DeFi — A Deep Dive
Our last week’s post gave a brief overview of DeFi, including a few use cases, benefits, and concerns. In continuation to the last article, we will look further into the most recent improvements in DeFi, its future potential, and extensive infrastructure this week.
Here’s a 200-word summary of the detailed article following it:
By eliminating third-party processes, Bitcoin, the world’s first public blockchain, revolutionized monetary transactions. Ethereum, the second-largest blockchain, laid the groundwork for disrupting the whole financial system by providing everyone with an open financial system irrespective of their location.
Until recently, Ethereum was the undisputed powerhouse of decentralized finance. However, as DeFi activity increased, various issues arose, such as scalability and rising gas prices, allowing other blockchains to participate in this rapidly expanding DeFi sector. Moreover, Ethereum’s interoperability issue has weakened its position as a preferred platform for future DeFi initiatives. Next-generation blockchains like Polkadot, Solana, and others are attempting to fix these issues to compete with Ethereum in the DeFi revolution.
Polkadot is seen as the main contender to Ethereum among these emerging blockchains due to its unique design, which provides high scalability and allows cross-chain communication capabilities.
Acala network, a DeFi project built on the Polkadot ecosystem, specializes in decentralized financial infrastructure and allows users to borrow, lend, stake, exchange, and earn with small gas fees. It is a one-of-a-kind project! It is both a platform on which other DeFi projects may be built and an application layer that delivers a variety of DeFi services.
Now that we have a bird’s eye view, let us dive deeper into the advancements in DeFi.
What’s exciting?
Think about it this way — you want to pay a shopkeeper Rs 1000 for the groceries you bought, but this time you want to pay in Ethereum Cryptocurrency (ETH). Now, what if you are asked to pay an additional Rs 500 for processing the transaction? That’s ridiculous, right? But, that’s a fact!
This occurs because miners (those who process transactions) on the Ethereum network favor transactions with large gas fees, a price charged to complete a transaction. This maximizes the rewards they receive on the network.
What is the cause for such exorbitant fees, you ask? The amount of on-chain transactions is increasing, each block has limited space for storing data, and the Ethereum network can execute only 10–15 transactions per second. So, in terms of trade, we would choose the ones that pay us more.
Over the last year, blockchain technology has evolved in a variety of ways, with DeFi garnering the most attention. According to the DeFi pulse, most of the top DeFi protocols run on Ethereum. Because of its smart contract capacity, the second-largest blockchain platform has been a preferred location for DeFi. However, Ethereum has been plagued by scalability concerns in recent years due to increasing demand. This implies that the platform cannot increase transaction throughput.
Is there a way out?
Let us take another scenario: QR-based payments were popular in India in the months following demonetization. Paytm launched its QR-based payment mechanism across the country, but you could only pay via the Paytm app.
This was inconvenient for both consumers and retailers since customers should have the right app downloaded on their mobile devices, and for retailers, it creates uncertainty about whether the consumer has the appropriate app to complete the transaction.
This gave rise to interoperable QR codes, which could accept payments from any app such as PhonePe, Gpay, Mobikwik, and so on. Much more convenient, right?
Now, this is how the blockchain ecosystem has been working, with many blockchains having their own ecosystem and functioning in silos.
Here's where Polkadot comes in! Consider the interoperable QR code to be the Polkadot network, which can collaborate and interact with other blockchains such as Bitcoin or Ethereum via a bridge that connects them.
Welcoming DOT, Polkadot…
Polkadot was established by Gavin Wood, an Ethereum co-founder. Gavin Wood identified a need for an Ethereum alternative that could scale, address the gas fee problem, offer on-chain governance, and most crucially, facilitate cross-chain asset transfer.
Polkadot is a “multi-chain network” that intends to integrate many specialized blockchains into a single unified network. It essentially resolves the interoperability problem. For example, DeFi built on the Ethereum blockchain can communicate and operate with the Polkadot ecosystem.
How does this work?
Polkadot is a sharded multichain network, meaning it can process numerous transactions on several chains simultaneously. This helps in avoiding bottlenecks that existed on other blockchains like Bitcoin that handled transactions one at a time.
The Polkadot network works on Proof-of-Stake transaction validation. Other blockchains would only need to join the network and operate in parallel as “parachains”. Parachains are sort of side chains that function on the network in parallel.
This eliminates the need for parachains to identify and bootstrap their set of validators, lowering the barrier to entry. Meaning, the parachains may rely on the shared security offered by the Polkadot “relay chain” ( sort of the main chain).
To put it succinctly, Polkadot is a blockchain of blockchains that enables many chains to communicate and collaborate safely inside the same ecosystem. The Polkadot network’s internal token is “DOT.” The token holder will be able to vote on proposed code modifications, which may result in an immediate upgrade if a consensus is established.
Proof-of-Stake, what?
Proof of Stake is a consensus mechanism used in the blockchain ecosystem. The transaction validators under the POS model are selected in proportion to their quantity of holdings in a particular cryptocurrency. The fundamental premise is that more coins lead to increased mining capability.
POS is more energy-efficient, with reduced risks of centralization and lower barriers to entry.
DeFi on Polkadot Ecosystem:
DeFi teams work on the protocol layer, developing user apps. A protocol layer establishes the network’s business logic (a set of particular rules). It also ensures that the network follows the rules that govern the blockchain network.
Projects such as Acala have grown into their own ecosystem, exemplifying Polkadot’s most crucial characteristic — the blockchain of blockchains.
Think about Acala this way — You are off to Japan to enjoy your vacation. Now, to transact domestically in Japan, you must have Yen. To do so, you must convert your home currency to Yen. Now, what if you could pay for your purchases with any currency that you hold? In DeFi, Acala is practically all about this.
Here comes…Acala Network!
Acala is a platform and a set of DeFi-optimized apps for Polkadot. Acala not only provides a network for DApp developers to build on it but also allows users to access its DApps.
Acala was designed exclusively for the DeFi use cases, making it significantly more efficient at providing DeFi services. The platform provides a set of core protocols, making it the first decentralized financial consortium of its type.
This graphic aids in the comprehension of the Acala ecosystem:
Below are the main protocols of Acala:
Honzo Protocol — A Stablecoin Protocol
The Acala stablecoin, often known as “aUSD”, is tied to the US dollar at a 1:1 ratio. Users can obtain aUSD loan by locking certain cryptocurrencies such as DOT, ETH, BTC, and so on as collateral. It is a multi-collateralized, decentralized stablecoin backed by other cryptocurrencies.
DAI, the most popular decentralized stablecoin, has a strong use case, however, it has certain constraints that aUSD does not. To mint or create a stablecoin as a loan, one will have to lock up their cryptocurrencies as collateral. The stablecoin’s circulation is restricted to the collateral that has been locked up.
In the case of DAI, however, only ETH is accepted as collateral for the creation of new stablecoins. But, because of the multi-collateralized nature of the Honzo Protocol, aUSD can be minted by locking up more than one crypto asset such as DOT, ETH, BTC, and LDOT.
Homa Protocol:
“Can we simultaneously have safety and liquidity?” The answer to this question is the Homa Protocol.
For a set length of time, every DOT token staked on Polkadot is locked to the relay chain. This makes the staked DOT tokens inaccessible for transfers or use as collateral in loan applications. This causes issues such as capital inefficiencies since all staked DOTs are removed from circulation. They could otherwise be used to stimulate the ecosystem’s economic activity.
However, with Homa protocol, users can stake their DOTs utilizing Homa protocol instead of the Polkadot relay chain. They will receive L-DOTs (Liquid DOT) in response. Users can utilize these L-DOTs in a variety of ways, such as collateral for a stablecoin loan or transfers, exchanges, and so on. If a user wants his or her DOT back, he or she may simply return the L-DOTs and receive the staked DOTs back. In this scenario, the user not only receives the staked DOTs but also the monetary benefits for staking them.
Acala DEX
The Acala DEX (Decentralized Exchange) protocol is comparable to those of other decentralized exchanges such as Uniswap. Acala DEX’s primary goal is to allow users to trade tokens and earn interest by providing liquidity to the platform.
Features distinguishing Acala
- Because of its deployment on Polkadot, it enables cross-chain asset transfers. Tokens and data can be transmitted from one parachain to another with the use of the Polkadot relay chain, which provides shared security. Acala can use bridges to interface with blockchains that are not part of the Polkadot ecosystem, such as Ethereum and Bitcoin. This allows Acala users to connect with the entire blockchain ecosystem.
- By leveraging Polkadot’s shared security model, Acala can operate with a comprehensive security architecture from the start. As a result, the expense of developing its own set of validators to protect the network is reduced.
- Acala lets you pay the gas charge with whatever token you possess. Thanks to the Acala DEX, which exchanges Acala tokens for non-Acala tokens. This, however, is not achievable on other blockchains. For example, with protocols on Ethereum, gas fees may only be paid in ETH and not in other cryptocurrencies.
Backers and Partnerships:
Even though the Acala project has not yet been completely launched, the Acala team has attracted various collaborations and backers. Polychain Capital, Coinbase Ventures, Pantera, Divergence Ventures, and others are among the investors. Acala has collaborated with various DeFi protocols such as Compound, and Ampleforth. It has also established a partnership with Current, a renowned Fintech company in the U.S.
DeFi is an intriguing arena. However, the issue is that it is a somewhat complicated field. Fintechs can assist with this because fintech businesses are well-known for creating intuitive consumer experiences. Fintech businesses began by developing these experiences on top of legacy banking infrastructure, but there is no reason why they can’t do the same with DeFi.
Concluding…
Acala is one of the most promising projects in the crypto space due to its unique design and positioning. As interoperable projects like these continue to push the boundaries of what blockchains can do, the industry may be entering an era of shared resources and sustainable innovation. It makes everything simple!
Article by Pavish Saravanan and Vikas Kabra
