Observing the DeFi market and token distribution reform from the A-share market

This article is published in the Benmo Zone.

If the A-share market's new stock issuance delivers risk-free new stock benefits as an exchange for shareholders to lock up their shares, then DeFi similarly delivers risk-free new coin benefits in exchange for token holders to lock up their LP pairs. Locking up LP pairs can trigger a reversal of supply and demand, leading to skyrocketing token prices and subsequently generating positive feedback.

Many people are confused about why DeFi (Decentralized Finance) can rise, and even surge dramatically. As someone who previously worked in securities investment, I can say that I am a time traveler living in two parallel worlds. I have discovered that DeFi is very similar to the new stock issuance reform of 2014. This DeFi bull market, and even the cryptocurrency bull market, is likely to follow a path and outcome similar to that of the A-shares in 2015.

Reviewing the 2014 A-share new stock issuance reform

Due to some issues with the "inquiry-based issuance" of new stocks in the A-share market in 2010, by the end of 2013, the new stock issuance system was reformed into the current model of "market value allocation and lottery drawing." According to the "Measures to Improve the New Stock Issuance Reform," new stocks are issued at a fixed price-to-earnings ratio of 23 times, with the lottery share determined by market value. Additionally, there are limits on price fluctuations on the first day of listing, initially set at 20%, then 10% daily, later changed to 44% on the first day, followed by 10% daily, while currently, there are no limits for the Sci-Tech Innovation Board and the Growth Enterprise Market.

This reform was initially criticized by the "market faction," claiming it was a return to "planned economy." However, as new stocks surged after issuance, shareholders began to feel that it was "really good." Investors bought some large blue-chip stocks in the Shanghai and Shenzhen markets as lottery chips, getting new stocks for free. After winning the lottery, the stock would be locked at a 44% increase at the opening, followed by continuous daily limit-ups with no trading volume, ultimately resulting in total gains far exceeding the increases before the new stock issuance reform under the "inquiry system." Before the reform, shareholders criticized the "inquiry system" for its "three highs" in issuance prices, with profits taken entirely by the primary market. Now, with the new system, all gains after the listing at a 23 times P/E ratio were captured by shareholders. It was indeed "really good!"

Initially, I also had the intellectual arrogance of a scholar, thinking this reform was not "market-oriented," and I even expressed skepticism about it. Later, I won a lottery for a stock and unexpectedly made 100,000 yuan! It was too good; who cares about inquiry or market orientation—just stay away!

In fact, looking back now, the issuance at a 23 times P/E ratio redistributed part of the benefits that the listed companies should have raised to shareholders. If companies set their own prices, the issuance price could have been at 46 times, allowing them to raise twice as much capital. However, this portion of funds was not raised for the company but became a price difference between the primary and secondary markets, benefiting those who subscribed to the new stocks.

Before the reform, stocks issued under the "inquiry system" had relatively high prices, with listed companies and primary market investors earning more, leaving very little for retail investors, who complained due to their losses. After the "reform," the profits that used to go to listed companies were now in the hands of winning shareholders, making shareholders happy while listed companies cried. Moreover, shareholders did not express gratitude for the "lower issuance price" but instead engaged in rampant speculation, driving the 23 times P/E ratio stocks up to 100 times. If it had followed the original inquiry system, the issuance price would have been at most 50 times, and it might have even dropped after listing.

The most ridiculous part is that stocks issued at a 50 times P/E ratio under the inquiry system are more valuable than those issued at a 23 times P/E ratio because the latter raised less capital, indicating weaker company strength. The 23 times P/E ratio merely represents the benefits transferred to the lucky winners, and once it opens, it turns into a worthless token with a 100 times P/E ratio and less capital raised.

However, reasoning in the stock market is futile; it just keeps rising—where can you reason about it?

Comparison of DeFi and the 2017 ICOs

I won't reiterate the frenzy of ICOs in the cryptocurrency market in 2017. However, upon closer examination, the ICO model is strikingly similar to the "inquiry system" for new stock issuance! During the late 2017 frenzy of coin issuance, ordinary retail investors could hardly access ICOs or invest in projects, often needing to pay someone to invest on their behalf or participate in "funds." Before a coin is listed, it often undergoes multiple rounds of private financing, and when it finally lists on an exchange, it is like a new stock under the "inquiry system," debuting at an extremely high price and plummeting immediately, harvesting a large number of retail investors.

The criticism of ICOs stems not only from unreliable projects but also from the severe situation of teams and various private equity funds exploiting investors, reminiscent of the previous issuance system in A-shares, where companies like Haipu Rui and Huarei followed this pattern: high-priced issuance, high opening prices, with the opening price being the highest, completely resembling a zero-value token model.

The most significant improvement in DeFi is the enhancement of initial token distribution. New projects in DeFi do not have private equity funds or pre-ICOs; the project's tokens are gradually released to investors through completing certain tasks (such as being an LP, liquidity provider). This shifts the enormous benefits of token listings from individuals like Li Xiaolai, Guo Hongcai, Yi Lihua, and Lao Mao to ordinary retail investors.

It is important to note that, like the stock market, the cryptocurrency market is ruthless, and capital is equally bloodthirsty. In the past, during certain project booms, some large funds would find ways to block the ETH network, preventing small accounts from issuing contracts, or use various methods to hoard most of the early tokens for themselves. Nowadays, many DeFi projects require initial deposits into pools, and tokens can only be released through mining, objectively eliminating the possibility of large funds monopolizing primary market price differences. Many retail investors have made millions just by claiming free tokens from airdrops.

Moreover, objectively speaking, participating in mining projects is a win-win situation. Besides locking up tokens to help prices rise, investors also help projects complete certain tasks. For example, in DEX projects, participating as an LP in Uniswap means working for the project while holding tokens (the work of DEX is to provide liquidity). In lending-type DeFi contracts, some involve lending mining, which objectively enables the lending project to operate because deposits are necessary for loans.

Through this approach, not only can projects start from scratch, but many individual investors also rise through these projects. If we use new stock subscriptions as a metaphor, winning a lottery in the crypto world could potentially earn millions.

Thus, DeFi has improved the distribution of initial token benefits, providing significant concessions compared to ICOs, allowing more people to share in the rising benefits of token projects. This benefit provides the cryptocurrency circle with a relatively high risk-free yield (equivalent to the risk-free yield of new stock subscriptions in A-shares) ------ which may attract off-market funds to enter.

The overheating of new stock issuance leads to a bull market cycle

After the new stock issuance reform in 2014, due to the explosive rise of new stocks, the gains far exceeded those of already listed companies in the same industry, leading to a retaliatory rebound of many old stocks in the same sector. That year, the Growth Enterprise Market experienced a bull market. The A-share market saw new stocks rising alongside old stocks, with returns originating from the low-risk yields generated by subscriptions.

On the other hand, the market value allocation policy was also a transaction with retail investors. At that time, the A-share market had been in decline for years, with large-cap blue chips ignored, and the cost of delivering benefits to retail investors at a 23 times P/E ratio was that retail investors bought in to protect the market. Thus, the capital used by retail investors for lottery subscriptions became staking, objectively significantly reducing the circulating chips in the A-share market. This portion of locked-up market value gained excess returns from new stock subscriptions, effectively offsetting the risks of capital depreciation.

By 2015, quantitative changes turned into qualitative changes, as the locked-up capital began to rise (due to various factors, including increased demand from market value subscriptions and the central bank's loose monetary policy ------) new stock subscriptions transformed into "rising capital + new stock profits," creating risk-free windfall profits. Funds accelerated their entry into the A-share market, which was then further fueled by relaxed regulations and leveraged financing, leading to a frenzied bull market. Countless lives were changed as a result.

This also explains why, in 2015, the market widely believed that A-share listed companies experienced significant increases despite no improvement in performance. Besides monetary easing, it likely had a lot to do with the market value allocation policy. The market value allocation policy unexpectedly triggered a positive feedback loop, combined with loose monetary policy and lax regulatory environments, leading to an uncontrollable bull market.

Can DeFi staking trigger a positive feedback bull market in the cryptocurrency circle?

Similarly, DeFi staking is likely to trigger a positive feedback bull market in the cryptocurrency space. In DeFi, most projects require participation as an LP to receive project tokens, meaning you need to hold a certain amount of coins to receive the new tokens from the project, which have enormous risk-free benefits. This is akin to having a market value of 10,000 yuan to enter a lottery for new stocks.

If the A-share market delivers risk-free new stock benefits as an exchange for shareholders to lock up their shares, then DeFi similarly delivers risk-free new coin benefits in exchange for token holders to lock up their LP pairs. Locking up LP pairs can trigger a reversal of supply and demand, leading to skyrocketing token prices and subsequently generating positive feedback.

However, the market conditions from last September remind us that relying solely on locking up LP pairs for liquidity mining, allowing token prices to engage in a self-perpetuating Ponzi scheme, will eventually collapse. Therefore, external conditions are also needed for support ------ just like in the A-share market, where the current issuance system is still in place, yet it cannot rise. If external conditions are exhausted, the core benefit of new stocks surging cannot be sustained, and the reasons for locking up will also disappear. If the bull market rises too high, existing stocks will also crash, and everything will return to normal (just like now).

However, the cryptocurrency market now has the potential to trigger positive feedback ------ extremely loose monetary policies, not referring to the Federal Reserve, but to USDT, with massive funds pouring into the cryptocurrency space. At the same time, there is also no regulation, allowing for arbitrary leverage, and even allowing coins to be used in DeFi to borrow money for further leverage.

The cryptocurrency market is likely in a situation similar to the A-share market in 2014, where positive feedback has just begun. Many funds are eager to enter DeFi to earn low-risk yields, which will create positive feedback, prompting high-risk preference funds to invest more leverage in the cryptocurrency market, ultimately likely leading to an uncontrollable bull market similar to A-shares in 2015.

Many things, once they happen, cannot be stopped, right?

What will the outcome be?

I don't want to say that DeFi is a bubble that will eventually burst; this has no practical significance. Just like in the long run, everyone's outcome is the same.

However, many things are not linear. For example, after the collapse of the A-share bull market in 2015, Jia Yueting also collapsed. But looking back now, the path pointed out by Jia Yueting for electric vehicles has succeeded. In a bubble, the direction represented by the bubble is often correct, while the individuals within the bubble perish.

Even further back, during the internet bubble of 2001, most internet companies died, yet today we live in a world dominated by the internet. I believe the A-share market in 1993 was also worthless, consisting of local collective enterprises, with stocks resembling tokens, and people didn't even know what "shareholding system" was for. But now everyone knows, and we live in a shareholding world.

One day in the future, today's DeFi projects may fail, but we will live in a blockchain world, widely applying decentralized finance, making financial activities freer and more convenient. Today's DeFi bubble merely points to a rough, vague, yet correct direction. On one hand, we need to see this direction; on the other hand, we must first earn this money. Only by earning this money can we afford to lose when the tide recedes, allowing us to invest the remaining portion into the next round of the real blockchain economy and achieve our dreams of success in life.