The innovation speed of DeFi is 10 times faster than traditional Fintech applications.
Written by: Chris McCann, co-founder of venture capital fund Race Capital Compiled by: Perry Wang
Decentralized finance (DeFi) is redefining the future of finance. Financial support for the underlying application infrastructure is also a major shift is changing our view of the licensing and control, transparency and risk.
DeFi is a developing market segment, where blockchain technology, digital assets and financial services intersect. According to data from DeFi Pulse , the value of digital assets locked in DeFi applications has increased from less than 1 billion U.S. dollars in 2019 to more than 10 billion U.S. dollars in 2020, and once exceeded 80 billion U.S. dollars in 2021 (Chain Note: The range of DeFi protocols counted by DeFi Pulse is limited. In fact, the total lock-up volume of DeFi protocols peaked at more than US$120 billion in 2021; in order to maintain data consistency, the data of DeFi Pulse in the original text is reserved. However, DeFi applications and their underlying infrastructure are still in the immature stage of development.
The goal of this report is to introduce the emerging field of “DeFi Infrastructure” that empowers DeFi applications today.
Although the public is easily fooled by the hype and speculation around this area, but I focus on the key components of the long-term impact of DeFi applications, the main difference DeFi applications and traditional finance, as well as the potential risks resulting from the application of these DeFi in the article.
The main structural commonality of DeFi applications
DeFi application is no central counterparty financial applications. In practice, this means that you do not need to access these financial applications through any institution (such as a bank); instead, users directly interact with the programs on the protocol itself (such as smart contracts). I strongly recommend that you read the report on the introduction of DeFi basics published by the Wharton School of Business to learn more about the introduction to DeFi.
Introduction to the basics of DeFi published by the Wharton School of Business
The main categories of DeFi applications include: decentralized exchange DEX , lending platform , stable currency , synthetic assets , insurance, etc. Although their coverage varies, all these DeFi applications have a set of major commonalities, including:
Use the underlying blockchain as the core ledger
Open source and transparent by default
Interoperability and programmability (composability)
Fully open, everyone can access (no permission required)
Use the underlying blockchain as the core ledger
Compared with traditional financial applications that use core banking systems (Fiserv, Jack Henry, FIS, etc.) as the underlying ledgers, DeFi applications use blockchain as their underlying core ledgers.
Used to build some of the most DeFi application of the block chain include: Ethernet Square, Solana and coins, etc. An intelligent BSC chain. These underlying blockchains store the ledger status of assets deposited in DeFi applications, all content stored in smart contracts, all transactions and withdrawals.
To ensure that all core accounting functions of matching input and output are handled by the blockchain itself, DeFi applications do not need to create an external system to align the balance of the ledger, because all transactions can be queried across various block explorers.
In addition, compared with traditional financial systems, DeFi does not have a separate settlement and clearing process. Transaction processing, clearing and settlement all occur at the same time as the transaction broadcast . Although it is recommended that everyone wait for about 21 blocks or more to ensure the finality of the blockchain itself.
Open source and transparent by default
Traditional financial applications are closed source, and built on proprietary systems, by contrast, DeFi application usually is completely open source, and built on open bottom block chain.
“Many APIs” in the banking industry
This brings three interesting qualities:
Combination of: DeFi diverging application itself, may be mixed or reused in many other applications (see below for more details).
Transparency : Since DeFi applications are open source and completely auditable, it is possible to accurately understand what the smart contract is doing in terms of functions, user permissions, and user data.
Auditability : Since the underlying blockchain itself is open source, the entire flow of funds is fully auditable, including the collateral in the system, transaction amount, default events, etc.
The traditional financial system is opaque. It runs on a partial reserve system and is vulnerable to market shocks. Unlike the DeFi system, which is completely transparent and over-collateralized, this allows DeFi companies to survive the market downturn more effectively.
Interoperability and programmability
In order to allow developers to gain the trust of users, most DeFi applications are completely open source-including the front end and the smart contract itself. Further, since the DeFi applications running on a common platform (bottom block chain), so these applications DeFi fully interoperable with each other, and may be used by any other application programming DeFi and ecosystems.
This is often referred to as the “money Lego” or “composability” feature of DeFi. All these DeFi applications are like separate Lego bricks, which can be recombined to build new things together with other Lego bricks.
This traditional financial system is in sharp contrast:
Infrastructure fragmentation : Traditional financial applications are not built on a common infrastructure.
Application silos : Traditional financial applications are usually proprietary to a banking institution. For example, all of Wells Fargo’s “financial technology applications” can work together, but applications from different banking institutions cannot work together.
Not friendly to developers : Traditional financial applications do not cater to other developers to build services on top of it.
The traditional financial system does have common standards, but it is extremely difficult to reach consensus among market participants, because financial institutions treat software as their own competitive moat rather than product as a differentiating factor.
One of the biggest reasons we see so many innovations in the DeFi field is because the system is interoperable, which allows the developer ecosystem to have more creative expressions of the products and services they create. The most important is that developers do not need to waste time again from scratch, but can be built on a common framework, and focus on making their products unique.
Reference reading:
” Composable Infrastructure as Code: An Introduction to the Maker DeFi Ecosystem “
Fully open, everyone can access
For traditional financial applications, new users usually need to go through a long hands-on process, income verification, credit check, and even face-to-face meetings-just to be able to use a given financial product.
Because financial institutions have formulated these arbitrary rules, these hands-on procedures are prone to biases, including loan discrimination, denial of basic banking services, opening credit lines without consent, and charging illegal fees.
With DeFi applications, you only need a wallet address to interact with these systems. DeFi applications do not require income verification, nor credit checks, and in most cases, they do not even need to know other information besides the wallet address.
This is often referred to as a DeFi application that requires no license. If you have funds for transactions in your wallet, you can do it. No agency or intermediary agency will stop or refuse to provide services to you. No matter what your background is or which country you are from, DeFi applications will not discriminate.
This is one of the least valued characteristics of DeFi products.
Reference reading:
” This Is What Racism Sounds Like in the Banking Industry “
” DeFi Infrastructure 101 — Overview & Market Landscape “
” The History of Lending Discrimination “
” The Legacy of Racism in the Banking Industry “
” The Racialized Costs of Banking “
” Wells Fargo to pay $175 million in race discrimination probe “
Traditional Fintech Infrastructure vs. DeFi Infrastructure
The following architecture diagrams of the main technical differences between traditional Fintech applications and DeFi applications are as follows, I have simplified them for the sake of brevity:
The following is a more direct comparison of some of the main differences between centralized and decentralized financial applications:
DeFi infrastructure-market landscape
Here are two views of different market structure DeFi ecosystem, a Solana is built on the ecosystem, and the other based on Ethernet Square ecosystem.
The reason why I chose these two ecosystems as the focus is to show how extensive DeFi applications are built across two different underlying protocols. Personally, I also believe that Solana is the most impressive freshman first layer L1 protocol, because it has high transaction throughput (50,000 transactions per second pen), sub-second time delay and trade confirmations, as well as the developer of the agreement in Solana Build a fast-growing ecosystem of DeFi applications.
Although the two structures are similar, each underlying protocol builds an ecosystem on top of itself, and the ecosystem is largely independent of each other. Below is a more in-depth explanation of each layer and the trade-offs between them.
Bottom (L1)
The bottom layer is the blockchain where the core ledger itself is located. Ethereum is today’s most important L1 public chain, and Solana is the most promising challenger, with faster transaction speed, higher throughput and cheaper transaction fees.
Node infrastructure
Need to query the endless amount of data, confirm the underlying ledger related information, profit search block, search for transactions, synchronize data, write transactions, etc. In the Ethereum ecosystem , subdivisions such as Infura and Alchemy have emerged to address this demand.
In sharp contrast, Solana’s underlying ledger is fast enough and synchronized enough that the team can directly query Solana’s remote procedure call (RPC) nodes-although this situation may not last forever.
The second layer (L2)
On Ethereum, there are a variety of L2 solutions that are mainly used for capacity expansion, because Ethereum itself cannot handle all transactions. Two promising expansion solutions include Matic and Optimism .
On Solana, since only one layer can be built and no L2 expansion solution is required, there is no need for special integration, and there will be no mismatch with the underlying ledger that handles settlement.
Order book summary
Solana is unique in that there is a DeFi project called Serum that occupies an additional layer alone. The project provides a Central Limit Order Book (CLOB) for all DeFi projects built on Solana.
When new DeFi projects (DEX, automatic market maker AMM, Options Options, etc.) are built on top of Solana, they can pull orders from Serum ( https://projectserum.com/#/ ) and push them back to Serum , Greatly reducing the cold-start challenges faced by most new financial applications.
The best way to think about this is to think of it as a “network liquidity” and “order management” system, which is used by most projects in the Solana ecosystem.
One of the more innovative examples combining CLOB and AMM is Raydium (very similar to Uniswap v3). The combination of these systems allows passive liquidity providers (LP) to use Serum for active market making.
DeFi toolset
Whether it is from the developer or end-user’s perspective, these DeFi run applications require a common set of tools. There is no direct traditional financial analogy for these services, but they include:
Wallet : The main interface that people use to store assets and interact with DeFi applications.
Oracle: DeFi application based on a reference price and the price chain execution data stream transaction (eg, liquidation) of.
Block explorer and analysis tools : Tools such as block explorers are designed to allow people to directly query the blockchain ledger. This type of tool is used most frequently when confirming transactions.
Currency stability: two main assets DeFi ecosystem include underlying native protocol token (ETH or SOL), and the desired stabilization credits (USDC, Dai or Pai) chain.
Front-end : An emerging layer that can create easy-to-use front-end applications to interact with multiple DeFi projects at the same time or to simplify transactions. Examples of this type include Zapper.fi in the Ethereum ecosystem, or Step Finance in the Solana ecosystem.
DeFi applications
The DeFi application itself is composed of all core financial applications that can be used directly, or embedded in various other applications in the encryption ecosystem.
DeFi tool category Ethereum example Solana example
Temporarily missing areas in the DeFi infrastructure
When comparing and contrasting DeFi infrastructure with traditional financial infrastructure, some sectors that do not yet exist in the decentralized world may be worth exploring.
Here are a few highlights:
Consumer financial applications : In the traditional financial world, consumers usually interact with consumer financial applications, such as Robinhood, Chime, and Transferwise, rather than the underlying protocol itself. The front end of the DeFi field can be greatly improved and play a greater role in the overall consumer experience. In general, from a consumer’s point of view, the UI/UX of most DeFi applications is still not easy to use.
Customer relationship management : There is no real concept of customer relationship management in the DeFi field, and no amount of consumer data is usually collected. Although it’s a good thing from a privacy perspective, it’s also valuable to know your customers better.
Notifications : There are no notifications or alerts in the DeFi world. On a broader level, there is also no good way to communicate with users.
Product analysis : There are some tools that can measure blockchain activities, but they cannot measure participation in DeFi applications.
Security : DeFi products usually undergo security audits; however, no security audit can guarantee the most common protective measures that consumers are accustomed to in the traditional financial world. Most importantly, security auditors are in short supply, so this is a big bottleneck.
Transaction rollback : In traditional finance, if you make a mistake, financial institutions can roll back the transaction. There is no such precedent in the DeFi field.
Custody : Currently, most DeFi projects need to interact from a personal wallet. No custodian allows you to interact with DeFi applications.
Developer platform : Most developers in the encryption field build on the L1 protocol itself. There is currently no concept of a developer platform or middleware.
Embedded wallet : The current wallet is regarded as an external service, and no white-label wallet product can directly embed these into the DeFi application itself. There have been some new projects, such as Torus, but they are still in their infancy.
Identity : One of the biggest complaints about DeFi in the traditional financial world is the anonymity of users. Ideally, there needs to be a way to keep bad actors out while continuing to protect consumer privacy.
The future of financial applications
After meeting with hundreds of founders and seeing the progress made by each team, I feel that one thing is very clear: DeFi innovation speed is 10 times faster than traditional Fintech applications.
In traditional finance:
The underlying ledger is not open source, nor is it friendly to developers.
There are currently many “bank as a service” applications, but they are just for packaging the underlying cooperative banks into a developer-friendly platform.
Fintech applications face many challenges in terms of regulation, and it usually takes years of development to release a single product.
In contrast, DeFi is the opposite:
Everything is open source, including the ledger itself.
All transactions are public.
Everything is built from the perspective of developers building applications on top of the protocol.
New DeFi applications are built and released in weeks, rather than years.
We at Race Capital believe that DeFi developers will permanently change the way the financial world operates. We are very optimistic about the DeFi infrastructure stack and community.
Many thanks to Bartosz Lipinski, Kas Vardhanabhuti, George Harrap, Dylan Macalinao, Anmol Singh, Edith Yeung and Kim McCann for their review and feedback on this article.
Interest statement: The author is a seed investor in Solana Labs.
