In this article, I want to dive into more depth about Defi because it is very complicated how Defi blockchain works and what it really meant by Defi.
What is Defi?
Defi or decentralized finance is a blockchain-based financial system that is opposed to centralized financial institutions.
Defi is a 5-layers cake
It is not just that simply of decentralized character. Defi has five layers that stack on top of each other due to its technological design.
The five layers are the Settlement layer, Asset layer, Protocol layer, Application layer, and Aggregation layer.
Settlement layer
It is a foundation layer of trustless execution blockchain layer that serves as a settlement and dispute resolution layer. It provides an ecosystem that serves as an arbitrator because of its incorruptible.
Examples of such layers are Bitcoin blockchain or Ethereum blockchain.
They are all have been tested and functioning well. They are secure and able to process settlements unbiasedly.
It is like a central bank and its commercial banking system.
Asset layer
The name suggests that this layer runs token. Because layer 1 settles any disputes, there is less space to process coins or tokens which may drag the speed of payment transactions. instead, tokens are running on layer 2. It is also referred to as a scalability layer that only serves as token transactions. It opened another new world for additional tokens to issue and run on this layer rather than using Layer 1 coin such as Bitcoin or Ethereum. It adds up another security layer in case layer 2 tokens were stolen, there were always layer 1 coin to back up the assets.
It is like a central bank-issued fiat current such as a dollar to circulate in the nation.
Protocol layer
The protocol layer or application layer gives Defi an execution layer to handle rules and smart contracts. This is a place you can build your exchange marketplace or any financial products that use tokens from layer 2.
It is like the stock market were to trade listed stocks.
Application layer
As the name suggests, in this layer you can build a user-oriented application so that users can interact using this layer.
Simply, this layer is like the Robinhood app for instance for users to access trading.
Aggregation layer
This is an extension of the application layer to enhance application features. It makes the application more user-friendly and easy to use.
An example such as the UX/UI design of the application of the Robinhood app so that users can easily trade their stocks without referencing the user’s manual frequently.
Uniswap as an example
Uniswap is one of the popular Defi. Using our 5-layers analysis you can find:
Settlement layer: Ethereum blockchain
Asset layer: ERC-20 token or Uniswap token
Protocol layer: Decentralised exchange (DEX)
Application layer: Liquidity providers (LPs), Automated market maker (AMM)
Aggregation layer: Uniswap v3 with several new features described in the white paper
In conclusion
After you understand these 5-layers you can easily understand how each Defi designed and worked. It really helps you to know Defi in depth and follow the white paper on who each feature improvement works in a way that may benefit you.
What do you think?
Frankly saying I don't have any idea about defi. I don't know how this work. I heard this word many time but still don't know anything. I hope I am not missing something good.