Financial Ecosystem using Blockchain
Financial ecosystem that revolves around cryptocurrency is the beginning of a new future, a better future. A heads up, I am neither a cryptographer, computer scientist nor a developer. My background in engineering does little justice to the rapid change and advancements of technology out there. My goal is to be able to reach out to the general masses hence I will keep the explanations simple and non-technical and link references of experts and articles for future readings.
Cryptocurrency leverages blockchain technology without the need for intermediaries such as central governance, banks, lawyers, etc. The reason I am a fan of Bitcoin is that the system is built upon which is completely decentralised and distributed, without reliance on the pre-conditions or influences of external parties. This means that anyone will have access to Bitcoin Blockchain technology as it is both permissionless and censorship-resistant.
Some of the topics covered as follows :
- Bitcoin’s layer 2.0 Lightning Network and Taproot
- Decentralised Finance (DeFI) — Lending and Borrowing, Stable Coins, Decentralised Exchange (DEX), Liquidity Pool, Margin Trading & Derivatives, Chain Links
- Smart Contracts & Decentralised Applications
- Yield Farming — Liquidity Mining & Leverage
BITCOIN’S LIGHTNING NETWORK
Bitcoin’s existing transactions based on its blockchain platforms are slow as it can only hold 7 transactions per second (Visa can process 65,000 transactions per second). Lightning Network is a second layer built on a blockchain network that can extract all of Bitcoin’s benefits but records the transaction on this layer. It also has a fraud prevention capacity. Lightning network is a globally scalable network, making it a perfect pairing of fast micropayment methods for Bitcoin, which could replace cash and credit transactions. Read more from Block Geek from the link below
BITCOIN’S TAPROOT WATCH
Taproot improves Bitcoin’s scripting capabilities and privacy, making smart contracts more efficient and private. In smart contract transactions using taproot, only the spending amount will be revealed.
Taproot uses a soft fork deployment method called BIP9 and Block Signalling, whereby 90% of the miners have to signal for deployment in their mined blocks. It works in periods of 2016 blocks, whereby 90% or 1815 have to signal for readiness. The dateline to achieve this deployment is this August 2021. At present, there are 1615 signalling blocks, and 374 upcoming signalling blocks making it 1989 (>98%) which means taproot will readily lock-in. More benefits of Taproot can be read here
DECENTRALISED FINANCE (DeFi)
DeFi or decentralised finance has been the talk of the town for some time now. Traditional financial systems require banks and central banks that have infinite capabilities to produce cash and leverages on interest and high permissible requirements for anyone to attain funds such as loans, abandoning the harsh reality that billions of adults around the world do not have access to bank accounts. DeFi on the other hand, uses cryptocurrency, blockchain, and smart contracts and is a completely peer-to-peer system that is permissionless and censorship-resistant. As of 30 April 2021, DeFi has a market capitalisation of $100B (Read here).
Currently, all DeFi contracts are on Ethereum blockchain as it uses a programming language called Solidity that is flexible in implementing robust smart contracts. Bitcoin’s blockchain with Lightning Network will kick off numerous DeFi applications soon.
Lending and borrowing — DeFi allow anyone to take a loan without the approval of a 3rd party through smart contracts and (over) collateral. Some of the common names in the lending project category are Compound, BlockFI (which has credit cards with Bitcoin rewards), and Aave (Leading market cap can be viewed here). Users can also supply assets (Ether, Tether) and make interest while using that as collateral to borrow other assets. Crypto lending Interest Rates that are updated hourly can be viewed here
Stable coins — these are pegged to cryptocurrency, fiat, or commodities. For example, USDC or USDT are pegged to US dollars.
Decentralised Exchanged (or DEX) — has 2 types which are liquidity pool and order-book model. In a traditional finance system, market liquidity and accounting liquidity refers to assets that can be quickly bought and sold at their perceived value. DEX is also the opposite of a centralised crypto exchange in the sense that is it decentralise (peer-to-peer exchanges) and permissionless. Order book models are used by major exchanges such as Coinbase and Binance where there are buyers/bidders and sellers. Market makers facilitate trading by providing liquidity/assets to ensure there is always buy and sell in the event the buyers’ price and seller’s price can’t meet.
Liquidity pool in decentralised exchanges utilised automated market-maker-based systems. Automated market makers use a pre-funded ‘on-chain’ system whereby a liquidity provider of a token will supply an equal amount of tokens in a pool (x + y). Finematics has an excellent example of this. Uniswap’s program allows the market to expand automatically by correlating the price of a token to the equal amount of token required in a pool. This allows larger pools to have a lesser impact on price changes given the number of tokens in them. Pancakeswap by Binance is based on Uniswap’s mother chain and is gaining popularity very quickly.
Margin trading & Derivatives — Margin trading is done by borrowing funds, providing multiples of leverage in trading, amplifying results, and profiting larger gains. Futures buy or sell contracts in the derivatives market. I do not have enough knowledge to write about so I will skip it entirely but I do intend to explore the trading market, trends and analysis thoroughly, perhaps in one of the upcoming writeup
Chain Links / Industry Block Chains — Oracle utilises Etheruem blockchain and has been successful in deploying it across industries. The high positives are creating a link between not just buyers and sellers, but the whole circle of raw material supplies, logistics, recyclable products hence adding value to the circular economy. However, the risk of a centralised cryptocurrency remains with the potential bugs in smart contracts, change of blockchain protocols, centralised governance and admin key holders as well and gas fees or network fees among some.
Some additional nuggets, according to coin market, DeFI originated from a Telegram chat between Ethereum developers and Entrepreneurs namely Inje Yeo (Set Protocol), Blake Anderson (0 x), and Brendan Foster (Dharma) in August of 2018. This is a great talk of DeFi by Brendan Foster hosted Fluidity in 2019.
Smart Contracts are self-executable contracts without the need for a centralised 3rd party to establish trusts such as banks or lawyers. It was first proposed by Nick Szabo in 1994 who also invented BitGold in 1998. Smart Contracts is leveraged onto the Ethereum platform and has been adopted by DeFI related applications, payments, and an industry-based supply chain and circular economy such as healthcare and retail by Oracle (chainlink). IBM released Hyperledger Fabric 2.0 which is a closed/private blockchain network that does not have its native currency nor can be used on other digital cryptocurrency platforms.
I’ve only covered some of the popular parts of the Financial Ecosystem. This explosion of innovations in the Blockchain financial ecosystem is only the beginning of Bitcoin Blockchain’s journey. With El Salvador adopting Bitcoin as an official currency of the country, and more countries to come, the day to day transactions become common, and it leaves ample room for more growth in this industry. I for one can’t wait to see all of this unfolding in real-time.