Banks track the story of money to prevent double spending, but money management is a power that can be abused by regulations, greed, and outright fraud.
Blockchain technology was first introduced in a 2008 white paper for Bitcoin, with Bitcoin then going live in 2009. By recording transactions with transparent logs on dynamic ledgers, public and private blockchains solve the double-spend problem with fewer third parties taking a cut, and instead, redirecting resources to cover the raw costs of computing, electricity, and network verification. The unspent transaction output (UTXO) model for tracking transactions and balances fractures this digital asset from the initial whole. These fractions are used as currency, which makes accounting inclusive, verifiable, and very transparent.
EXTRA SHOT
This contribution is by scottrepreneur, a UX designer and blockchain developer building at the forefronts of technology.
Blockchain technologies have reached mainstream adoption, but cryptography has been studied since the 1980s. Bitcoin was first to crack the code, and now different blockchains and more onchain layers are being combined in powerful ways. Today, there are four main types of blockchain networks: public blockchains, private blockchains, consortium blockchains, and hybrid blockchains. It’s impossible to count private blockchains, consortium blockchains, and hybrid blockchains, but there are hundreds of public blockchain that are permissionless. This means they are fully decentralized and anyone with an internet connection can equitably access the blockchain as an authorized node. Bitcoin and Ethereum are the two largest blockchains, with 10% of the global population owning some form of countless cryptocurrencies.
Within each blockchain, layers provide separating infrastructure for developers. Hardware, data, network, consensus, and application layers make blockchain technologies more usable, with each layer offering unique functionality. The last ingredient in a blockchain recipe is hashing, which delivers verifiability by assembling a historical ledger where any tampering of previous transactions will disrupt current calculations. With verifiable ledgers storing only valid transactions, we can automate value.
Smart Contracts
Smart contracts allow us to program, exchange, and intermediate value using the storage mechanisms first introduced by Bitcoin. Programming languages allow smart contracts to store data on specific blockchains, with small amounts of cryptocurrency used for gas fees, which is the cost to cover computational intensity and network interactivity. These primitives help coordinate mechanized value, with tokenomics and technical testing leading to effective governance on and off blockchains.
Tokens & Standards
As smart contracts began conforming to implementation criteria, token standards led to initial coin offerings (ICOs) that were sourcing funds for a wide variety of projects. Many overly ambitious projects damaged trust with unfulfilled promises and led to ICO bubbles, but the speed and effectiveness of such aligned collaboration hints at the power of this mechanism. The adoption of standards across an ecosystem allows for tight composability and interoperability across protocols. Tokens and standards are the building blocks for decentralized finance (DeFi), with stabilizing support from stablecoins.
Stablecoins
Stablecoins are a type of cryptocurrency that pegs steady value off another asset.
Fiat-backed stablecoins are backed by fiat money in an auditable account and have structural similarities to money market funds. Fiat money is a government-issued currency, such as the US dollar, that is not backed by a commodity such as gold. While fiat stablecoins are easy to scale, they are less decentralized yet remain popular because they are backed by existing currency and established regulations.
Collateral-backed stablecoins are backed by assets that are locked onchain and transparently auditable. When done right, these types of stablecoins have great decentralization properties, but they are hard to scale and can have liquidity issues from a market squeeze.
Algorithmic stablecoins are balanced with a system known as seigniorage shares, which uses mathematical algorithms and smart contracts to maintain a stable value relative to a target asset. Implementation of algo-stablecoins has been unsuccessful to date, so avoid these types of stablecoins until technology can unequivocally support the ideology. Alright, with tokens and places to store value onchain, let’s look at innovating within traditional financial exchanges.
Lending & Exchanges
Organizations committed to a BUIDL market have delivered on over-collateralized lending and borrowing onchain. Lenders can lock collateral to earn from borrowers, but borrowers need to be lenders of another token and ensure their loans remain sufficiently over-collateralized. Lending and borrowing both rely on asset prices to determine liquidation thresholds, but if these can be manipulated, the system remains vulnerable. Oracles provide an example of systems that can support blockchains with real-world data to keep decentralized mechanisms in tune as the value and frequency of cyber attacks increase.
Early experiments around what order books looked like onchain were clunky. Each bid, update, acceptance, or cancellation required another transaction and small but constant gas fees. This changed in 2018, when Uniswap used the Ethereum blockchain to provide a simple interface to swap tokens. Instead of creating offers to buy or sell, a market maker provides two tokens in a pool. These pools are called automated market makers, with pilot protocols that leverage a constant product market maker equation (k=x*y) to hold the ratio of pooled tokens equal. This supports non-custodial token swaps with fewer steps. If parameters for a transaction are not met, the smart contract will not execute, which keeps the exchange stable.
Pioneering Frontiers
Crypto has fast-moving frontiers. This makes for a continuous experiment, with good discoveries along the way. While gold awaits any gold rush, progress does not come without struggles, sacrifice, and reparations.
Let’s use the technology life cycle of crypto as a case study. Concepts like liquidity incentives tested financial yields from onchain assets. This model was well-received (2022), but token inflation without enough value loops became unsustainable. Initial coin offerings (2023) were also a wild way to rope in financial capital, but fake projects took over as fraud became easy. Bad actors affect the public’s sense of trust early in any technology’s life cycle. This adds hesitation and slows adoption, but failed experiments are required.
Years of rapid experimentation keeps innovation curves rolling on any frontier. As the volume gets louder around other technologies, less good noise is often perceived as a stall, or more drastically, the beginning to an end. Less noise may lead to fewer people actively building into a shared direction, but a trendy talent shift does not mean a misunderstood technology has had its day.
Within the short timeline of this brief case study, Narrow AI had been conversationalized and Agentic AI was signaling toward General AI. This turned attention (deservingly so) away from web3 concepts, blockchain technology, and mechanized money, but the decentralized progress lies in wait and the concepts of crypto are not going anywhere.
The technologies and economies that digital depth supports provide balance. Even in quieter BUIDL cycles, cross-chain interoperability, token standards, layered development, and global regulations will continue to push DeFi forward.
DeFi’s Destiny
Any dark forest can be treacherous, but system-level engineering takes time, and it’s liberating to build with intrepids who are learning together. As we complete this download, here are more interesting use cases to keep us thinking about what’s possible beyond traditional finance.
- Instead of getting paid every 2 weeks or each month, smart contracts can create payment streams. Instant access to financial capital furnishes more financial freedom. Along with incoming compensation and outgoing subscription fees, self-repaying loans can further automate and optimize financial command.
- Prize-linked savings accounts, also known as no-loss lotteries, are not uncommon in traditional finance. Local municipalities and credit unions have generally handled them, but smart contracts enable little to no overhead. Pooling capital and lending it to others is also used in smaller communities to help with small, low-cost loans.
- Flash loans allow for borrowing a near-infinite amount of a token, provided the loan is paid back within the same transaction. These trusted transactions require significant capital, but can be facilitated within one block, then democratized to anyone with access to the blockchain, a scripting language, and a relaying node.
DeFi provides composable tools for traditional and innovative finance primitives. Being able to mechanize money and the value it delivers within a network is power that’s less fragile and more translucent. As web3 concepts hook into the financial primitives of crypto, the global economy can leverage faster, more equitable, and safer peer-to-peer commerce.
Brewed From Within
#77 📖 Technology
