Author | Chris McCann

Decentralized finance (DeFi) is redefining the future of finance. The underlying infrastructure that powers financial applications is undergoing a major shift. It is changing the way we think about authority and control, transparency and risk.

DeFi is a developing market segment at the intersection of blockchain technology, digital assets, and financial services. According to data from DeFi Pulse, the value of digital assets locked in DeFi Apps has increased tenfold, from less than $1 billion in 2019 to over $10 billion in 2020, with a peak of over $80 billion so far in 2021. However, DeFi Apps and the underlying infrastructure are still in their infancy.

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The main structural commonality of DeFi App

DeFi App is a financial application without a central counterparty. In practice, this means that when you access these financial applications, there is no institution (such as a bank) docking with you; instead, the user directly docks with the program (such as a smart contract) on the protocol.

Use the underlying blockchain as the core ledger

• Use the underlying blockchain as the core ledger

• Open source and transparent by default

• Interoperable and programmable (composability)

• Use the underlying blockchain as the core ledger

Use the underlying blockchain as the core ledger

Compared to traditional financial applications that use core banking systems (Fiserv, Jack Henry, FIS, etc.) as the underlying ledger of record, DeFi programs use blockchain as their underlying core ledger.

Several of the most well-known blockchains used to build DeFi Apps include Ethereum, Solana, and Binance Chain, among others. These underlying blockchains store the content of the DeFi App program, the content stored in the smart contract, and the ledger status of all transactions and withdrawals.

All core accounting functions of ensuring matching inputs and outputs are handled by the blockchain itself, and DeFi apps do not need to create external systems to reconcile balances, as all transactions can be queried between various block explorers.

Also, there is no separate process for settlement & clearing of transactions compared to traditional systems. When a transaction is broadcast, transaction processing, clearing, and settlement all happen at the same time. Though it's best to wait around 21 blocks or more to ensure finality on the blockchain itself.

Open source and transparent by default

In contrast to traditional financial applications that are closed source and built on proprietary systems, DeFi applications are usually completely open source and built on an open underlying blockchain.

This leads to three interesting properties:

• Composability - The DeFi App program itself allows forking, remixing and reuse in many other applications (more on this below).

• Transparency - Since the DeFi App is open source and it is fully auditable, it is possible to know exactly what the smart contract does in terms of functionality, user permissions, and user data.

• Auditability - Since the underlying blockchain itself is open source, the entire flow of funds is fully auditable, including collateral in the system, transaction volume, defaults, etc.

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Interoperable and programmable (composability)

In order for developers to gain the trust of users, most DeFi App programs are completely open source - including the front end and the smart contract itself. In addition, since DeFi App programs all run on a common platform (the underlying blockchain), these DeFi App programs are fully interoperable and can be programmed to operate with any other DeFi App programs in the ecosystem.

This is often referred to as DeFi"or"or"Composability". All of these DeFi apps are like standalone Lego bricks that can be remixed with other Lego bricks to build something new.

This is in stark contrast to the traditional financial system:

• Decentralized infrastructure - Traditional financial applications are not built on a common infrastructure.

• Siled Applications - Traditional financial applications are often proprietary to one banking institution. For example, Wells Fargo's all"Financial Technology Application"Both can be operated together, but not in different banking institutions.

• Developer Unfriendliness - Traditional financial applications are not made to serve other developers building services.

The traditional financial system does have common denominators; however, it is very difficult to achieve consensus among market participants as financial institutions view their software as their competitive moat rather than the product as a differentiator of.

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open, accessible to all

In traditional financial applications, new users often need to go through a lengthy application process, income verification, credit checks, or even meet in person - just to be able to use a financial product.

Due to these arbitrary rules set by financial institutions, these application processes are prone to deviations, including loan discrimination, denial of basic banking services, opening of credit lines without consent, charging illegal fees, etc.

With DeFi apps, you only need a wallet address to interact with these systems. DeFi App programs don’t require income verification, they don’t require credit checks, and in most cases, they don’t even need to know who you are, other than the wallet address you use.

DeFi App programs are often referred to as permissionless. If you have funds in your wallet for the transaction you want to do, you can do it. There are no agencies or intermediaries to prevent or deny you services. No matter what your background is or what country you are from, DeFi App programs will make no difference.

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Comparison of traditional financial technology architecture and DeFi architecture

Below is a more architectural diagram (simplified for brevity) of the main technical differences between traditional fintech apps and DeFi apps:

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DeFi Infrastructure - Map Report

Below is a map report of two different DeFi ecosystems, one built on the Solana ecosystem and the other on the Ethereum ecosystem.

The reason I chose these two ecosystems to focus on is to show the breadth of DeFi applications built on two different underlying protocols. I also believe Solana is the most interesting new Layer 1 protocol because of its high transaction throughput (50K+ transactions per second), sub-second latency and transaction confirmation time, and the speed of building DeFi applications on top of the Solana protocol. Growing developer ecosystem.

While structurally similar, each underlying protocol has its own ecosystem that is largely independent of the others. Below is some further explanation of each layer and the tradeoffs between them.

Base layer (Layer1)

Node infrastructure

Node infrastructure

A never-ending data query (retrieving blocks, finding transactions, synchronizing data, writing transactions, etc.) to the underlying ledger is required. In the Ethereum ecosystem, an entire industry has sprung up to address this need (Infura, Alchemy, etc.).

In contrast, Solana's underlying ledger is fast enough and synchronized that teams can directly query Solana's RPC nodes (although this may not last forever).

Layer2

On Ethereum, there are various Layer 2 solutions mainly for scaling, because Ethereum itself cannot handle all transactions. Two of these promising scaling solutions include Matic, Optimism, and others.

On Solana, since only one layer can be built (no need for Layer 2 scaling solutions), there is no need for specialized integration, and there is no mismatch with the underlying ledger that is processing the settlement.

Order Book Aggregation

For Solana, there is an additional layer occupied by a DeFi project called Serum, which provides a CLOB (central limit order book) that is used by all DeFi projects built on top of it.

When new DeFi projects are built on top of Solana (DEX, AMM, Options, etc.), they can pull orders from Serum and push orders back to Serum, greatly reducing the cold start challenges most new financial applications face.

It's best to think of it as being used by most projects in the Solana ecosystem"and"and"order management"system.

A more innovative example combining CLOB (Serum) and AMM is Raydium (very similar to Uniswap v3). The combination of these systems allows passive LPs to use Serum for active market making.

DeFi toolset

No matter from the perspective of developers or end users, a common set of tools is needed to operate most DeFi App programs. These services have no direct traditional financial analogs, but they include:

• Wallet - the main interface people use to store assets and interface with DeFi apps.

• Oracles — On-chain data feeds used by DeFi apps to reference prices and execute transactions (eg: liquidations).

• Block Explorers and Analytics - Tools like Block Explorers were created to allow people to directly query the blockchain ledger itself, which is most commonly used when validating transactions.

• Stablecoins — The two main assets used in the DeFi ecosystem include underlying native protocol tokens (ETH or SOL) and ideally on-chain stablecoins (USDC, Dai or Pai).

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Apps for DeFi

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The Potentially Missing Piece of DeFi Infrastructure

When comparing DeFi infrastructure to traditional financial infrastructure, there are a few parts worth exploring that don't exist in the decentralized world.

Here are some parts to highlight:

• Consumer Apps – In traditional finance, consumers typically act through consumer apps (e.g. Robinhood, Chime, Transferwise) rather than the underlying protocol itself. The front end of the DeFi space can be vastly improved and more consumer experiences integrated into it. Generally speaking, from a consumer perspective, the UI/UX of most DeFi App programs is still very difficult to use.

• CRM (Customer Relationship Management) - The DeFi space does not have a real concept of customer relationship management, nor does it collect any consumer data. While great from a privacy standpoint, there is also a lot of value in gaining a better understanding of your customers.

• Notifications - Notifications or alerts really don't exist in the DeFi space. On a broader level, there isn't any good way to communicate with users either.

• Product Analytics - There are tools to measure blockchain activity, but no tools to measure engagement in DeFi Apps.

• Security - DeFi products are often subject to security audits; however, none of the security audits can guarantee the protections consumers are used to and most commonly seen in the traditional financial world. In addition to this, the demand for security auditors exceeds the supply, which is a big bottleneck.

• Transaction Rollback — In traditional finance, if you make a mistake, the financial institution can initiate a transaction rollback. This doesn't exist yet in DeFi.

• Escrow — Right now, most DeFi projects need to interact from a personal wallet perspective. There is no custodian for you to interact with DeFi App programs.

• Developer Platform - Most developers in the cryptocurrency space are built on top of the Layer 1 protocol itself. There is currently no concept of a developer platform or middleware.

• Embeddable wallets - Wallets are considered as these external services, and there is no white label wallet product that can be directly embedded into the DeFi App itself. There are several initiatives such as Torus, but these are still in their infancy.

• The Future of Financial Applications

The Future of Financial Applications

After meeting hundreds of founders and seeing the progress the teams have made, it is abundantly clear that DeFi is innovating 10x faster than traditional fintech applications.

In traditional finance:

• The underlying ledger is not open source and not friendly to developers.

• there are a large number"banking services"app, just to wrap the underlying partner bank in a developer-friendly platform.

• Fintech applications are very challenging to regulate and often require years of development before a single product is released.

Everything is open source, including the ledger itself.

• Everything is open source, including the ledger itself.

• All transactions are public.

• Everything starts from the perspective of developers building applications on top of the protocol.

• New DeFi apps are built and released in weeks, not years.

We believe that DeFi developers will change the way the financial world works forever. We are very bullish on DeFi's infrastructure stack and community.