined in innovative ways
Unprecedented automatization
  • algorithmic finance
  • programmable money
Novel financial instruments
  • Stablecoin with no counterparty risk
  • Flash loans
Key Risks & Security Practices
Protocol Risks
  • Smart contract bugs can lead to complete fund loss
  • Impermanent loss may exceed LP earnings
  • Rug pulls leave investors with worthless tokens
User-Level Threats
  • Phishing sites mimic legitimate DApps
  • Token approvals grant unlimited spending access
  • Unverified protocols offer zero consumer protection
Security Best Practices
  • Regularly audit approvals via revoke.cash
  • Bookmark verified DApps to avoid phishing
  • Use hardware wallets or multisig for large holdings
Crypto Economics Valuation
Token Function
Used for Governance vs collateral vs currency
Incentive Alignment
Properly aligns incentives across stakeholders
Scarcity Mechanism
disinflationary vs deflationary vs burned
Value Generation
The mechanism to generate value
Network Effects
The mechanism to generate network effects
Tokenomics Value Accrual Mechanisms
Economic Design
Token buybacks (Binance) and profit-sharing models generate value for holders through scarcity creation.
Utility Functions
Infrastructure operation and fee collection (RenProtocol) tie token value to protocol usage.
Security Models
Proof-of-Stake with slashing (Cosmos) aligns validator incentives with network health.
Governance Rights
Decentralized governance (MakerDAO) and ownership (NFTs) create intrinsic value through participation rights.
Stablecoins
Fiat-backed
Tether - USDT
Backed 1:1 by traditional currency reserves
Crypto-backed
Dai
Collateralized by cryptocurrency assets
Algorithmic
TerraUSD - UST
Maintains peg through algorithmic mechanisms
Revolution:

From CEX to DEX
Uniswap
Decentralized Exchange Protocol
Uniswap is a fully decentralized on-chain protocol for token exchange on Ethereum that uses liquidity pools (AMM) instead of order books.
Liquidity Provision
Anyone can quickly swap between ETH and any ERC20 token or earn fees by supplying any amount of liquidity. And anyone can create a market (i.e., liquidity pool) by supplying an equal value of ETH and an ERC20 token.
Market Mechanism
Uniswap allows only one market per ERC20 token. The market creator sets the exchange rate, which shifts through trading due to Uniswap's "constant product market maker" mechanism. When trading reduces one side of the pair's liquidity relative to the other, the price changes. This creates arbitrage opportunities, encouraging more trading.
Aave
Decentralized Lending Protocol
Aave is a decentralized protocol that lets you lend and borrow crypto without intermediaries.
Liquidity Pools
Lenders earn interest by supplying assets to liquidity pools.
Collateralized Borrowing
Borrowers provide collateral and take out loans instantly.
Dynamic Interest Rates
Interest rates adjust algorithmically based on supply & demand.
Smart Contract Automation
Everything is transparent, permissionless, and runs on smart contracts.
🧠 Think of Aave as a decentralized money market—where you're the bank.
Pendle
Pendle lets you split future yield from your tokens into tradable components:
Your DeFi token (e.g., stETH, aUSDC) is split into:
  • Principal Token (PT) – the base value.
  • Yield Token (YT) – the future yield stream.
You can sell future yield now, buy discounted principal, or speculate on rate changes.
Resources:
Relatively Safe Investment options for BTC, ETH, USDC - https://app.ether.fi/
Even safer option but lower yield - https://app.aave.com/
Guide on Staking & BTC Yield options - https://davidstancel.com/blog