Decentralized Finance broke its all-time record at $276 billion in total value locked in November, according to the Cointelegraph. With that unprecedented growth and the continuous confidence found in the DeFi space, it’s important to tackle the basics and understand what makes up this bourgeoning concept.
We’ll discuss the sectors of DeFi, namely, stablecoins, transaction layer, and oracles.
What is a stablecoin?
A stablecoin is a type of cryptocurrency pegged to a fiat currency like the US dollar, which has a fixed value. Examples of stablecoins are Tether (USDT) and USD Coin (USDC). It is treated as good as a dollar and used for the exchange of cryptocurrencies.
It is a standard for exchanging cryptocurrencies or purchasing power because it holds a firm value over a long period of time, unlike most coins which are highly volatile.
Its role is vital in making decentralized finance more adaptable to the general public. DAI is an example of a decentralized stablecoin. It helps facilitate transactions in the crypto space by serving as a means for trade. Investors and traders earn while steering away from market volatility.
What is a transaction layer?
The transaction layer talks about the sector of DeFi where the services are executed. It is said to have problems that hinder its scalability, especially being highlighted now that DeFi is gaining traction in mainstream crypto. Developers are solving this with layer 1 and layer 2 blockchain scaling solutions.
First, let’s understand that a layer 1 network, such as Bitcoin and Ethereum, are blockchains. Meanwhile, a layer 2 protocol talks about the integration of a third-party. Layer 2 solutions allow the blockchain to scale by improving transaction speed and the amount of throughput. There are projects that aim to decrease transaction fees and decongest networks.
How do layer 2 solutions do this? They act as a secondary layer to the blockchain and execute independently from layer 1 so that security can be maintained. Examples of layer 2 solutions are Polygon, Lightning Network, and Plasma.
These scaling solutions play a vital role in DeFi because they help bring up transaction speeds and lower gas fees. It promotes mass adoption, allowing more people to use it with convenience.
What is an oracle?
Oracles feed authenticated data, such as real-time asset price, to smart contracts within blockchains. They are third-party service providers which verify data with sources like Binance and Coinbase. With real-time information at hand, smart contracts can execute in a very reliable manner.
While oracles have a play to part with a blockchain transaction, it does not have the same consensus mechanism of a blockchain. This makes it vulnerable to attacks, usually from parties that want to maliciously alter pricing.
Chainlink and Compound are examples of platforms that lead the oracle development space. MakerDAO is an example of a DeFi platform that makes use of oracles for real-time pricing feed.
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