AndreyPopov/iStock via Getty Images Decentralized Finance, or DeFi, has stirred a lot of attention in the last two years. The industry is seeing tremendous growth as more developers move into the space to build innovations in the hopes of disrupting the current financial and monetary system. We have seen the hype surrounding altcoins, NFTs, and the metaverse, as well as illicit financial activities, rug pulls, and major hacks.
The White House announced last week that President Biden would be signing an executive order to ensure the “responsible development of digital assets.” Six key priorities are stated. Given the current state of DeFi, I see the EO as an overall positive for the industry. In general, it should bring more trust to the space as regulations and risk assessments are imposed. Furthermore, DeFi’s philosophical aim of being more inclusive to everyone (the so-called “democratization of finance”) is largely consistent in principle with the priorities listed. A Brief Overview of How DeFi Got to Where It Is Now
DeFi’s Progress (DeFi Pulse) (Source: DeFi Pulse )
Many things have developed since Satoshi Nakamoto released the Bitcoin ( BTC-USD ) whitepaper in 2008. The concept of using blockchain to support a completely decentralized (read: unable to be controlled by any government) digital currency was revolutionary and the de facto starting point for DeFi. Bitcoin’s design solved the double-spending problem of digital currencies. It also ensured that historical record of transactions could be verifiably untampered. Also, these records are publicly distributed (often referred to as a public or distributed ledger), and each entry required a majority of the network to agree that the entry is legitimate. In general, solving these problems is what allows Bitcoin and blockchains to be considered decentralized. Bitcoin is intended to be money. Economists assign three functions to money: a unit of account, a store of value, and a medium of exchange. Bitcoin’s current volatility means that it is good at none of those (whether it will be is not the topic of this article).
However, today’s DeFi has evolved from simply creating a new form of money . Rather, it is more related to reducing the role of financial intermediaries, automating and simplifying complicated steps, and creating economies grounded in financial accessibility and decentralization. The hundreds of altcoins are not all separate digital currencies which people really believe will replace any fiat currencies. Rather, the hype around DeFi is that blockchains can do more than simply record transactions on a public ledger. Ethereum ( ETH-USD ) ushered in this second revolution in 2015 with idea of a smart contract . A smart contract is code stored on the blockchain which can be executed by people. Smart contracts meant that people could create specific instructions which could be used by others. The code would perform exactly as written. In a way, this is a lot like an application you would use on your phone. Because the smart contracts are executed on the blockchain, they are decentralized. The applications created by smart contracts are called decentralized applications, or dapps .
Another important part of this story is that Bitcoin and Ethereum both relied on the proof-of-work consensus algorithm. The important consequence of this was that transactions were very slow and expensive. Dapps need to be fast to be useful to people. This need for speed (along with attempts to address other issues) paved the way for other blockchains to develop. Notably, variations of the proof-of-stake consensus algorithm is what most of today’s blockchains use. This allowed transactions to be faster, which meant faster dapps.
Recall that Bitcoin’s network required a majority agreement to approve an entry to the ledger of transactions. Proof-of-stake blockchains use ownership of the native cryptocurrency to signal “stake” in the blockchain. Those with higher stake would have a vested interest in ensuring the soundness of the network, and so they are tasked with approving transactions for the network. In fact, many of the top coins by market cap are signals of stake in their respective blockchains. Top 14 Coins By Market Cap (Investing.com) (Source: Investing.com)
In the picture above BNB, LUNA, ADA, SOL, AVAX, and DOT are native coins whose blockchains all use variants of proof-of-stake. If Ethereum moves to Ethereum 2.0 and implements a proof-of-stake consensus, ETH will also join this list. In general, those who stake cryptocurrencies earn a fee for helping the network validate transactions. Therefore, many of these coins can be viewed almost like equities in the sense that they represent a proportional claim on certain cash flows […]
source What President Biden’s Crypto Executive Order Means For DeFi
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