DeFi Series 2: How was DeFi born?
No technical content is created out of thin air, there must be more technical building blocks at the time of its birth to form a series of technical innovations afterwards.
Blockchain and Cryptocurrency
In 2008, Satoshi Nakamoto published his famous “Bitcoin White Paper”, which demonstrated a decentralized system for peer-to-peer transactions and used the blockchain as the underlying technology. The key innovation of Bitcoin is the combination of blockchain (i.e. timestamp) and Proof of Work (PoW) consensus mechanism to form a cryptocurrency based on cryptographic scarcity, trust without regulation, and tamper-evident distributed ledger technology backing it.
The blockchain technology creates an unmodifiable decentralized ledger and the consensus protocol is a set of rules of the game for all participants to agree on, which enables them to pick out the blocks that can be incorporated into the blockchain among the many candidate blocks. Accordingly, the consensus is that the longest blockchain is the one that is legitimate and valid, and if an attacker wants to create a longer chain containing malicious transactions, it must exceed the sum of the computations of everyone else in the network. Obviously, no one would repeat the same calculations that everyone else has done in order to tamper with a transaction, which guarantees the blockchain’s tamper-evidence.
Cryptocurrency, the most widespread application that accompanies blockchain, protects on-chain accounts based on asymmetric key encryption algorithms, making it impossible for any transaction to take place without ownership of the corresponding account. The cryptographically protected and transmitted tokens make it impossible for anyone to make fraudulent transactions, which creates a payment network that allows bitcoins to be stored and traded globally in real time without any intermediaries or auditing.
Smart Contract Platforms
The smart contract platform was first proposed by the ethereum blockchain, giving the blockchain programmable functionality. Smart contracts are code that runs on the blockchain and can create or exchange arbitrary data or tokens. Their power lies in the fact that smart contracts allow users to code any type of transaction with peace of mind, or even create rare assets using specific features.
Many traditional business terms can be converted into smart contracts, and such “contracts” also use algorithms to enforce terms. Smart contracts can be used not only in the financial sector, but also in gaming, data management and supply chains.
In terms of the Ethernet blockchain, Ethernet is the equivalent of a huge computer with many smart contract applications. Developers can integrate various applications into the smart contract platform, but in order to limit the waste of blockchain resources, Ethernet will charge a certain transaction fee (gas) for each smart contract and the transactions running on it, which also ensures the security of the Ethernet blockchain.
Prophecy Machine System
For blockchain contracts, the contracts and ledger are isolated from the world outside of them. That is, the Ether blockchain only knows what is happening on the Ether blockchain and has no knowledge of what is happening outside the blockchain.
This drawback restricts the application of Ether’s own contracts and tokens, and limits the functionality of the smart contract platform, which is known as the prophecy machine (oracle) problem. During the development of a smart contract platform, the prophecy machine is the data source that can broadcast information external to the blockchain.
There are various implementations of the prophecy machine in different DeFi applications. One common means is to have a prophecy machine that belongs to the application itself, or to bind a prophecy machine to a trusted platform. The prophecy machine system is an open design problem, and DeFi must consider the prophecy machine problem if it wants to extend its functionality beyond the blockchain.
Stable Coins
Stablecoins were created because many cryptocurrencies are too volatile in price, which makes it difficult for users who want to apply DeFi, but can’t afford price fluctuations, to get started. Stable coins, however, can be anchored to the price of widely used assets such as the US dollar or gold, which maintains price stability and makes it easier for users to participate in DeFi applications.
There are currently three main types of stablecoins in the market, with the largest market cap being fiat-collateralized stablecoins, which are typically anchored by a reserve off-chain underlying asset, while an external entity or team oversees the collateralized assets and the regulator confirms the existence of the collateral through routine audits. The largest fiat-collateralized stablecoin is currently TEDA (USDT).
The second largest type of stablecoin is the cryptocurrency collateralized stablecoin, where the collateral is another cryptocurrency. The most popular cryptocurrency collateralized stablecoin is DAI, issued by MakerDAO, which uses ETH and other cryptocurrencies as collateral.
The third category is the uncollateralized stablecoin, which does not use any underlying assets as collateral, but instead uses an algorithm to raise or contract the supply for coin price regulation. However, because they do not have any underlying value to support their token transactions, they may lead to “bank runs” in times of economic crunch, which exposes a large number of tokens in the hands of token holders to devaluation and even a significant de-anchoring of the underlying price.
Decentralized Applications
dApps are very similar to traditional software applications, except that they are built on a decentralized smart contract platform. The advantage is that the license-free and censorship-resistant nature allows anyone to use dApps and no one can interfere with them.
DeFi apps can also be called dApps, as the first dApp projects provided a precedent for the mass birth of DeFi apps, which are also decentralized apps built on smart contract platforms.
In addition, a Decentralized Autonomous Organization (DAO), where all of its operating rules are coded using smart contracts, can determine which actions to perform. The DAO community also typically requires a governance token, the holder of which has a percentage of the voting power and can vote on community proposals.
About Bitbyte
Bitbyte.finance provides SAAS services for developers in the Web3 space, including Defi&NFT applications, Swap and mining pools, and community traffic services. Bitbyte is committed to helping developers quickly build their own Defi finance ecosystem and lower the threshold for traditional users to migrate to decentralized finance, creating a secure, convenient, reliable and reliable and their own decentralized platform.
