Which platform will dominate the decentralized finance? Will Avalanche network be the prominent space for DeFi applications?
Decentralized finance (DeFi) is is a peer-to-peer finance enabled by decentralized technologies built on the blockchains. DeFi is a growing, very promising and popular area that may provide fast and easily accessible financial services to individuals around the world (1–3). For now, DeFi provides financial services to individuals who have no access to traditional financial instruments including banks, exchanges, and variable investment assets. Nowadays, in a few minutes it is possible to lend or borrow money from a decentralized exchange, to trade cryptocurrencies, to swap different digital assets, to trade or collect NFTs and even to invest in litigation funding. Time will show us what kind of relationship will develop between the DeFi and traditional financial systems. DeFi in its current form requires some connections with the traditional systems. In future it may replace traditional systems or perhaps they can cooperate together. The horizons of blockchain technology and its ‘passion fruit’ DeFi are very wide and are limited to developers’ and users’ imaginations. This is a very productive area of the current technology and developers are inventing every day new instruments.
Content of decentralized finance
Total value (USD) locked in DeFi is about 16 B$ on December 18th 2020. Lending-borrowing, DEXes, assets and derivates are the main DeFi categories at the top of DeFi pulse list. Today, majority of the DeFi products are working on Ethereum blockchain. From lending & borrowing platforms to stablecoins and wrapped BTC, the DeFi ecosystem provide several different products and financial instruments. The smart contracts are key elements of DeFi and the DeFi is one of the main customers of blockchain technology. In DeFi, smart contracts are the key component who replace all the infrastructures, authorities, rules, institutions, and whatever needed for financial services. Any bug or error in the smart contracts can cause non-recoverable consequences. There are several unsuccessful project launched in the DeFi system and immediately terminated after launch because of smart contract issues. Therefore smart contracts should be tested several times by the developers and testers. An audit and perhaps insurance can increase trust in the project before deployment of the smart contract (2–4).
What are the advantages of decentralized finance?
DeFi has several advantages over traditional systems. First of all any individual can access DeFi products with an internet connection and a cryptocurrency wallet anywhere in the world that makes DeFi permissionless. Almost all transactions are transparent and can be tracked on blockchain scanners e.g. Etherscan. There are some exceptions like encrypted transactions in some cryptocurrencies. Users have full control over their assets and their personal data. DeFi protocols aim interoperability which means different interfaces and applications can directly interact with each other while using the DeFi platform. The transactions are performed on the blockchain where the smart contract has been developed. The use of blockchain provides security and also an audit. DeFi ecosystem has many features including decentralized exchanges (DEXes e.g. AirSwap, Liquality, and Uniswap), borrowing and lending platforms (e.g. Compound), gaming platforms (e.g. PoolTogether), payment utilities, margin trading option, derivates trading, prediction markets (like betting applications e.g. Augur), fiat currency paired stablecoins (e.g. USD, GBP, AUD stablecoins), staking option, saving platforms (e.g. Dharma, Argent), insurance (e.g, Nexus Mutual) and more. DeFi ecosystem frequently uses web3 wallets (e.g. MetaMask, Argent, Gnosis Safe and others). The transactions can be tracked and available data can be analysed over different platforms (eg, Defi Pulse, Etherscan etc) (1–4).
Role of Ethereum blockchain in current DeFi ecosystem
For now, Ethereum blockchain is being used as the main DeFi infrastructure and majority of DEXes and other applications work on Ethereum network. There are several developers working on new DeFi projects on the Ethereum blockchain. Those developers and the Ethereum network have been the repulsive force behind the current advancements in DeFi. However, Ethereum network has several issues including scalability, transaction capacity, high transaction costs, and POW derived problems. In order to facilitate access to DeFi products there is need for a smart, fast, secure, and cheaper network. Ethereum 2.0 is being developed and tested now and nobody knows when it will be ready to run officially or really will it be successful at the end of the testnets. In proof of stake protocols there is no mining like proof of work systems and validators do not earn as much as miners of the current system earn from transactions and validating processes (1–4).
Potential role of Avalanche as a new candidate for providing better DeFi infrastructure
At this point Avalanche network which has the ability to work as an Ethereum virtual machine (EVM) is been developed. Avalanche network launched its mainnet in late September 2020. Avalanche network is active with its 630 and over validators and its native token AVAX is being traded on several CEXes.
Avalanche platform has a very smart infrastructure consisted of three main blockchains inherent to the network. All of these chains are validated by the default subnetwork.
These chains are consisted of X chain (coming from exchange) that serves like a decentralized platform allowing to create and trade smart digital assets. Digital assets are ruled automatically by the smart contracts and act according to the algorithms defined in their smart contracts. Avalanche platform’s native token ‘AVAX’ is being used on the platform. Avalanche platform allows to create and trade custom digital assets on the X-Chain.
Avalanche’s P chain (platform chain) manages metadata of the Avalanche network. Clients have ability to create custom and private subnets, to add validators to the subnets and to create other blockchains via the application programming interface (API) of the P-Chain.
The third chain is so called ‘C chain’ is the contract chain that allows to create smart contracts. The C chain can use the Ethereum Virtual Machine (EVM) powered by Avalanche to generate smart contracts and also DeFi projects via the API of the chain. Since the C chain can work as EVM it supports smart contracts deployed on Ethereum blockchain which means all projects deployed on Ethereum network can also run on Avalanche’s C chain using Avalanche’s validating system. This is very important and it may be considered that Avalanche has already launched Ethereum 2.0 before the Ethereum community (5, 6).
Avalanche networks infrastructure: genuine smart consensus protocols
Avalanche network’s originality and power come from its strong and smart infrastructure depending on genuine Avalanche and Snowman consensus protocols (5–8).
Briefly, Avalanche protocols ask to a small, random subset of validators to validate or to reject a transaction and if the validators think the transaction is invalid, rejected or conflicting they reply that the transaction should be rejected. Otherwise, the subset of validators reply that the transaction should be accepted. The proposals of sufficiently large portion (alpha) of the validators affect the decision of the validator either to accept or reject the transaction. The validator repeats this sampling process until alpha of the validators queried reply the same way (accept/reject) for beta consecutive rounds. For example a transaction without any conflicting proposals from the network is finalized very quickly. In case of conflicts, validators quickly cluster around preferring one of the conflicting transactions. A positive feedback loop occurs and goes on until all validators accept or reject the transaction. This cascading process inspired the developers to name it as Avalanche (5).
‘Avalanche’ and ‘Snowman’ consensus protocols are genuine Avalanche products which make the network work as it is. Recently the Ripple’s new project Flare network (SPARK) used Avalanche’s consensus protocol (9).
Access to DeFi with Avalanche
From the very beginning AVA Labs designed the Avalanche network as a strong platform dedicated for financial projects. Their motto ‘Build the internet of finance’ is getting more close to reality days after their main net launch. The team is working hard and moving always forward in a smart scheduled agenda. Cryptospace is full of similar, non-original and even Ponzi or scam projects. Avalanche is far from those and build its own network and launched successfully its mainnet. Several DeFi projects are currently using Ethereum’s network and there are so few DeFi applications that work on other platforms. For instance although it is the first DeFi project, Bitcoin’s blockchain is apparently not suitable for today’s DeFi requirements and does not allow instant transactions. Avalanche can potentially attract and run all the projects deployed on Ethereum network since it has solved scalability, security, transactional finality, capacity, energy and cost effectivity issues seen on the Ethereum network.
Current conjuncture and DeFi-cryptocurrencies
Bitcoin appears to become a store of value (like gold bullions of central banks) with limited supply against limitless increasing fiat currencies. Fiat currencies have unlimited supply and are not bind to gold like a century ago. In the last century gold prices rose up to 2000 USD from 20 USD levels. Several financial institute estimated that it may reach 3000 USD per once by the end of 2021 (10, 11). Central reserve banks are providing more liquidity to the markets by issuing more fiat currency in almost every country and are keeping on following their quantitative easing (QE) policy which can cause hyperinflation, bankruptcies of corporations and even states worldwide. Furthermore, COVID-19 pandemic is making hard to find reasonable solutions to the economic issues. Under this conjuncture we are watching the rise of the new century’s gold ‘Bitcoin’ which will probably followed by powerful alternative coins. In the near future DeFi will become more popular and platforms like Avalanche will bring almost all financial instruments from DEXes to initial litigation offerings, artwork auctions, digitized stock exchanges and more to end users.
References
1. Yan Chen, Cristiano Bellavitis, Blockchain disruption and decentralized finance: The rise of decentralized business models. Journal of Business Venturing Insights 2020; 13: e00151. https://doi.org/10.1016/j.jbvi.2019.e00151.
2. Ibrahim Alkurd. A guide to decentralized finance. https://www.forbes.com/sites/theyec/2020/10/16/a-guide-to-decentralized-finance/
3. Blockchain for decentralized finance (DeFi). https://consensys.net/blockchain-use-cases/decentralized-finance/
4. Zetzsche, Dirk Andreas and Arner, Douglas W. and Buckley, Ross P., Decentralized Finance (DeFi) (March 2020). IIEL Issue Brief 02/2020, European Banking Institute Working Paper Series 59/2020, University of Hong Kong Faculty of Law Research Paper №2020/010, University of Luxembourg Faculty of Law, Economics & Finance WPS, Journal of Financial Regulation — forthcoming, Available at SSRN: https://ssrn.com/abstract=3539194 or http://dx.doi.org/10.2139/ssrn.3539194
5. https://docs.avax.network/#key-features
6. Team Rocket, Maofan Yin, Kevin Sekniqi, Robbert van Renesse, and Emin Gun Sirer. Scalable and Probabilistic Leaderless BFT Consensus through Metastability. https://arxiv.org/pdf/1906.08936.pdf
7. https://docs.avax.network/#avalanche-consensus-protocol
8. https://docs.avax.network/#snowman-consensus-protocol
9. https://flare.ghost.io/theflarenetwork/
10. https://howmuch.net/articles/rise-and-fall-dollar
11. https://www.internationalinvestment.net/news/4014280/gold-forecast-hit-usd-months-bank-america
