DeFi is a growing market sector at the intersection of blockchain technology, digital assets and financial services. According to DeFi Pulse, the value of digital assets locked in DeFi apps grows tenfold, from less than $1 billion in 2019 to more than $10 billion in 2020 and peaking to date at more than $80 billion in 2021. However, DeFi apps and the underlying infrastructure are still in the early stages of development.
The purpose of this report is to present the current emerging infrastructure space that supports DeFi applications. While it is easy to get caught up in the hype and speculation in this space, this piece will focus on the key components of DeFi applications, their key differences from traditional finance, potential risks, and the long-term impact these DeFi applications are causing.
Key structural commonalities of DeFi applications
DeFi applications are financial applications that do not have a central counterparty. In practice, this means that we do not need to engage with any institution (e.g. a bank) to access these financial applications; instead, the user interacts directly with the program (e.g. a smart contract) on the protocol itself.
The main categories of DeFi applications include decentralized exchanges, lending platforms, stablecoins, synthetic assets, insurance, etc. Despite the differences in scope, all of these DeFi applications have one major thing in common, including:
Use the underlying blockchain as the core ledger
Open source and transparent by default
Interoperability and programmability (composability)
Open access to all (no license required)
Uses the underlying blockchain as the core ledger
In contrast to traditional financial applications that use core banking systems (Fiserv, Jack Henry, FIS, etc.) as the underlying ledger, DeFi applications use the blockchain as the underlying core ledger.
Some of the best-known blockchains used to build DeFi applications include Ether, Solana, and CoinAction Chain. These underlying blockchains store the state of the ledger deposited into the DeFi app, everything stored in the smart contract. Transactions and withdrawals.
All core accounting functions that ensure matching inputs and outputs are handled by the blockchain itself, and the DeFi app does not need to create an external system to verify balances, as all transactions can be queried through a different block browser.
In addition, there are no separate settlement and clearing processes compared to traditional systems. When a transaction is propagated, transaction processing, clearing and settlement all occur simultaneously. While it is recommended to wait for about 21 or more blocks to ensure the finality of the blockchain itself.
Open source and transparent by default
In contrast to traditional financial applications that are closed source and built on top of proprietary systems, DeFi applications are typically fully open source and built on top of an open underlying blockchain.
This leads to three interesting properties:
Composability – DeFi applications themselves can be forked, remixed, and reused in many other applications.
Transparency – Since the DeFi application is open source, it is fully auditable to know what the smart contract does in terms of functionality, user permissions and user data.
Auditability – Because the underlying blockchain itself is open source, the entire flow of funds is fully auditable, including collateral, transaction volume, defaults, etc. in the system.
Traditional financial systems run on a fractional reserve system and are vulnerable to market shocks – whereas the DeFi system is fully transparent and overcollateralized – allowing companies that adopt DeFi to weather downturns more effectively.
Interoperability and programmability
In order for developers to gain the trust of their users, most DeFi applications are fully open source – both the front-end and the smart contracts themselves. In addition, because DeFi apps all run on a common platform (the underlying blockchain), these DeFi apps are fully interoperable with each other and can be programmed to work with any other DeFi app in the ecosystem.
This is often referred to as the “money Lego” or “composability” aspect of DeFi. All these DeFi applications are like individual Lego blocks that can be remixed to work together with other Lego blocks to create something new.
Compared to the traditional financial system;
Infrastructure fragmentation – traditional financial applications are not built on top of public infrastructure.
Shaft applications – traditional financial applications are usually exclusive to one banking institution. For example, all of Wells Fargo’s “fintech apps” can work together, but not across different banking institutions.
Developer unfriendly – Traditional financial applications are not designed to allow other developers to build services on top of them.
The traditional financial system does have common standards: however, it is extremely difficult to reach consensus among market participants because financial institutions see their software as their competitive moat rather than as a differentiating factor for their products.
One of the biggest reasons we are seeing so much innovation in the DeFi space is that these systems are interoperable, which allows the developer ecosystem to have a more creative expression of the products and services they create. On top of that, instead of wasting time reinventing the wheel, developers can build on a common framework and focus on what makes their products special.
Open access for all
In traditional financial applications, new users typically have to go through lengthy entry processes, income verification, credit checks, and even in-person interviews – just to be able to use a given financial product.
Because of these arbitrary rules set by financial institutions, these entry processes are prone to bias, including lending discrimination, denial of basic banking services, opening lines of credit without consent, charging illegal fees, and more.
With DeFi apps, we only need a wallet address to interact with these systems. deFi apps require no income verification, no credit checks, and in most cases, they don’t even need to know who you are, except for the wallet address the user uses.
This is often referred to as a DeFi app that requires no permission. If the user has enough money in their wallet to complete the transaction they want to do, they can do so. No agency or intermediary stops or denies service to users. No matter what their background is or what country they come from, DeFi apps will not discriminate against you.
This is one of the most underappreciated aspects of DeFi products.
Traditional Fintech Architecture vs DeFi Architecture
Here is an architecture diagram (a simplified version) of the main technical differences between a traditional FinTech application and a DeFi application:
Here is a more direct comparison chart of some of the key differences between centralized and decentralized financial applications:
DeFi Infrastructure – Market Map
The following figure shows the market map for two different DeFi ecosystems, one built on the Solana ecosystem and the other built on the Ether ecosystem.
These two ecosystems were chosen to demonstrate the breadth of DeFi applications built across two different underlying protocols. I also believe Solana is the most interesting new layer protocol because of its high transaction throughput (50,000+ transactions per second), sub-second latency and transaction confirmation times, and the rapidly growing ecosystem of developers building DeFi applications on the Solana protocol.
While similar in structure, each underlying protocol has its own ecosystem that is largely independent of the others. Below is a further explanation of each layer and the trade-offs between them.
Base layer (layer 1)
The base layer is the blockchain where the core ledger itself resides. Ether is the dominant layer today, while Solana is the most promising new entrant with faster transactions, more throughput and cheaper transactions.
The amount of data needed to query the underlying ledger (retrieve blocks, find transactions, sync data, write transactions, etc.) A whole industry has emerged in the Ethernet ecosystem to address this need (Infura, Alchemy, etc.).
There are various Layer 2 solutions on Ether, mainly for scaling, as Ether itself cannot handle all transactions. Three of the promising scaling solutions include Polygon (Matic), Optimism and Arbitrum. there are also noteworthy cross-Rollups and cross-chain transfer transaction solutions Orbiter and Hop.
On Solana, since it needs to be built on only one layer (no Layer 2 extension solution), there is no need for specialized integration or mismatch with the underlying ledger that handles settlement.
Order Book Aggregation
For Solana, there is an additional layer occupied by a DeFi project called Serum, which provides a CLOB (Central Limit Order Book) for use by all DeFi projects built on top of it.
When new DeFi projects are built on top of Solana (DEX, AMM, Options, etc.), they can pull orders from Serum and push them back into Serum, greatly reducing the cold start challenges most new financial applications face.
The best way to think about this is as a “network liquidity” and “order management” system, which is what most projects within the Solana ecosystem use.
One of the more innovative examples of combining CLOB and AMM is Raydium (which is very similar to Uniswap v3). The combination of these systems allows passive LPs to use Serum for active market making.
Running most DeFi applications requires a common set of tools, both from a developer and end-user perspective. There is no direct traditional financial analogy for these services, but they include
Wallets – the primary interface that people use to store assets and interface with DeFi applications.
Oracles – DeFi applications use on-chain data to reference prices and execute transactions (e.g.: clearing).
Block Explorers and Analytics – Tools like Block Explorers were created to allow people to directly query the blockchain ledger itself. These are most commonly used when verifying transactions.
Stable Coins – The two main assets used in the DeFi ecosystem include the underlying native protocol tokens (ETH or SOL) and the on-chain stable coins (USDC, Dai or Pai).
Front End – An emerging layer that creates easy-to-use front-end applications to interact with multiple DeFi projects simultaneously or to streamline transactions. This includes Zapper.fi in the Ether ecosystem or Step Finance in the Solana ecosystem.
The DeFi app
The DeFi app itself consists of all core financial applications that can be used directly or embedded in various other applications in the crypto ecosystem.
The Potentially Missing DeFi Infrastructure
When comparing and contrasting DeFi infrastructure with traditional financial infrastructure, there are a few things that don’t yet exist in the decentralized world that are worth exploring.
A few are highlighted below.
Consumer applications – In the traditional financial world, consumers typically deal with consumer applications (e.g., Robinhood, Chime, Transferwise) rather than the underlying protocol itself. the front end of the DeFi space can be greatly improved and play a greater role in the overall consumer The front end of the DeFi space can be greatly improved and play a larger role in the overall consumer experience. In general, the UI/UX of most DeFi applications is still difficult to use from a consumer perspective.
Customer Relationship Management – DeFi spaces don’t really have a concept of customer relationship management and typically don’t collect any amount of customer data. While great from a privacy perspective, there is great value in understanding your customers better.
Notifications – Notifications or alerts don’t exist in the DeFi space at all. Nor is there any good way to communicate with users on a broader level.
Product Analytics – There are tools to measure blockchain activity, but not engagement with DeFi applications.
Security – DeFi products are typically audited for security; however, none of the security audits guarantee the most common protections that consumers are used to in the traditional financial world. On top of that, the demand for security auditors exceeds the supply, so this is a big bottleneck.
Transaction Rollback – In traditional finance, financial institutions can initiate a transaction rollback if a user makes a mistake. This does not yet exist in DeFi.
Escrow – Currently, most DeFi programs require interaction from a personal wallet perspective. There is no custodian that allows you to interact with DeFi applications.
Developer Platform – Most developers in the crypto space are building on top of the layer1 protocol itself. There is no concept of a developer platform or middleware.
Embedded Wallets – Wallets are considered these external services and there are no white label wallets that can be embedded directly into the DeFi application itself. There are a few like Torus, but they are still in their infancy.
Identity – One of the biggest complaints about DeFi from the traditional financial community is the anonymity of users. Ideally, there needs to be a way to keep bad actors out while protecting consumer privacy.
The future of financial apps
After meeting with hundreds of founders and seeing the progress the team has made, one thing is clear – DeFi is innovating 10 times faster than traditional fintech applications.
In traditional finance.
The underlying ledger isn’t open source or developer-friendly.
There are a ton of “bank-as-a-service” apps that are just designed to wrap the underlying partner bank in a developer-friendly platform.
Fintech applications are very challenging to regulate and often take years of development before a product is released.
Contrast that with DeFi, where:
Everything is open source, including the ledger itself.
All transactions are public.
Everything is built from the perspective of developers building applications on the protocol.
New DeFi applications can be developed and released in weeks, not years.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/overseas-investment-institutions-interpret-the-defi-industry-defi-summer-is-coming-again/
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