DeFi: The battle of the blockchains

For some, open, public blockchains provide a second chance at building a digital economy. The fact that applications built on top of such blockchains work with each other and that the information they store is visible to all is reminiscent of the idealism of the early architects of the Internet, before most users embraced the walled gardens offered by tech giants. The idea that a new kind of “decentralized” digital economy might be possible has gained momentum over the past year, as the numerous applications built on top of various blockchains have grown in size and functionality.

The Rise of DeFi: How Tokens Can Change Our Lives

Perhaps the most important part of this economy is DeFi applications, which allow users to trade assets, take out loans and store deposits. An intensifying battle for market share is now breaking out in this sector. Most importantly, Ethereum, the leading platform in DeFi, appears to be losing its near-monopoly. The race shows how DeFi is subject to the wars that have broken out and other emerging technologies – think Sony Betamax vs. vhs videotapes in the 1970s – and it shows how DeFi technology is improving by leaps and bounds.

The idea behind DeFi is that blockchains – databases distributed across multiple computers and kept secure using cryptography – can help replace central intermediaries such as banks and technology platforms. The value of assets stored in this nascent financial system has grown from less than $1 billion in early 2020 to more than $200 billion today.

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Source: DefiLlama

Until recently, the Ethereum blockchain was the undisputed host of all this activity. It was created in 2015 as a more general-purpose version of Bitcoin. Bitcoin’s database stores information about transactions in the relevant cryptocurrency, providing proof of who owns what at any given time. Ethereum stores more information, such as lines of computer code. An application that can be programmed in code can be guaranteed to work as written, thus eliminating the need for any middleman or entity.

But just as Ethereum improved upon Bitcoin, it is now usurped by newer, better technology. The race is like a competition between computer operating systems, says Jeremy Allaire, the boss of Circle, a company that issues USD Coin, a popular stablecoin.

Current blockchain technology is boring. Both Bitcoin and Ethereum use a mechanism called ” Proof-of-Work “, where computers compete to solve mathematical problems to verify transactions, in exchange for a reward. This slows down networks and limits capacity. Bitcoin can only process seven transactions per second. Ethereum can only handle 15.

During peak periods trading is either very slow or very expensive (and sometimes both). When demand to complete transactions on the Ethereum network is high, the fees paid to the computers that verify those transactions skyrocket and settlement times increase. There are quite a few stories out there of some outrageous amounts of fees (on the order of several tens of dollars) for transferring a very small amount.

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Developers have been trying to improve this shortcoming of Ethereum for a long time. A plan on top of that is, in fact, re-engineering the network and architecture. Plans are underway to move Ethereum to a more easily scalable mechanism called Proof-of-Stake later this year. Another idea is to split the blockchain, through a process called “sharding”. Shards essentially share the load, expanding capacity. Some developers are also working out ways to group transactions, reducing the number of transactions that need to be verified directly.

The problem is that every development comes with a cost. Proponents of DeFi tout the virtue of being able to transact securely and without central intermediaries. But the gains in scale could also come at a price, making the platform less secure or less decentralized. The grouping of transactions before they reach the blockchain tends to be done by centralized entities. And it may be easier for hackers to attack a single piece of a blockchain than the entire network. As a result, Ethereum developers are slow to make changes.

This sluggishness has made the network vulnerable in a different way — by emboldening adversaries. In early 2021 almost all assets locked in DeFi applications were on the Ethereum network. However, in a recent research note, JPMorgan Chase bank estimates that the share of DeFi applications using Ethereum will drop to 70% by the end of 2021. A growing number of networks, such as Avalanche, Solana, Cosmos, Algorand, Cardano and Polkadot, now use Proof-of-Stake in their blockchains which do the same basic job as Ethereum, but much faster and cheaper. Avalanche and Solana, for example, process thousands of transactions per second.

USD Coin’s experience shows these changes. This token was launched on Ethereum just three years ago, but has since been launched on various other competitor networks, including Algorand, Hedera and Solana. Mr Allaire says that while Ethereum transactions are subject to cost and speed limitations, Solana transactions can handle “Visa-like volumes” with “settlement finality in around 400 milliseconds and transaction costs around one-twentieth of a penny” . Other DeFi applications, such as Venice Swap, an exchange founded on Ethereum, have also launched on several other blockchains.

With the planned changes to Ethereum likely to take at least a year, if not longer, “the risk is…the Ethereum network will lose further market share,” wrote JPMorgan’s Nikolaos Panigirtzoglou. For Mr. Allaire, the picture is pleasantly competitive: “Just like with the web, where Windows, iOS and Android are all competing against each other, there are competing blockchain platforms.” He believes that the ultimate winner will be the platform that attracts the best developers to build applications and therefore reap the best results of a network.

What are the Advantages and Uses of DeFi Applications

But this analogy to the battle of operating systems can only be stretched so far, only in part because of the nature of open, public blockchains. Anyone can access the data it produces and see its operating code, making it possible to build bridges or applications that run on multiple blockchains or aggregate information from different blockchains. Some apps, like 1inch, already scan exchanges across multiple blockchains in order to find the best execution prices for various cryptocurrency transactions. “Multi-chain” blockchains, such as Polkadot and Cosmos, act as bridges between different networks, making it possible to work on them.

As long as DeFi is so important and promising, the competition as the network of choice will naturally be intense. But the idea that the ultimate winner takes all, gaining total control of the digital economy and how it develops, may one day seem as outdated as the videotape.

Would you like to join Defi world? Trade on Venice Swap.

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