Our DeFi experts demystify and explain decentralized finance, how it works, and how to capitalize on its growth potential.
General Discussions About Decentralized Finance
MakerDAO: The History and Role of the Building Block of DeFi
MakerDAO is an open-source Decentralized Autonomous Organization (DAO) and financial lending and borrowing application on the Ethereum blockchain. The protocol is partly Governed by the Maker Foundation, although it is fast moving towards a self-governed system. Developers across the globe started working on the MakerDAO between 2014 and 2015 to build the initial version of its codebase and decentralized architecture. After two years of development, the Maker platform released its first documentation. The project was described as a system for creating the DAI stablecoin on the Ethereum blockchain using collateralized debt positions embedded in smart contracts. The project developers were a decentralized team of individuals and organizations that included developers from the Maker Foundation, partners of the foundation, and other entities. DAI, Maker’s stablecoin was initially a single collateral asset, SCD called Sai. It became protocol started supporting multiple collaterals with issued Dai backed according to their volatility of the collateral asset. The decision was reached through scientific voting, another feature of Maker that keeps the platform decentralized. What Is the Maker Protocol? The Maker protocol comprises two main assets and other ERC20 assets that serve as collateral on the MakerDAO platform. The first asset MKR is the governance token of Maker that can be used to vote on 1MKR:1 vote basis on changes to the protocol. The MKR token is also used to protect the system from arbitrary decisions that can affect the parameters set to ensure the sustainability of the MakerDAO protocol. As the governance token of MakerDAO, MKR ensures stability through decisions on adding collateral asset types and defining the parameters for this collateral. MKR holders decide on modifying and adding risk parameters for new collateral asset types. MKR is also crucial in modifying DAI savings rate, choosing oracle feeds, the trigger of emergency shutdowns to protect the system, and upgrading the system. The DAI stablecoin functions as an on-chain decentralized stable currency with the complete features of fiat money and can be owned through minting by locking collateral assets such as Ethereum in Maker Vaults within the protocol or by buying Dai from exchanges. Minted DAI was kept at a minimum of 150% collateral ratio, which meant that if you were to $500 worth of Dai, you would need to keep a minimum of $750 worth of ETH or other collateral in the vault. With the approval of the Multi Collateral Dai or MCD collateral contract in 2019, the minimum collateral ratio is now 175%. Minters of DAI through collateral vaults must pay a stability fee and the amount of Dai generated to liquidate their vault and reclaim their assets. There is also a 13% liquidation fee paid on liquidated vaults which the protocol keepers can initiate an auction mechanism to settle fees when the need arises fully. Maker was established to create a price-stable cryptocurrency that gets its backing on-chain from crypto assets instead of fiat or physical assets. Dai is a neutral collateral-backed cryptocurrency that is free from the volatility of Bitcoin. According to the protocol whitepaper, Dai serves to create leverage positions for traders who want to hold their collateral assets such as ETH and gain exposure to the same or other cryptocurrencies while remaining fully collateralized and retaining their original assets. Remittances can also be settled in a stable digital asset using Dai and charitable contributions that want to stay transparent using the advantages of blockchain technology. Dai can also be used to wager on the future prices of assets without exposure to the volatility of the original asset in prediction markets. As one of the first protocols to run reliable price-feed oracles on the Ethereum blockchain, Maker also hopes that its oracles will be used by future DeFi projects to ensure the security of their system. The stability mechanism of MakerDAO and the Dai stablecoin is pretty complex. Still, it is important to note that MKR also acts as a stability mechanism that keeps the peg of Dai as close as possible to the US dollar. The Dai Saving Rate (DSR) is the parameter that determines the amount earned in APY on Dai savings. MKR holders reduce the DSR, which is normally around 6% APY when the price of Dai moves above the peg. Doing this will reduce the supply of Dai by reducing the demand since users will be less interested in minting new Dai at such low yields. The demand for circulating Dai will push the price back to the peg. MKR holders also increase the DSR when the price of Dai falls below the peg, thus causing demand to put pressure on the price of Dai until it reaches the 1:1 peg with the dollar. Who Can Access DAI Stablecoin? Anyone can access Dai using Ethereum or other collateral ERC20 assets supported by the Maker protocol. These assets are used to create a collateralized debt position which is essentially a smart contract on the Ethereum blockchain that holds the collateral in a vault. Minting Dai simple even though the explanation sounds a bit technical. Dai can simply be minted on Oasis or other supported platforms decided by MakerDAO that forms the community ecosystem. It is also possible to own Dai by purchasing it on popular exchanges. The Founder of MakerDAO Rune Christensen, a Danish biochemist, and businessman, is the identifiable co-founder of MakerDAO. On Rune’s profile on the popular professional networking platform LinkedIn, Rune describes MakerDAO as the first stablecoin on the blockchain that eliminates volatility through a system of smart contracts. Rune owns two bachelor's degrees, one in Biochemistry specializing in complex chemical machines from the University of Copenhagen and another in International business from Copenhagen Business School. What Makes MakerDAO Special? Maker’s DAI is without doubt Ethereum’s native stablecoin even though there are now multiple stablecoins on the Ethereum blockchain today. It is the most widely used and longest-running protocol on the Ethereum blockchain. It is the 6th protocol by total value locked or TVL in the collateralized debt position, CDP category on the Ethereum blockchain with over $23 million in value. According to sources, Andreessen Horwitz, renowned venture capital, invested $15 million in Maker DAO to buy 6% of the total MKR supply as a part of its early investment through its a16z cryptocurrency fund. Created the core layer of DeFi MakerDAO laid the groundwork of ideas that led to creating several protocols on the Ethereum blockchain. The launch of DAOs like Curve, Uniswap, and other protocols that were based on collateralized lending, exchange, swapping, and the allocation of value on-chain attests to the groundbreaking work of MakerDAO in DeFi. Newer protocols, successful and unsuccessful on the Ethereum blockchain, have often cited MakerDAO for their careful economics and stabilization mechanism. Developments in algorithmic stablecoins are also offshoots of MakerDAO. The key mechanisms of DeFi as we know it today, including AMMs, vAMMs, and other smart contract-based models and stability mechanisms, are similar to the collateral debt mechanisms and other stability contracts on the Maker protocol. How DAI, ETH, and MKR Work Together Dai is the stablecoin created when collateral debt positions or vaults are opened on the Maker protocol. It offers users a stable asset while allowing them to lock volatile assets as collateral in the issuing vaults. Dai is also used to pay stability fees charged by MakerDAO. It is the primary asset of the protocol. To mint Dai, however, you must add ETH to the vault. Although the collateral has now been extended to include other ERC20 assets with varying liquidation parameters, ETH was the primary collateral asset and the reason for the name Sai which was initially the appellation for what is now known as the Dai stablecoin. MKR is the governance token and restabilization asset for the MakerDAO protocol. It triggers liquidation, suggests proposals, and protects the system from sudden events such as uncoordinated and abrupt liquidation which can endanger the protocol. You need ETH to get DAI and need MKR to sustain the setup that allows the creation of the crypto-collateralized stable asset.
General Discussions About Decentralized Finance
Key Features of DeFi Explained
Decentralized finance, DeFi in short, is an umbrella term that captures all of the financial tools built on the blockchain. Namely, it is a fast-growing financial technology that aims to eliminate mediation and enable everyone connected to the internet to lend and borrow money easily. DeFi has the ability to take away control over money and financial services from banks. Without them acting as intermediaries, the financial market can reach a new level of openness and freedom. DeFi is based on four main pillars known as the DeFi layers: Settlement layer This acts as the anchor for the entire system and ensures the necessary security people are looking for in a decentralized system. Protocol layer In simple terms, this is a layer that provides the rules of the entire blockchain network. Application layer This layer comprises all of the blockchain-generated applications that users might use to trade, exchange, buy, sell, lend and even borrow assets. Aggregation layer This is the topmost layer where you can find the services that aggregate the blockchain-generated applications that users can use to trade, exchange, buy, sell, lend, and borrow assets from multiple networks. The Key Features of DeFi Permissionless The fact that DeFi does not require anything else apart from an internet connection to partake is one of the main reasons it is so attractive. Everyone can get a crypto wallet, regardless of their financial status and geographical location. Contrary to traditional finance, DeFi welcomes everyone and offers open access. Programmability This feature promises—or at least increases—the likelihood of DeFi having a bright future ahead of it. It means that new digital assets can be created based on the needs of the users, instead of the needs of a centralized body. While most of the solutions that DeFi offers at the moment are based on Ethereum and the ETH blockchain, it has more than enough support to address any financial service challenge. Transparency One of the main benefits that the DeFi system offers is its transparency. This means that everyone on the blockchain is given insight into the transactions, effectively having the ability to audit while keeping their privacy at the highest level possible. Namely, the identities of users are protected with anonymity, and the visibility over the system makes it trustworthy. Immutability As a term, immutability is a word for not being susceptible to change. All of the data on the blockchain can never be changed, which means that it cannot be tampered with—making it highly auditable and completely secure. This is one of the key features that give DeFi an advantage over the traditional financial systems. Interoperability Interoperability means that the applications built into DeFi are designed in a way that allows for easy integration between them. They complement each other and allow developers to create new solutions and add features to existing applications more conveniently. Composability like this also allows UI customization and integration of third-party apps. Non-Custodial Out of all the features we mentioned above, this is probably the most important characteristic of DeFi and the top reason that it has become so popular. It means that the assets and personal data are completely controlled by the user and no one else. This feature alone opens doors to a new age of financial services tailored specifically with the user in mind. Why the Popularity of DeFi Is Increasing At the beginning stages of the decentralized blockchain, there were only Bitcoin and Ethereum. Nowadays, there are whole new concepts like liquidity mining and yield farming that attracted the attention of millions of newcomers. Here are some of the most popular applications that contributed to the rise of decentralized finance: Decentralized Exchanges DeFi allows users to purchase cryptocurrency with fiat money and then exchange it as they please without mediation. This means that the users can trade currencies as much as they want without ever paying a fee to an external intermediary like a bank. Lending Platforms With the use of smart contracts, users can lend and borrow finances securely. The execution of this agreement is almost fully automated, so all parties involved can have an immediate and certain outcome without the need for intermediary third parties. Additionally, users lose no time when dealing with smart contracts. Stablecoins Cryptocurrencies are naturally volatile and widely deemed as unstable. For this reason, stablecoins like USDT, BUSD, and USDC are a nice addition to blockchain technology. They are coins tied to a traditional currency and can be used to maintain the stability of cryptocurrencies. Prediction Markets The place where users can bet on the futures of cryptocurrencies. Recently, it has become a very popular market, especially because there are no intermediaries.
General Discussions About Decentralized Finance
Smart Contracts in Blockchain: What They Are and How They Work
Smart contracts are self-executing computer protocols built on a blockchain network. They facilitate the execution of trusted transactions and pacts among anonymous individuals without the supervision or control of a third party. Additionally, they automate workflow and eradicate human errors by triggering the outcomes of predetermined conditions. Smart contracts run on a blockchain network, meaning that the terms and conditions are stored in an immutable, decentralized database. All the transactions are processed and recorded on the blockchain, automating payments and counterparties. How Do Smart Contracts Work? Smart contracts work by obeying basic if/then statements coded into a blockchain. A series of connected computers/nodes perform the next action when the coded statements are met. Such actions include sending digital assets to a given address, voting, registering a property, issuing event tickets, or notifications. The nodes then record the actions in the blockchain; hence, they cannot be altered. Smart contracts contain multiple options to ensure that the participants are satisfied with the task at hand. To arrive at a mutual agreement, the participants determine how transactions will be represented on the blockchain, give consent to the if/then statements that control transactions, search for ideal exemptions, and agree on a framework for determining disagreements. Here is a simple explanation of how a smart contract works. Assume Josiah wants to purchase a piece of land from Tyson. Instead of signing a paper-based agreement, they create a “digital agreement” and code it into the Cardano blockchain. This “digital agreement" between Josiah and Tyson contains the duration of payment, measurements, cost, and title deed of the property. In other words, the agreement looks like this: “WHEN Josiah pays Tyson 4,500,000 ADA, THEN Tyson will hand over the ownership rights to him.” Once this agreement is coded into the Cardano blockchain, it cannot be altered, implying Josiah can feel safe to pay Tyson 4,500,000 ADA for the property. If we eliminate smart contracts from this deal, Josiah and Tyson will incur enormous fees for intermediary services, and the deal may take several months to process due to manual verification. Why Should You Use Smart Contracts? Smart contracts have multiple benefits over traditional arrangements, including: Accuracy One of the basic requirements of a smart contract is recording all the predetermined terms and conditions clearly. This is because a slight omission can lead to severe errors. Besides, since smart contracts are automated, they eradicate human errors associated with filing mass amounts of paperwork. Transparency All the participants can access the predetermined terms and conditions of smart contracts, minimizing future disputes. Additionally, the transactions are recorded for future reference. Speed Smart contracts are software protocols built on Blockchain networks. Unlike traditional contracts, smart contracts perform transactions quickly. Security Smart contract records are encrypted, making them difficult to hack. Besides, since each recording block is connected to the previous and next block on a blockchain, hackers would have to modify the entire network to alter a single record. Savings Another significant benefit of smart contracts is eliminating expensive processes and intermediaries. They don’t require lawyers, government agencies, witnesses, and financial institutions to run. Guaranteed outcomes Smart contracts significantly reduce or even eliminate the need for litigation and courts. When two or more parties use a smart contract, they commit themselves to abide by the set rules and conditions as they are already aware of the consequence of not following them. Real-World Examples of Smart Contracts Inmusik A music streaming platform that decentralizes earnings and allocates them to the right content creator. It leverages smart contracts to validate content ownership via a transparent tagging mechanism. Pharma Portal Sonoco and IBM Blockchain use smart contracts to monitor temperature-controlled pharmaceuticals by increasing supply chain transparency. Tracr This platform uses smart contracts to offer end-to-end tracking of diamonds from mining to retail. Maersk and Tomcar also apply smart contracts to streamline the supply chain system. Limitations of Smart Contracts Despite the benefits of smart contracts, they are not without their limitations. The most prominent ones include: Difficulty in modifying Modifying smart contracts is almost impossible since even slight changes are time-consuming and costly. Possibility of loopholes Smart contracts may contain bugs that hackers can exploit. Vague terms and conditions Sometimes, smart contracts contain statements that some participants do not clearly understand or are not applicable in some jurisdictions. Most businesses and government agencies are embracing smart contracts at a high rate because of their innovative approach and benefits. They are essential for the thriving of the digital economy as they offer the much-needed automation, accuracy, speed, safety, and transparency for peer-to-peer platforms. It is clear that they will become far more commonplace in the future.
General Discussions About Decentralized Finance
What Is DeFi: Beginner’s Guide to Decentralized Finance
How many times have you scratched your head in silence as your friends go on and on about this newfangled finance topic known as DeFi? How many times have you Googled ‘DeFi’ only to be tyrannized by the flurry of jargon? This has to end. In this article, we will explain what DeFi is and how it makes a difference. What Is DeFi? DeFi, short for decentralized finance, is an umbrella term for the emerging peer-to-peer financial services that run on blockchains. Cryptocurrencies like bitcoin are built on blockchain technology. They facilitate decentralized transactions, throwing centralized financial institutions and middlemen out of the picture. However, the scope of blockchain technology is not limited to coins and payment executions. DeFi applies blockchain technology to deliver complex financial use cases like insurance, lending, borrowing, yield farming, trading, staking, crowdfunding, and lotteries. Here, instead of a central authority or a third party, a smart contract facilitates the transactions. Smart contracts are programs stored on a blockchain that run when predetermined conditions are met. Unlike traditional contracts, smart contracts don’t require tedious paperwork or expensive intermediaries. They are automatic and self-executing agreements, featured by transparency and immutability. Decentralized Finance vs. Centralized Finance How does DeFi stand apart from centralized finance? Here is a quick look. In centralized finance, assets and transactions are managed by a set of people or institutions. Centralized finance is not confined to institutions based on fiat currency. For example, many popular crypto exchanges like Coinbase and Binance use a centralized business model similar to traditional stock exchanges. When it comes to decentralized finance, DeFi protocols do the part. Instead of humans, you place your trust in predefined algorithms. As you sign up for centralized financial services, you hand over the control of your assets to the platform. If the platform’s security is at risk, so are your funds. In decentralized finance, you keep your assets in decentralized wallets like Metamask. Here, nobody can access your funds except you, as long as the password is hidden. The Benefits of DeFi Transparency DeFi replaces trust with transparency. The transactions on a DeFi application can be seen and verified by anybody. Atomicity DeFi transactions are made indivisible by blockchain technology. All the sequential actions in a transaction have to be completed for it to process, or else they fail collectively. Anonymity DeFi applications provide users with better anonymity than their centralized counterparts. They don’t ask for your name, phone number, or ID. All you need is a wallet address to get started. If your jurisdiction bans cryptocurrency, the government can always freeze your assets in centralized applications. Your best bet in this scenario for the safekeeping and transaction of digital assets would be DeFi. Faster trading DeFi can facilitate the exchange of cryptocurrencies faster since decentralized exchanges rely on automated market-maker (AMM) protocols rather than limit order books. Open around the clock DeFi services like lending, borrowing, yield farming, and insurance are available throughout the day. Accessible to all The most attractive feature of DeFi is that it makes financial freedom feasible for all. Passive streams of income like yield farming and liquidity mining opened our eyes to the massive potential of DeFi. When applying for a DeFi service, your income, financial statements, and credit score don’t matter. The Risks of DeFi For starters, smart contracts lack the human element, which is key to making decisions in many circumstances.If any error makes its way to the smart contract, all transactions are at risk. The blockchain ecosystem is still figuring out interoperability and cross-chain transactions. The erratic fluctuations and volatility in the market can lead to huge losses. Moreover, if you lose access to your wallet, all your funds are gone. There is no way of retrieving them. What Is the Future of DeFi? In the last two years, DeFi has played a key role in bringing cryptocurrencies to the mainstream. The innovative streams of revenue characterized by transparency and anonymity continue to lure people in. The huge market caps of DeFi tokens stand testimony to its success. However, DeFi is not without its share of limitations. Like all blockchain applications, DeFi is still in its infancy. The industry is prone to scams, frauds, and failures like its centralized counterpart. With a more robust infrastructure, will DeFi and DeFi 2.0 find their way to the masses? Only time will tell.
General Discussions About Decentralized Finance
Brief History of Bitcoin: The Beginning of DeFi
Understanding the history of DeFi requires an understanding of the cryptocurrency genesis. Bitcoin was the first decentralized payment solution; some argue this could even be the first DeFi protocol. Regardless, the creation of Bitcoin led to the arrival of Ethereum, which lay the building blocks of DeFi as we know it today. What Is Bitcoin? Bitcoin is a digital currency that functions free of any central control of traditional banks or governments. It relies on a peer-to-peer network built on blockchain technology. Every transaction is recorded on the Bitcoin network and is publicly accessible by anyone with an internet connection. Users can access this cryptocurrency through crypto exchanges that help connect buyers and sellers. Why Was Bitcoin Created? The anonymous group or person, Satoshi Nakamoto, established Bitcoin in 2009 as a response to the financial crisis of 2008. Satoshi had the idea of disintermediating banks from their control over financial transactions. Several years down the line, Bitcoin has evolved and is now hailed as an icon of decentralization and financial autonomy. Some investors also see Bitcoin as a hedge against inflation due to its deflationary structure and fixed supply of 21 million coins. How Has the Value of Bitcoin Changed Over the Years? The Bitcoin price chart currently sits around $38,000. However, this has not always been the case, as this cryptocurrency has always had a volatile price history. In the early days of Bitcoin valuation, the cryptocurrency was almost zero. However, all that changed when its price jumped from $0.09 to $29.60 within the span of a year (2010 - 2011). Consistent price fluctuation has become synonymous with the Bitcoin market. Bitcoin has continued to experience several rallies and crashes throughout its existence as speculative retail investors and traders entered the space. In 2017, the BTC price broke new heights by attaining a massive spike of $2,000 from $1,000. At this stage, mainstream investors, government institutions, and even traditional banks started to recognize the presence of bitcoin and started trying to adjust to the upwardly mobile prices that BTC reflected at the time. A couple of years later, cryptocurrencies have grown in popularity across the board, with Bitcoin remaining the leader of this new class asset. Institutional investors have started taking an interest in Bitcoin, and as their money tricked in, the price soared, reaching highs of more than $60,000 in 2021. How Is the Bitcoin Price Influenced? The price of Bitcoin depends largely on perceived value, supply, and demand. Its price is not regulated by any individual, government, group, or entity. By design, there will only ever be 21 million bitcoins created, eliminating the mass production of bitcoins and curbing inflation. Its deflationary mechanism means that the closer Bitcoin gets to its limit, the higher its price will be, as long as demand remains the same or increases. Aside from its in-built inflation control system, other factors that may influence the price of Bitcoin include: Fluctuations in supply and demand.Media attention on cryptocurrenciesThe implementation of regulations for managing Bitcoin's utility and scalabilityThe cost of Bitcoin miningSynthetic products and Bitcoin derivatives Will We Use Bitcoin for Years to Come? Bitcoin's value proposition as a decentralized payment solution hasn't budged in the last twelve years. With governments around the world taking a harsher approach towards controlling the financial capabilities of their constituents, we may see more people flock towards Bitcoin and its offerings to counter government overreach and censorship. As traditional investors and Wall Street bankers start to embrace Bitcoin, the lines between conventional financial assets and Bitcoin become blurred. Leading Wall Street investors allocate up to 5% of their portfolios to Bitcoin, which may indicate that the cryptocurrency has grown big enough that its market cap will catch up with gold in the future. Perhaps, one day, it could be worth more than gold! El Salvador was the first country to adopt Bitcoin as its legal tender. If their experiment proves successful, we may see more nations that suffer from similar economic predicaments to El Salvador toe this line. This could bring Bitcoin to the level of true mass adoption, ushering in the age of the "hyperbitcoinized world." However, there is still a chance that things will go downhill. Governments may frown upon the growth of Bitcoin since they cannot control it, and they may implement massive regulations that stifle its adoption rate. This type of heavy-handed regulation likely won't kill Bitcoin, but it could seriously tank its price, bringing about a long-term bear market. Whether bullish or bearish, the future of Bitcoin remains unpredictable. The best thing investors can do is constantly do their research and keep up with the news to stay afloat in this space. In the end, the users and the Bitcoin community should brace for future challenges to the Satoshi experiment. Overcoming these obstacles will require innovation, perseverance, and education.
General Discussions About Decentralized Finance
Limitations of Bitcoin: Scalability, Smart Contracts, and More
Bitcoin derives its value from its relative scarcity, market demand, and the marginal cost of production. Bitcoin commands a high valuation, with a total market cap of $1.11 trillion as of November 2021. Bitcoin is currently trading roughly 50% lower than its latest all-time high of around $69,000. Despite Bitcoin's price decline, online communities are still buzzing with miners discussing best practices, investors consulting on profit strategies, and developers seeking improvements to the network. Annual Bitcoin conferences are always packed with new attendees every year. Sustained activity and growth in these communities suggest widespread interest in Bitcoin and its offerings and an increase in the popularity of Bitcoin amongst users. While Bitcoin price has retracted from its all-time high, these Bitcoin maximalists remain convinced about the crypto's long-term viability and see it as a guaranteed 'win' for champions of decentralization, individual freedoms, and financial sovereignty. What Is Bitcoin? Bitcoin is the proto-cryptocurrency; it utilizes peer-to-peer technology to complete payments on its network and exists independently of any government, state, or financial institution. The Disadvantages of Bitcoin Despite gaining a lot of ground since its creation and offering several benefits over traditional currency, Bitcoin is still not widely accepted. The skepticism with Bitcoin stems from issues that its critics view as a demerit to using this form of digital money. Some of these disadvantages include: No buyer protection It is practically impossible to undo a Bitcoin transaction if the seller doesn't deliver the products promised. Without the availability of smart contracts, Bitcoin transactions are irreversible. Deflationary issues The total number of Bitcoin is capped at only 21 million Bitcoins. This in-built deflationary mechanism promotes scarcity and rewards the early birds as the value of Bitcoin increases with time. The deflation could trigger spending spikes, causing sharp and unpredictable fluctuations in the Bitcoin market as investors struggle with the decision to sell or spend. Use limitations Bitcoin isn't widely accepted. Although there is an increasing number of organizations accepting Bitcoin payments, it still hasn't reached the mass adoption phase. This restriction puts a limit on where one can spend Bitcoin. Volatility There is a correlation between Bitcoin price and investor sentiment. News headlines or the opinions of influential figures in the crypto space can significantly affect the demand for Bitcoin and sway its price. Due to this, Bitcoin doesn't offer the level of price stability possible with traditional financial assets. Valuation guarantee Since Bitcoins have no central authority, no one entity can guarantee their value. So, if a considerable percentage of Bitcoin owners decide to abandon the system, its value will plummet, hurting users who have large sums invested. The Greatest Limitations of Bitcoin Regardless of all the merits Bitcoin brings to the table, certain things still hold it back and limit its utility, particularly the absence of scalable growth infrastructure and smart contracts. Scalability Scalability is the ability of a protocol to grow without being hampered by its structure or available resources when faced with increased demand. Bitcoin suffers from scalability problems since the network cannot handle large quantities of transactions quickly. The average transaction processing capacity on the Bitcoin network is seven transactions per second, which is unimpressive when compared to traditional payment services like Visa and Paypal that process thousands of transactions in seconds. If Bitcoin becomes widely adopted in its current state, there is a chance that the network may freeze or seize operation. Bitcoin developers are constantly looking for solutions to the network's scaling problem. Several proposals have been put forward, including the Layer 2 solution—Lighting Network, blocksize increment, and other efficiency improvements like Schnorr signatures. Smart Contract Issues Smart contracts are computer protocols that allow the digital verification, control, and execution of contracts. Smart contracts, like regular contracts, specify rules and penalties around an agreement and enforce those responsibilities. Blockchains benefit from the deployment of smart contract functionalities since developers can leverage this to build new dApps and various programs with diverse utilities on the blockchain. Ethereum, Solana, and Polygon have all benefitted from integrating smart contracts. These blockchains now have hundreds of valuable dApps on their networks. The absence of smart contract functionality on the Bitcoin network prevents developers from creating useful applications, reducing its overall utility. The Problems of Smart Contracts Scalability Smart contract-powered blockchains allow for the creation of interesting decentralized applications. However, scalability issues become apparent as the demand for these dApps continues to increase. Many smart contract blockchains suffer from long transaction times, delays, and costly transaction fees. Immutability The immutability of smart contracts means that their performance is guaranteed to take place based on their coding. This limitation gives no room for any modifications or reversals. Therefore, a smart contract's performance is irrevocable in the event of any errors in the code. Readability Non-developers find it challenging to comprehend smart contracts because they are written in programming languages such as Java, Python, and C++. Serialization Smart contracts are executed serially by miners. Miners cannot execute another smart contract until the complete implementation of the current contract, which limits their performance. Is Bitcoin Viable as a Currency Option? Bitcoin's deflationary design of the 21 million Bitcoin hard cap ensures its scarcity, which drives its demand. However, scarcity isn't enough to justify its status as a viable currency. On the surface, Bitcoin constitutes the idea of what a currency should be. It serves as a medium for exchange and is tradeable for goods and services. The question is, does Bitcoin properly fulfill its role as a currency? A proper currency must: Remain valuable over a long periodHave a limited supply Be divisible/portable These are why gold and silver have remained a great medium of exchange throughout human history. Bitcoin appears to tick all the right boxes; however, Bitcoin critics point to issues with volatility and slow transactions, which they claim make Bitcoin unusable as a currency. People who share this sentiment only view Bitcoin as a community asset. Before passing judgment on Bitcoin's viability as a currency, one must consider the fact that the limitations of Bitcoin may not always be there as developers are constantly working on improving the network and deploying new Layer 2 solutions that solve scalability issues. Therefore, whether or not Bitcoin becomes widely accepted as currency in the future hinges on the successful implementation of its scalable solutions.
General Discussions About Decentralized Finance
How Ethereum is Changing the Crypto Narrative
There are still many people who haven’t heard about Bitcoin, although Blockchain data available on Statista shows over 300% increase in the number of crypto wallets from 21 million people in 2017 to over 81 million at the time of writing this article. That is only a part of the current crypto trend that is now the subject of ministries of finance and governments across all continents of the globe. From Eastern Europe to Asia, Africa, North America, South America, and Australia, governments are having face-offs with what they have dubbed a potential threat to financial stability and a haven for cybercriminals. Nevertheless, the advantages of cryptocurrencies continue to unveil in unimaginably positive ways, making it obvious to most countries that it means more good than evil for everyone and can reduce wealth inequality. In some quarters, citizens have scorned governments and public officials as clueless baby boomers, yet the public keep using crypto in cases where they would have given their rights away quite easily thanks to the blockchain and decentralization. The buzzword making headlines today in crypto is Bitcoin. It is the flagship cryptocurrency that introduced the world to the power of blockchain technology when applied practically. The next thing to Bitcoin in crypto is Ethereum, and the popularity of Ethereum is merited because it gave more use-cases to the technology and made adoption possible at the same time. So Bitcoin is more popular because many people love to be conservative, but there is more in cryptocurrency than Bitcoin, and Ethereum is the true gamechanger. What Is Ethereum? Ethereum is a decentralized universal computer for applications on a public virtual machine—known as the Ethereum Virtual Machine (EVM)—that brings everyone on the network to a consensus or agreement on the state of the network. All users of Ethereum can ask this computer to perform a wide range of transactions which are then broadcasted to the network for validation and verification by other participants on the network. The EVM changes in its state with every transaction initiated on the network, which is added and broadcasted throughout the network so that nodes or computers participating on the network can update their copy of the ledger to the latest state. Transactions on Ethereum are known as requests, and they are verified, validated, and stored permanently on the blockchain, updating the state of the EVM with each group of transactions in a block. The network uses cryptography to secure transactions and ensure verification and validity. Ethereum supports the uploading of reusable codes to the EVM that developers publish to the EVM data layer. These codes or programs uploaded to EVM can be called by anyone using the Ethereum network with specific parameters that instruct the EVM to perform some defined computations in the code. The codes are known as smart contracts, and developers pay a fee to the network to make smart contracts public. The possibilities with the parameters for smart contracts are nearly unlimited, and each parameter represents a unique use case for the Ethereum network. Ether (ETH) Ether or ETH is the native currency of Ethereum. It is used to incentivize validators of transactions or miners on the Ethereum network. Transactions on Ethereum require payment of fees known as gas fees to these miners. Ethereum gas is a unit of computation needed for transactions on Ethereum. These computations consume some resources, and gas settles the cost of those computational resources. Ethereum Gas Fees Fees on the Ethereum blockchain are denominated in gwei or giga-wei, which equals to a billionth of an ETH. Wei is the smallest unit of Ethereum which takes its name from Wei Dai, founder of the popular B-money cryptocurrency project. Currently, Ethereum uses a proof-of-work consensus whereby each transaction is calculated by multiplying the gas limit or base amount of gas you are willing to consume for a transaction by the gas fee denominated in gwei. Suppose an anonymous user, Bob, decides to send 1 ETH to another user, Charlie, with a gas price of 200. We can arrive at the gas fees paid in ETH given that the gas limit for Ethereum transactions is fixed at 21,000 units thus: 21,000 x 200 = 4,200,000 gwei = 0.0042 ETH, arrived at by 4,200,000/1,000,000,000, which is the amount of gwei in 1 ETH. So Bob will send 1.0042 ETH from which 1ETH goes to Charlie, and the remaining 0.0042 goes to the miner for verifying and adding the transaction to a block for validation and inclusion on the EVM state. With the recent London hard fork or upgrade, however, Ethereum has made efforts to make the gas fee more predictable by introducing a target block size of 15 million and a maximum block size of 30 million, which determines a base fee. Since Ethereum is the most popular blockchain for building decentralized applications, it has often been difficult to verify transactions. With this upgrade, a base fee determined by the level of demand for the spaces in a block is set and incremented by 12.5% when the target is exceeded. That base fee is burned, and the tip incentivizes miners. So transactions on Ethereum are now given by: (Gas limit x base fee) + tip So in our previous example, if Bob was to send 1 ETH to Charlie at a base fee of 100 gwei and a tip of 10 gwei. The calculation will be: 21,000 x 100 + 10 = 2,310,000/1,000,000,000 = 0.00231 ETH 0.0021 ETH is burned of this amount, while 0.00021 ETH goes to the miner as fees. Going by the block size rule, when the block space demand crosses 15 million, the 100 gwei base fee becomes 112.5, representing an increment of 12.5%. Smart contracts on Ethereum are written in solidity, and deploying them requires higher computational power than the average transaction. Ethereum is moving to proof-of-stake soon, which will decentralize the current concentration of ETH among a few by allowing anyone with 32 ETH to become a validator. Ethereum powers some of the most popular DeFi applications, such as Uniswap, Bancor, Balancer, and Curve. Ethereum vs. Bitcoin: Key Differences Support Ethereum is more practical and value-driving to the crypto and blockchain than Bitcoin. Even though people often cite cases of forks such as the Ethereum Classic, which represents a division of the Ethereum blockchain, Ethereum still outperforms the flagship cryptocurrency on several points. It is also important to note that Bitcoin has forks of its blockchain, such as BCH and Bitcoin Gold. Mining and Staking Ethereum currency uses a combined proof-of-work/proof-of-stake algorithm, thanks to the Beacon chain, which shipped on December 1st, 2021. Bitcoin uses a proof-of-work consensus. Proof-of-work requires miners to solve a piece of mathematical computation to add new blocks to the state of the network. Although Ethereum supports the creation of decentralized applications that have limitless use cases—most of which are still being explored today—Bitcoin only recently got the Taproot upgrade that allows the creation of apps on top of the Bitcoin blockchain. However, Ethereum is still a step ahead in technology. There are plans to make ETH a complete proof-of-stake blockchain that will be live in months, according to Vitalik Buterin at the ETHDenever event. Mining Ethereum is not different from mining Bitcoin at the moment. The only way to create ETH and BTC out of nothing is by solving complex mathematical puzzles required to generate a block. The popular function used for solving blocks is SHA 256, developed by NASA, which hashes strings to get target results for new blocks to be created. As Ethereum upgrades to proof-of-stake, staking will create blocks on the network through a similar process that qualifies verifiers on a base amount of token holdings, such as 32 ETH. Market Cap and Transaction Fees The total maximum supply of ETH is 120 million. However, the number will keep going down due to the burn mechanism introduced by Ethereum, which sends a fixed number of ETH to an only-deposit-to address from each transaction. On the other hand, Bitcoin has a total fixed supply of 21 million. Transaction fees on Bitcoin are cheaper than Ethereum gas fees. The current gas fees on Ethereum in the past ranged from $15 to $52.46 in gwei since January. Transactions on the Bitcoin blockchain costs just $2.30 on average. Going by the market share, Bitcoin holds twice as much value as Ethereum. The flagship cryptocurrency holds more than $700 billion in value, while Ethereum’s market share is in the neighborhoods of $300 million. Ethereum has steadily lost value to other programmable blockchains like Solana due to its high gas fees. However, the fees are down to a reasonable level since its all-time-high. Energy Consumption Energy consumption is measured in watts, or joules per second. Suppose you think about a joule as a unit of energy. In that case, we can then say a watt is a unit of energy per second. Bitcoin uses 124 TW/H or terawatts per hour, an energy usage around five times New York City’s energy consumption. Ethereum consumes an average of 48 TW/H, which is much smaller than Bitcoin’s energy consumption by a factor of 3. With the proof-of-stake upgrade of Ethereum, the energy consumption will go down by 2,000% to around 2.4 TW/H. Functionality Bitcoin was the first cryptocurrency that removed the world from the shackles of centralization. It serves as digital money and a store of value, and with the current taproot upgrade, it will be possible to build decentralized projects on Bitcoin. Ethereum is a decentralized computer for everyday applications with limitless opportunities. The Future of Ethereum Keep in mind that even though Ethereum fees are high, we are yet to explore the impact of dApps on the Bitcoin network, so it is hard to compare both blockchains on that level. In terms of energy consumption, however, Bitcoin is so far behind Ethereum that companies like Tesla have stopped accepting Bitcoin. Even though Bitcoin supporters think this is unfair because banks consume about 140 TW/H, the number of people using Bitcoin is fewer than those using Banks. You can imagine the energy situation when everyone starts using Bitcoin. Ethereum is energy efficient, and several upcoming upgrades will make the platform even more preferable to Bitcoin.