License-free composable DeFi is igniting the spark of innovation

Highlights Summary

  • The composability of DeFi allows developers to use permissionless and manipulation-resistant infrastructure in development, thus focusing on the development of core business logic.
  • Multiple DeFi applications (ie “currency Lego blocks”) can be combined organically to create unprecedented application scenarios and financial products.
  • The traditional financial system requires permission to enter, and access barriers and costs are very high, so it is difficult to achieve composability in real applications.
  • If DeFi applications are to achieve composability, they must perform due diligence on each protocol to reduce the systemic risk of the entire DeFi ecosystem.

After Ethereum released programmable smart contracts, it gave birth to a new type of permissionless and borderless network. Many decentralized applications (dApps) in the network can be parallelized at the same time.

The first application scenario is to generate digital tokens on the blockchain and track the ownership of the tokens. However, the recent round of dApp innovation has surpassed the original certificate ownership tracking, further expanded and innovated on top of traditional financial products, and developed a unique management and transfer model. This innovative financial system is also known as decentralized finance (DeFi), valued at more than 100 billion U.S. dollars, including decentralized trading platforms, mortgages, lending platforms, leveraged transactions, synthetic assets, prediction markets, and payment networks And other functions.

The key element to accelerate DeFi innovation and application is to provide developers with permission-free composability. Composability can combine the various modules in the system to meet specific application requirements. The uniqueness of DeFi is that it allows developers to arbitrarily combine DeFi protocols without any special permission, which will bring unprecedented innovation to the traditional financial industry.

At the beginning of this article, we will discuss the bottlenecks of the current traditional financial system; after that, we will share several practical application scenarios and discuss how combinable DeFi applications can achieve a license-free financial infrastructure; at the end, we will focus on how to deal with this model. Of systemic risks.

Traditional Finance vs DeFi

Composable financial applications are not a new concept. In fact, many mainstream user-oriented applications (such as Uber, Lyft, and AirBnB) have adopted a composable design concept. For example, the financial service Plaid and Stripe integrates many web applications to provide users with native payment functions. This greatly reduces the workload of developers and shortens the listing cycle, because developers do not need to build fiat currency payment infrastructure from scratch.

However, the modular financial application itself has certain bottlenecks.

Access requires permission to obtain

Traditional centralized financial services require permission to build, and both parties must sign a financial contract, and this contract is only a paper promise. This raises the barriers to entry, and it is difficult for developers to develop fully automated or fully impartial financial applications, because access rights may be cancelled at any time. Centralized entities can control the key modules of the application, which cannot provide third-party developers with the high certainty they need.

The DeFi application uses a permissionless model, which completely subverts the traditional financial model and establishes an open platform. Any developer can immediately gain access to the financial infrastructure, and believes that the financial infrastructure has a high degree of tamper-proof modification and reliability. This will give birth to truly fair and highly deterministic applications that will run strictly in accordance with the code and cannot be shut down at all. Application access to the DeFi infrastructure does not require the permission of the original developer, which will lower the threshold for innovation and eliminate all intermediate bottlenecks.

Information is not transparent

Traditional financial services generally lack transparency, or are prone to information asymmetry, and it is difficult for the public to see clearly the back-end architecture. This leads to unknown risks and reduces risk management capabilities. For example, financial institutions adopt a combinable design concept to create new mortgage securities on the basis of existing mortgage loans. Many people think that these financial products are very safe because they are very diversified and have received 3A ratings from traditional rating agencies. However, in 2008, everyone discovered that many securities were actually wrapped in toxic subprime assets, which also triggered a global financial crisis. If the information is more transparent, this crisis can be completely avoided.

In contrast, DeFi products are inherently open and transparent. They are developed using open source technology, and every transaction and every interaction between users and dApps is recorded in a non-tamperable distributed open ledger. Up. If a centralized cryptocurrency trading platform goes bankrupt, it may not be discovered until months or even years, but the operation status of DeFi is open to the open source community, and everyone can observe any fraud and systemic risks at any time. .

Composable DeFi applications

The DeFi ecosystem adopts a composable design concept. Developers can access key infrastructure at any time without permission, so they can focus on the development of core business logic. DeFi developers do not need to establish their own trading platform when casting new tokens, nor do they need to spend money to trade tokens on a proprietary centralized platform. They can issue tokens in the established decentralized trading platform (DEX), and this trading platform has undergone security audits and has its own user group. Pass holders can immediately trade the pass in hand and participate in various financial application scenarios, which will greatly enrich the functions of the pass.

The decentralized infrastructure for developing DeFi applications includes:

  • Smart contract blockchain (Ethereum)
  • Anti-tampering oracle network (Chainlink)
  • Permanent data storage/web hosting (IPFS)
  • Manipulation-resistant domain name (ENS)
  • Reliable data query and index (The Graph)

Issuing tokens on a decentralized trading platform is the simplest use case for composability, but at the same time, new DeFi applications can be connected to existing applications, just like “currency Lego blocks”.

“Currency Lego blocks” in the DeFi field include:

  • Trading platform in order book mode (Loopring and dYdX )
  • Automatic market maker (Bancor and Sushi)
  • DeFi Aggregator (1inch and Alpaca)
  • Stable coins (Liquity and Fei)
  • Currency market (Aave and Compound)
  • Synthetic assets (Synthetix and Alchemix)

Many modules can be combined together to build various structures, so that each module has a synergistic effect and exerts greater value. Here is a reminder that many of the above applications cannot be completely classified into a certain category, which means that the same application can be combined in different ways to produce different effects.

“DeFi’s biggest value proposition is that it is interoperable. Our financial system can interact with the larger ecosystem, which means that anyone can combine two protocols (such as Aave and Synthetix) to create new products, and Innovative user experience. Good products will soon produce network effects, because liquidity will also transfer to each other, which will completely subvert the traditional financial industry.”

-Founder and CEO of Aave, Stani Kulechov

Composability network effect

Composable DeFi applications have a core function, that is, it can connect various decentralized applications together. This will improve capital efficiency, assets can be used for multiple applications at the same time, there are almost no friction costs and no licenses are required. In addition, this can also expand the network effect, each new DeFi application can access the existing DeFi application, and enhance its function and practicality.

For example, a user can create a decentralized stable currency by issuing an over-collateralized loan, and thus obtain working capital. However, if these stablecoins are deposited in the decentralized currency market and become non-custodial interest-bearing tokens, they will generate greater value. In other words, although the underlying stablecoin in the currency market can earn interest through loans, the interest-bearing token created based on the ownership of the stablecoin can be used in other DeFi applications, or even to pay for products and services.

In addition, multiple users can also put interest-bearing stablecoins in the same fund pool to create a lossless savings game without permission. In this type of dApp, all the interest generated by the stable currency of the fund pool within a certain period of time will be rewarded to the winner, and in the end everyone can withdraw their own principal. This lossless savings game can turn user deposits into tradable tokens (that is, proof of ownership of deposits), and continue to promote the development of modular DeFi applications.

The above applications have already landed in the DeFi field, with Ethereum, Chainlink, MakerDAO, Compound and PoolTogether all participating. PoolTogether uses Maker’s stablecoin DAI , Compound’s currency market cTokens, and verifiable random functions to create an innovative decentralized application, eliminating the need to create stablecoins, develop currency market protocols, or verifiable random numbers on the chain.

License-free composable DeFi is igniting the spark of innovation

A set of currency Lego bricks, showing the design concept of DeFi’s permission-free composability

Aggregate data from decentralized trading platforms

Another DeFi application that focuses on composability is 1inch.exchange. 1inch is a decentralized trading platform aggregator that obtains price data from all decentralized trading platforms on Ethereum, and minimizes the slippage of on-chain token transactions. 1inch divides large orders into multiple small orders and settles them on multiple different decentralized trading platforms to obtain the most favorable exchange rate.

1inch provides users with an excellent trading experience. Users do not need to compare the current exchange rates of various decentralized trading platforms. They only need to log in to one platform to immediately obtain all transaction prices on Ethereum.

Flash loan

Another application that has achieved composability is the decentralized currency market Aave. This platform has greatly improved asset liquidity through lightning loans, thereby improving capital efficiency and deposit income. Flash loans are temporary unsecured loans that must be repaid in the same transaction, plus a small transaction fee. If the lender of the flash loan does not repay the loan in time, the transaction will be rolled back, so the agreement and the borrower will not bear the risk of default.

The concept of lightning loan is very powerful, not only has the characteristics of atomic transactions (note: the transaction is either successful or rolled back, there is no intermediate state), but anyone can borrow a large amount of money temporarily, which finally achieves fairness in the DeFi field. sex. The application scenarios of lightning loans are very rich, such as arbitrage between different decentralized trading platforms, adding leverage to loans, or replacing collateral or debt in loans, etc.

Use “currency Lego” as collateral

In addition to the above use cases, Aave also provides support for a unique mortgage asset, which is the token from other DeFi applications. For example, the first unique mortgage assets is Uniswap launch of the share liquidity pool, Uniswap automated market makers (AMM) to the center of the trading platform. The reason why Aave launched this feature within a few weeks is because they integrated the Chainlink oracle to provide them with the price data they need. Aave connects to Chainlink Price Feeds and can integrate advanced modules safely and seamlessly.

Let me introduce the background first: when users deposit funds in Uniswap’s liquidity pool (note: each fund pool requires depositing two kinds of tokens), they will receive the UNI fund pool token, which is Proof of ownership of funds. The UNI fund pool token is then deposited into the Aave currency market and used as collateral for the loan. This can greatly improve the capital efficiency of market makers, because they can not only provide liquidity and obtain transaction fees on Uniswap, but they can also use funds as collateral to obtain loans. Then, they can continue to deposit the loan in Uniswap, and leverage the Uniswap transaction fees and assets in the fund pool.

Potential risks of composability

Although composability has the above-mentioned benefits, developers must be careful to guard against risks when developing composable DeFi applications, so as not to create “castles in the sky.” The risks that may be encountered when developing composable DeFi applications can be divided into four categories.

First, the blockchain network where the decentralized application is located may have certain risks at the protocol level. If the base layer cannot reach a consensus or is tampered with, all applications running on the network will face risks and manipulation. This is not a problem unique to combinable DeFi applications, but a common risk in decentralized applications.

Second, every smart contract application has special risks during its operation. In order to meet specific needs, each application will make different trade-offs in design. For example, there may be bugs in the application’s source code, which can cause accidents in decentralized applications. In order to solve these security vulnerabilities, the Chainlink protocol has launched multiple rounds of smart contract security audits, including auditing each new product function, launching a bounty task for finding bugs, and making the code completely open source. In addition to the above-mentioned risk prevention strategies, we have also achieved decentralization at the three levels of data sources, nodes, and networks, creating a defense-in-depth strategy. This allows users to connect the application to the Chainlink oracle with absolute confidence.

Third, linking multiple smart contracts together will expand the attack surface in all the above areas. Two decentralized applications may each be safe, but when combined, there may be risks. An increase in the number of modules contained in an application will result in an increase in the attack surface, and the overall attack surface is greater than that of a single application. This will cause more edge cases, which need to be processed in advance to ensure the stable operation of the application. Another composability risk is that the mortgage assets in a certain DeFi application (such as the money market) may not meet the standard, and this will directly affect the overall robustness.

Fourth, users lack sufficient cognition and information channels. If users do not understand the applications they use, they are more likely to take more risks without knowing it. Therefore, user education and risk disclosure are essential elements for maintaining healthy ecological development. Composable DeFi applications can become extremely complex in a short period of time, so the key is to decompose each link to a level that users can easily understand.

All members of the open source community must actively participate in the research of DeFi applications and their modules, so as to effectively prevent the aforementioned risks in a timely manner. Combinable DeFi applications include many movable modules, each of which requires the highest quality assurance. In addition, industry standards must be established and implemented, best practices must be established in the entire ecosystem, and security levels must be continuously improved through various developer activities such as bug-finding bounty tasks, code audits, and hackathons. In this way, a more stable financial ecosystem can be established and the strongest security guarantee for user funds can be provided.

Summarize

DeFi has developed into a new type of financial ecology, keeping pace with the traditional financial system. DeFi does not require a license, is composable and resistant to manipulation, and can be completely transparent. Specifically, the modular DeFi application accelerates the pace of developers’ innovative financial applications, so that developers do not need to rebuild the core infrastructure, nor do they need to rely on the centralized financial services of the licensing system.

DeFi has the characteristics of open source and license-free, so it can create a fair environment for everyone, and participants need continuous innovation to maintain market share. Today’s DeFi applications adopt a composable design concept, laying the foundation for the next generation of dApps, and future dApps will contain more and more advanced functional modules. Composable financial products without permission will realize countless innovative application scenarios, and the prospects are bright.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/license-free-composable-defi-is-igniting-the-spark-of-innovation/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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