Is DeFi a part of Web3?
DeFi, which stands for decentralized finance is a sector of decentralized technological innovation that is encompassed in the Web3 technological and societal phenomenon. DeFi is used to enable decentralized financial services that operates in a more open-source and permissionless method in contrast to the traditional financial systems.
Web3 denotes the emergence of a new digital paradigm of the internet that is built on top of blockchain technology and is based on decentralization. It stands for the creation of an internet that is user-oriented. One of the major objectives of Web3 is to create a more decentralized, private, and secure internet owned and managed by its users.
Web3 applications are built on decentralized protocols and make use of smart contracts to automate interactions and transactions on the blockchain. Meanwhile, DeFi is an emerging financial system within Web3 that proposes new forms of value and utility that conventional financial systems lack.
The core difference between Web3 and DeFi is the fact that while Web3 is built on the internet, DeFi is built on top of smart contract platforms such as Ethereum.
Although they are fundamentally two distinct technological creations, DeFi and Web3 are somewhat related. They both aim towards creating an alternative model of the internet or finance respectively that is more decentralized, permissionless, open and more secure when compared to their centralized counterparts.
What is Web3, and how does it work?
Over the years, there has been massive evolution of the internet. We can all testify that the internet as we know today is different from its early inception.
We’ve recorded three distinct stages in the development and operation of the internet and they are: Web1, Web2, and Web3. There has been an evident shift from the centralized model to a more decentralized version of the internet.
Web1 is considered as the “read-only Web” or syntactic web. It is the first or original version of the internet, dating back to the 1980s. It is characterized as a web of ‘static information’ that connects to each other, so rather than a database, data and contents came from a static HTML file system. It lacked interactivity, visual, control, and there was no room for financial transactions just as we see in the current internet.
Web2 on the other hand is considered as the interactive “read-write web”, and the participative social web. Web2.0 revolutionized the internet, replaced Web1 and brought with it, interactivity, social connectivity, mobile applications and user-generated contents. Financial transactions over the internet became possible with the dawn of Web2.0.
Most commonly used websites are owned by major technological firms which caused a centralization of power.
Web3 exists to address some of the challenges of Web2 such as censorship, hack attacks, privacy and data control etc. It introduces decentralization, offering a more democratic experience of the internet using blockchain technology.
Web3 is generally a term used to describe the next stage or the evolution in the internet’s development. It introduces an internet experience where users will be able to interact, exchange information, own and control their data and securely conduct financial transactions without the regulation or control of any centralized authority.
Web3, commonly referred to as the “read, write, execute Web” offers an enhanced version of the internet we know. The features of Web3.0 comprises of a more semantic search system, intelligent connectivity, dynamic compatibility, permissionless and more democratic functionality.
Web3.0 works by merging the decentralization of web1.0 with the interactive feature of Web2.0 in a user-friendly interface, offering enhanced security through blockchain technology.
What is DeFi, and how does it work?
DeFi is an acronym that stands for decentralized finance. It is a non-custodial financial paradigm that leverages distributed ledger technologies to provide cryptocurrency-based transactions such as trading, lending and investing, between traders or investors, using open-source software running on decentralized networks independent of any centralized authority or third parties.
Through P2P financial networks, DeFi uses security protocols, connectivity, software, and hardware developments.
Through its applications, DeFi offers users more control over their data and money through personal wallets and trading services that provide to individuals. These applications aim to dismantle traditional finance by offering financial services that are accessible to everyone, irrespective of their location, status, gender or wealth. It embodies a permissionless system where users have the ability to participate in the system.
Among its attributes lies transparency because its functionality rests on blockchain technology. All transactions, data, and codes on the blockchain are visible to everyone, to examine and audit, which builds trust among the community of users in the network.
All financial transactions within the DeFi system are powered with smart contracts that are often supported on Ethereum-based blockchains. DeFi works by using the blockchain technology that cryptocurrencies use.
DeFi’s ecosystem includes the following: Layer 1, Decentralized exchanges, Aggregators and wallets, Decentralized marketplaces. We will go ahead to explain these briefly.
Layer 1
Layer 1 refers to a base network, such as Bitcoin, BNB Smart Chain, Solana, Ethereum, and its basic infrastructure. Layer 1 blockchains have the ability to validate and finalize transactions on its own blockchain without the approval or support of another network. They have their own native token and are referred to as ‘layer 1’ because they are the main networks within their ecosystem.
Decentralized exchanges
Examples of decentralized exchanges include: Uniswap, Bitfinex, CoinMarketCap, PancakeSwap, Binance, Kraken, Sushiwap etc. A decentralized exchange platform (DEX) is a peer-to-peer digital currency exchange marketplace, where traders and investors buy, sell and trade digital assets straight from a compatible crypto wallet, independent of any intermediary.
DEXs foster financial transactions that aren’t controlled by banks, brokers, or any middleman through the use of automated smart contracts. They are built on open-source code and take on a non-custodial model, which means that users get to preserve their rights over their assets and are solely responsible for handling their wallets and private keys.
Aggregators and wallets
Aggregators are platforms that gathers data from diverse DeFi protocols and combines them into a single interface, enabling traders to make smarter decisions.
What an aggregator does is that it collects the best prices from various yield farming platforms, decentralized exchanges, liquidity pools and lending services, integrates them into a single dashboard in order to help save time, maximize profit and increase efficiency for traders. They aim to resolve the issue of fragmented liquidity across several decentralized exchanges and other liquidity sources within the DeFi ecosystem.
Aggregators work by engaging sophisticated algorithms and automated market-making protocols to enable an effective, enhanced and reliable execution of trades. Some examples of DeFi aggregators are, Instadapp, Zapper, 1inch etc.
DeFi wallets on the other hand are considered one of the most powerful and essential tools in crypto as they enable the storage, and transfer of crypto.
Decentralized marketplaces
Decentralized marketplaces are online platforms or protocols that enable peer-to-peer transactions independent of central authorities or intermediaries. Decentralized marketplaces allow users to interact and transact on a global, permissionless, trustless, and self-executing platform.
How does Web3 benefit DeFi?
Web3 technology has brought several benefits to the DeFi ecosystem. It advances the decentralized and secure nature of DeFi, promoting greater trust, transparency, accessibility, and accountability in the financial system.
Web3 is regarded as the future of the internet and as such it embodies potential features that could change how money functions in the financial world. The capability of Web3 to support a huge number of prospective customers who desire to support DeFi and digital transactions has led to its enormous adoption and status.
With the growing popularity of Web3, its massive adoption by consumers could exponentially lead to the increase of participants in DeFi and digital transactions.
Web3 introduces programmable smart contracts which DeFi protocols utilize to automate various financial operations, including lending, borrowing, decentralized exchanges, and yield farming. It has the potential of promoting financial inclusion by providing open access to financial access to services.
Our generation has witnessed a growing popularity in digital transactions. With the increasing use of digital assets as payment in our present generation, users are becoming more accustomed to living in a cashless society. In the nearest future, DeFi and Web3 will eventually play enhance our digital experiences.
DeFi vs. Web3: Various properties compared
By employing the use of blockchain technology, web3 aims to create a more equitable internet experience for users. While being a subset of the wider Web3 movement, DeFi leverages the principles of Web3 technology to build decentralized financial protocols, DeFi aims to recreate traditional financial system.
Web3 on the other hand is a more inclusive vision of a transparent decentralized internet, encompassing various sectors beyond finance. The major differences between DeFi and Web3 lies in their implementation and overall usage.
Permissionless
Both DeFi and Web3 stresses the concept of ‘permissionless’, which is a major characteristic of the decentralized ecosystem. Web3 aims to create an internet where users can have more control over their data, interactions, and digital identities without restrictions.
By being permissionless, web3 offers users freedom to participate and interact without seeking the consent or approval of central authorities. Through the use of blockchain technology, cryptographic protocols, and decentralized networks web3 achieves permissionless.
Permissionless is also a basic principle in DeFi. Our conventional financial systems often require individuals to go through lengthy protocols, including intermediaries in order to access financial services.
Meanwhile, DeFi protocols aim to provide open and permissionless access to financial services for anyone with an internet connection.
Decentralized
When it concerns blockchain technology, decentralization refers to the network’s independence from the grip of a centralized authority, which is typically established by a globally distributed network of nodes that manage the network. By design, both DeFi and Web3 are decentralized.
Through the use of P2P protocols, Web3 aims to create a decentralized, open network devoid of centralization. DeFi on the other hand uses blockchain technology to carry out transactions without depending on centralized authorities like banks.
Interoperability
Interoperability in the context of blockchain technology implies the ability of different blockchain networks or systems to effectively communicate, interact, transfer tokenized assets, data and exchange information with each other smoothly. It provides a solution to the issue of fragmentation in the blockchain ecosystem. DeFi services that reside in a shared blockchain network are interoperable with each other.
Non-Custodial
DeFi applications are typically non-custodial, which basically implies that users retain ownership and control over their private keys. Web3 applications can also be non-custodial although some can be custodial, where a third party reserves the private keys and controls the assets. Non-custodial implies that user funds are not held by a bank or any centralized financial institution.
Cryptographically verifiable
Through verifiable cryptography, DeFi systems are also immutable, tamper-proof, and irreversible, making it utterly impossible to alter, reverse, or fabricate records on-chain. Web3 blockchain systems are also designed to be tamper-proof, with records on the chain validated via cryptography. Not only does this make the system more transparent and secure, but also makes it incredibly hard to falsify records on the blockchain.
Economic and governance systems
DeFi and Web3 engages economic systems and governance structures that depend on tokenization and decentralization of assets. Several blockchain and DeFi platforms are created with proof-of-stake mechanism. This means that network users can influence the advancement of these systems over time.
Entry barriers are reduced to the maximum given the ability of users to buy, trade, and invest in fractionalized and entirely divisible digital assets. This has given users who had little or no interest in trading given the supposed high barriers, an opportunity to participate.
What is the future of DeFi and Web3?
Financial and internet technologies have rapidly developed over the years. The future of DeFi and Web3 holds huge potential for revolutionizing the financial industry and the internet as we know it more accessible and equitable. Both promises to significantly contribute to shaping an effective, decentralized data, innovative and efficient financial and internet experience.
With the introduction of new financial products, there is an increasing inclination towards more innovation in the space. The products include, decentralized exchanges, yield farming and stablecoins. The continued development of blockchain technology and the adoption of these new models by people and organizations will further drive and boost the development of DeFi and Web3.
With the rapid advancements, they both offer potential advantages that tops the traditional centralized systems.
