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A new version of the world wide web is on the rise and it wants to put power back in the hands of people. Web3 is going to be decentralized and democratized i.e., its unregulated and peer-to-peer communication does not require or include an intermediary. It is the promise of a utopian web that will be self-governing, permissionless, trustless, and verifiable also opens door to various new fields and possibilities with it.
In this article, we will be discussing some of these exciting fields that web3 brings with it.
DeFi- Decentralized Finance
Decentralized finance refers to a global financial system that is open and accessible to anyone with an internet connection. No centralized authority owns this system, hence no one can block payments or deny access to any information and most importantly the markets are always open- that is, it runs 24/7!
DeFi enthusiasts consider it as an alternative to the traditional financial system which is decades old and highly regulated. DeFi gives people more control and visibility over their money. There's already a booming DeFi market where people can lend, short/long, buy, sell, and earn interest on their crypto and all of this can be done without any need for personal identification.
How Is DeFi Different From Traditional Finance?
There are some striking differences between them. Let us have a look at some of these differences here:
In a traditional financial system, institutions can block the access of an individual to set up a bank account or use a financial service, whereas in decentralized finance one does need any personal identification to access the system.
Traditional financial systems are regulated by governments, central banks, or other centralized institutions, whereas no one own's decentralized finance and no one can block anyone from getting paid.
In comparison to the traditional financial system, decentralized finance is open 24/7 for all.
Decentralised financial systems are transparent, anyone can look into the system and can analyze how the system works, while traditional financial systems are closed. One just can't access their loan book, transactions, and record of their assets on the go.
Traditional financial systems are incomplete without human intervention. What makes DeFi different requires no human intervention to process a transaction. This is achieved as exchanges run on a blockchain network under predetermined conditions specified in a smart contract(ie. a few lines of code).
How DeFi came into existence?
There's no single inventor of DeFi; these apps first came into existence built on top of Ethereum. It has since then expanded into other blockchain networks such as Solana, Binance Smart Chain. It is said that the term DeFi was born in an August 2018 Telegram chat between Ethereum developers and entrepreneurs including Inje Yeo of Set Protocol, Blake Henderson of 0x, and Brendan Forster of Dharma.
What can one do with DeFi?
There are many practical and real-life problems that DeFi Apps solve. Here are some examples:
Lending/Borrowing: Through DeFi, one can lend their crypto to exchanges and earn interest on it. Similarly one can borrow these digital assets, in order to trade or pay collateral. Many DeFi users use lending as a way to earn interest through yield farming.
Trading and Derivates Through various centralized and decentralized exchanges such as Coinbase, Binance, and Uniswap people can trade directly with one another. Skilled traders can even make leveraged trades in which they bet more than they have, or even create "synthetic assets" that mimic traditional stocks and commodities.
How DeFi works?
Defi uses smart contracts and cryptocurrencies to create a financial ecosystem that does not need intermediaries. Smart contracts replace the regulation of financial institutions. These are essential pieces of code, that when they once go live, cannot be tampered with and run under pre-determined conditions. It is public for anyone to inspect and audit, hence bad contracts will instantly come under scrutiny leading to a greater transparency in the system.
NFT stands for non-fungible tokens in economic terms. It refers to items that are not interchangeable with other items since these have unique properties. For example, digital art, gaming domain, domain names, etc. Digital currencies such as eth and stable coins are interchangeable for other digital currencies such as eth and usd, hence these are fungible tokens. NFTs are currently changing the lives of digital artists through huge sales to a new crypto-audience. Here is an example of a Bored Ape NFT worth $300,000 or around 75 eth:
DApps or decentralized applications are growing in popularity and they use blockchain to power users in the field of technology, finance, gaming, art and collectibles, and many other related fields. These are digital applications that run on a blockchain network of computers instead of relying on a single computer, hence free from the control and interference of a single authority.
Here are some features of DApps:
Decentralised: Dapps cryptographically store all of the user's data in a decentralized blockchain i.e. the data must be stored in a distributed manner across multiple participating nodes.
Open-source: DApps operate autonomously without a single point of authority or control; all stakeholders must consent for amendments.
Tokens: DApps offer a token or a coin native to the blockchain on which they operate. This is to allow access to the network and contribute value from all participants.
Consensus algorithm: Since dApps need a consensus from the participating nodes to validate any action, they need to have an algorithm that all participating nodes can follow to reach the consensus.
Types of dApps:
Financial Blockchain Apps: These are typically dApps that have their own blockchain. Ex Bitcoin. Bitcoin provides its users with a distributed and decentralized system of monetization.
Partially financial: These are the dApps that use the blockchain for type I dApps. For example, all the dApps that have been built on Ethereum are type II dApps. Initial Coin Offerings (ICO) is another example which apply standards such as the ERC20 Token Standard.
Fully functional: These are dApps that uses the protocol for type II dApps, however they also use features of distributed systems as well, i.e., online voting or decentralized governance. The government of UAE have already begun building the first blockchain-run government. Refer to the image given below to understand this better:
Metaverse and its use cases with blockchain
The metaverse is defined as a three-dimensional virtual reality space where users can interact, play games and experience immersive surroundings. The use case of metaverse with blockchain comes from the fact that the metaverse would also be decentralized in nature.
Immutable assets: In the metaverse, assets would essentially become non-fungible tokens or NFTs that one can earn and sell. VR gameplay would allow users to make real money that has value inside the metaverse. These assets would remain completely undamaged even if the user quit the game or there's an adverse event in the metaverse.
Self-identity authentication: Blockchain can keep track of identities on the metaverse, essentially acting as the equivalent of a social security number but virtual. Age, changes in one’s appearance, online activity history, and other unique details can be stored on the blockchain for transparency and to prevent crime in the metaverse.
Real estate in the metaverse: Real estate is another key commodity in the metaverse. Defining and regulating real estate can be a challenge. Blockchain could act as an immutable record of how real estate is created, altered, traded, and destroyed in the metaverse.
Incentivization: This will probably be among the first applications of blockchain in the metaverse. Creator incentivization through cryptocurrency would ensure that there are no arbitrary or unfair rules governing the exchange.
Tokens are virtual currency or denominations of a cryptocurrency. These are tradable assets or utilities that reside on the blockchain and can be used for the purpose of lending, borrowing or other economic activities. These tokens act like legal tender, which means token holders can use them to make purchases or they can trade tokens just like other securities to make a profit.
How coins are different from tokens?
Operates on its native blockchain: Blockchain keeps track of all transactions that involve its native crypto coin. For example: When we pay someone with Ethereum, the receipt goes to the Ethereum blockchain. If the same person pays us back later with Bitcoin, the receipt goes to the Bitcoin blockchain.
Acts as money: One can use crypto coins to purchase goods and services from major corporations today, such as Amazon, Microsoft, and Tesla. In fact, Bitcoin has recently become an official currency of El Salvador alongside the US dollar.
Coins can be mined: We can earn crypto coins in two ways. One is through traditional mining on the Proof of Work system and the other method is Proof of Stake, which is a more modern approach to earning coins. It's lighter on energy consumption and easier to do with Cardano being one of the biggest coins that adopt this system.
Unlike coins, tokens do not have their blockchain. Instead, they operate on other crypto coins' blockchains, such as Ethereum. A typical example of a token includes reward tokens, currency tokens, utility tokens, security tokens, and asset tokens. Few popular tokens on Ethereum include BAT, BNT, Tether, and various stable coins like the USDC. Refer to the imabge given below to understand this better:
In the next article, we will be looking at Development platforms around web3.
This article is part of Research & Development work being done by Pushkar Kumar, Suresh Konakanchi, and Ruchika Gupta. We will be covering a series of articles along with open source projects around blockchain, smart contracts, and web3 in general. Here is the list of all the articles that you can follow to start with Blockchain and write your first contract.