In this video, we will explore the concept of “Proof of Deposit” as a new primitive in the world of decentralized finance (DeFi). This tutorial is based on a transcript of a talk by John Fletcher, the CEO and co-founder of Cambridge Cryptographic, who proposes this governance proposal for Celo, a blockchain platform. We will discuss the importance of credit risk-free interest rates and stablecoins in the financial system and how Proof of Deposit can fill the missing piece in DeFi. Let’s dive in!
Proof of Deposit is an innovation that rewards holders of native stablecoins with interest, without any additional risk. It is analogous to the credit risk-free interest rates provided by central banks in traditional finance. The goal is to introduce stability into the blockchain ecosystem by incentivizing users to hold stablecoins and increase demand for them. This, in turn, positions stablecoins as a safe haven asset during market downturns.
Interest rates play a crucial role in finance and the economy. They determine the cost of borrowing and influence investment decisions. In traditional finance, the interest rate that banks receive for depositing money with the central bank is considered the risk-free rate. This rate sets a lower bound for commercial interest rates and ensures stability in the economy. However, blockchain lacks such a mechanism, and Proof of Deposit aims to bridge this gap.
By implementing Proof of Deposit, stablecoins become more attractive to investors. Holders of stablecoins are rewarded with a credit risk-free return, which offsets the effects of inflation and offers a hedge against market volatility. During a market crash, when other cryptocurrencies experience a decline, stablecoins become a preferred choice for liquidation. This increased demand for stablecoins leads to a buffering effect on the overall market, stabilizing prices and preventing the complete exit of money from the system.
Proof of Deposit is particularly beneficial for blockchain platforms with their own native stablecoins, such as Celo and Terra. It strengthens the value proposition of these stablecoins, making them more attractive to investors. Increased demand for stablecoins can lead to a rise in their market capitalization and the overall value of the blockchain platform. This incentivizes validators to compete for stablecoin deposits, creating a dynamic ecosystem that benefits both users and the platform.
Proof of Deposit not only addresses the missing piece in DeFi but also solves an outstanding problem in macroeconomics. Traditionally, central banks set interest rates to stabilize the economy. With Proof of Deposit, a market-determined risk-free interest rate becomes possible, promoting healthy economic growth and countering economic downturns. However, it is important to note that more work needs to be done to ensure the optimal interest rate for economic growth and stability.
The implementation of Proof of Deposit opens up new possibilities and applications. In the future, commercial banks may hold stablecoins as capital reserves, offering stability and resilience to the financial system. Additionally, the concept can be further explored and potentially tailored to the needs of central banks, creating opportunities for collaboration between blockchain platforms and traditional financial institutions.
Proof of Deposit presents a transformative concept for DeFi, providing credit risk-free interest rates to native stablecoin holders. It enhances stability, increases demand for stablecoins, and introduces market-determined interest rates. The workshop mentioned in the talk provides an opportunity to delve deeper into the subject and discuss potential implementation strategies.