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Learn How To Defi Part 3

Let’s continue learning Defi in part 3 and also reference my Notion page here for more details.

Check out my another article Learn How To Defi Part 2 

TL;DR

One of the most popular blockchain applications is the cryptocurrency

Smart Contract

Ether Gas Fee

Ethereum Request for Comments (ERC)

Oracles

Stablecoins

Decentralized Applications (Dapps)

Decentralized Autonomous Organization (DAO)

How DeFi provide service?

According to Eric Schmidt, the former CEO of Google made a statement in 2014 about Bitcoin that “is a remarkable cryptographic achievement and the ability to create something that is not duplicable in the digital world has enormous value.”

Cryptocurrency is an asymmetric key cryptography technology to prevent duplicates on the internet and solve the “double-spend” problem.

So, the more duplication internet can easily produce, the lower the value cryptocurrency will have and the lower the credibility cryptocurrency will have.

Smart Contract

Another crucial ingredient of DeFi is a smart contract platform.

When money flows within the contract with conditions pre-proposed, with an interest rate adjustment, money can become more valuable with a longer period of time of such contract is enforceable!

The smart contract makes cryptocurrency an enforceable contract with code and data that further pushes the possibility of the blockchain.

Many traditional business agreements with clauses now can enforce under algorithmically codified clauses to prevent breaching of contract agreements.

Ether Gas Fee

Remember blockchain was invented to fight Junk Mail by increasing the cost of massive distributing spam to receivers? Ether gas is a unit of computation power that costs money while letting miners validate each transaction. That is the nature of a decentralized trustless-based environment.

However, it leads to poor user experience, leads to worry about overpay/underpay or slow processing time of such transactions.

Because of the high gas fees, there are solutions to provide less gas fees such as Polygon, Cardano, or Litecoin. Or projects to provide gasless transactions such as Moralis.

Worth mentioning that even everyone hates high gas fees, the primary reason for gas is to prevent system attacks that generate an infinite loop of code. Similar to a car that depends on gas to reach a limited distance, Ether gas prohibits attackers to push the system to run exhaust without costing themselves more spending on attacking. This is commonly known as the halting problem.

Gas fee is a part of the decentralized solution since no one will shut down the system to identify malicious code yet incentivize highly efficient smart contract code with fewer resources and reduce the probability of failures that are beyond the benefits of the marketplace.

Ethereum Request for Comments (ERC)

ERC is Ethereum standard. They are proposals that officially adopt and implement into Ethereum Virtual Machine (EVM) to become one of their functionality/features (More technical background here).

One of the most important ERC that makes DeFi possible is ERC-20 TOKEN STANDARD. It is the standard for fungible tokens and defines an interface for tokens whose units are identical in utility and functionality (further reading here). 

Another important ERC is EIP-721: Non-Fungible Token Standard. It makes cryptocurrency unique and often used for collectibles or assets such as peer-to-peer loans (further reading here).

Oracles

Unlike the word meaning itself, the oracle problem in crypto means completely different!

It refers to a problem of the blockchain that has limitations containing applications to Ethereum native contracts and tokens and to reduce the utility of the smart contract platform.

Simply, blockchain is an isolation system that separates itself from the real world (source).

Oracle acts as an authoritative data feeder (some degree of centralization) and provides blockchain or in smart contract cases, using data to help smart contracts to perform more closed to the real-time marketplace.

There are many ways oracles can implement and provide various DeFi applications and one of the well-known Oracle is Chainlink by using an aggregation of data sources with a reputation-based system. We will explore more on the Oracle-specific section.

Stablecoins

Stablecoin is to solve the cryptocurrency’s volatility problem. It is a bridge between cryptocurrency and fiat currency (source). The largest market cap of stablecoin is Tether (source).

It intends to figure out a way to maintain price parity with some target asset like USD, gold, some proportional crypto assets or artificial algorithms.

There are 4 types of stablecoins:

  • Fiat backed or fiat-collateralized stablecoins: 1:1 ratio as 1 stablecoin to 1 unit of currency. (i.e. Tether – USDT)
  • Commodity backed or commodity-collateralized stablecoins: commodities include gold, oil, real state, and various precious metals. (i.e. Digix Gold (DGX) – Singapore suspended the operation since Jan 24th, 2022 under the Singapore Payment Services Act )
  • Crypto backed or crypto-collateralized stablecoins: their value either hard or soft pegged depends on the mechanism. (i.e. DAI from MarkerDAO)
  • Non-collateralized stablecoins: they purely operate under algorithm to determine its valuation (i.e. AMPL)
  • Bonus: CBDCs or Central Bank Digital Currencies: are issued, controlled, and regulated by a country’s central bank or monetary authority, they are exchangeable on a 1:1 ratio with their equivalent fiat and are likely to be considered as legal tender.

Decentralized Applications (Dapps)

Similar to Apps in your Apple iPhone, Dapps just like an App except live on a decentralized smart contract platform.

Two primary benefits of Dapps are permissionlessness and censorship resistance (further reading here).

Decentralized Autonomous Organization (DAO)

An organization is a fully autonomous and is not governed by a single person but through codes that based on smart contracts and governance token which gives an owner some percentage of vote on future outcomes. (source)

How DeFi provide service?

Financial services are provided through Decentralized Applications (Dapps)

DeFi works as money LEGOs to add up layers with features for users to achieve their desired financial goals.

Layer 0 → Bitcoin → consensus, prevent double spending

Layer 1 → Ethereum → Smart Contract to implement rules

Layer 2 → ERC -20 & ERC – 721 → Token, NFTs, Stablecoins, Governance Tokens

Layer 3 → Dapps → DEX, Lending & Borrowing, Derivatives, Governance, Insurance and more

Stay tuned for the next cheatsheet!

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