No matter what protocol it is, if a fund is utilized multiple times, it is leveraging; the more it is used, the greater the risk.

Written by: Huang Shiliang

Recently, I studied the Alpha mechanism of BN, which is quite popular in the industry, but I seem to have little interest in it. However, I want to share three other BN products and reflect on BN's ability to follow DeFi's innovation, as well as the spread of DeFi's leverage risks to CEX.

I used to think that in the competition between DEX and CEX, CEX should be very mature and wouldn't have any major innovations. However, the development of BN over the years has completely contradicted my judgment. Binance has indeed managed to protect its CEX moat while capturing a large amount of DeFi business.

It seems that as long as one is willing to invest and remain open, there is always room for innovation in even the most mature products.

These innovations from Binance make me feel that Binance has fully utilized DeFi's innovations, combined with a centralized experience, which has indeed enhanced user stickiness.

The first product was actually a failed product for Binance. However, I was quite surprised that Binance dared to launch this product at the time.

Binance, about three years ago, imitated Uniswap's AMM protocol and created a liquidity pool trading method on the Binance CEX platform that allowed users to add LP Tokens. The algorithm was essentially a complete copy of Uniswap v2. For example, users could add a liquidity pool for BTC/BNB, and then other users could directly swap BTC for BNB, while users who added to the liquidity pool could earn transaction fees.

We have heard many stories of large companies in various industries refusing to adopt new innovations because launching innovative products would compete with their existing market, ultimately leading to the downfall of these large companies.

For instance, Nokia was the first to invent the smartphone but failed to transition to smartphones on a large scale due to fear of impacting its dominant market position in feature phones, which ultimately led to Nokia's failure.

A similar case is Kodak, which refused to develop storage card cameras to protect its film business.

At that time, Binance dared to launch the AMM algorithm for adding liquidity pools and swap trading, attempting to directly challenge the largest order book business of CEX, which I found quite determined.

However, I still overestimated the opportunity for the AMM protocol in CEX, as the development led to Binance shutting down this product.

The second product is Binance's flexible wealth management, which is essentially modeled after lending protocols like Aave.

Binance's flexible wealth management is fundamentally a lending product. Users can deposit various coins into flexible wealth management, creating a deposit pool. The deposits can then be used as collateral to borrow other coins within the flexible wealth management.

For example, you can deposit ETH into flexible wealth management, and then this ETH can serve as collateral to borrow USDT. ETH deposits can earn interest, while USDT loans require interest payments.

This pooled lending method, compared to peer-to-peer (P2P) lending, greatly improves capital efficiency and flexibility. In P2P lending, the collateral of the borrowing user cannot earn deposit interest. Additionally, the funds of the lending user need to be matched to be lent out, and if not matched, they do not earn interest. The pooled method ensures that interest is always available as long as someone borrows, with all deposits sharing interest based on the amount, and deposit users can redeem their deposits at any time (in most cases), unless a bank run occurs.

I checked multiple other exchanges, and their lending services are still P2P; only Binance offers this pooled AAVE model. Clearly, this model provides users with better flexible interest rates and more flexible leverage conditions (earning flexible interest while also borrowing coins).

These new advantages are all brought by DeFi and utilized by centralized institutions like BN.

The third product is BN's issuance of liquidity tokens like BFUSD and FDUSDT based on the restaking model of reusing liquidity tokens.

In simple terms, BFUSD allows users to purchase a wealth management product from Binance using USDT and USDC, and Binance will return a BFUSD token (liquidity token) to the user, which can also be used as collateral in Binance's contract account for trading contracts.

This way, users can earn returns from the purchased wealth management product while also speculating in contracts with the same funds.

Similarly, the FDUSDT token is essentially the liquidity token for Binance's flexible wealth management, equivalent to AAVE's a-token. When users deposit USDT into Binance's flexible wealth management, Binance gives them an FDUSDT token, which they can then use to trade contracts.

Thus, with the same funds, users can earn interest from flexible wealth management while also speculating in contracts.

Of course, statistically speaking, speculating in contracts often results in a small portion of users making profits, while the majority tend to incur losses in the long run; such products are indeed crazy.

This reuse of liquidity tokens in other protocols for mining is a well-known trick in DeFi, and now it has been learned by CEX.

This innovation in DeFi has been adopted by CEX, and among several major exchanges, I only see BN doing this; other CEXs are not. This is quite strange. Don't other CEXs realize the efficiency of such funds, where one fund can be used multiple times, which has always been the greatest demand for speculation? Are they all very restrained?

I speculate that one possibility is that these DeFi techniques and tricks are essentially leveraging, which inherently amplifies the risks brought by volatility. To mitigate these risks and prevent various leveraged products from being liquidated during significant volatility, a very large market depth is required, which may be a condition unique to Binance.

To be honest, if we were to look back three years (before 2022), I would have admired DeFi, feeling that the various combinability of funds was excellent, which is what finance needs, what capitalism needs. However, after experiencing one round of significant market volatility after another, with ETH's price consistently experiencing massive fluctuations, I feel that the leverage effect of DeFi carries a certain original sin.

Now that CEX has also learned these tricks, I wonder if it will evolve into a huge disaster in the future.

Please remember, no matter what protocol it is, no matter what tricks are used, if a fund is utilized multiple times, it is leveraging, amplifying the volatility risk; the more it is used, the greater the risk.

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