Decentralized Finance is the fastest growing sector within the global blockchain ecosystem, yet it’s still nascent and has much-untapped potential. An increasing number of developers are producing sophisticated dApps (decentralized applications) for various financial use-cases, seeking to create an alternative to existing financial services. These use-cases range from simple transactions (ie, peer to peer payments) to much more complex and multiparty applications such as loans, asset trading, insurance, exchanges, asset tokenization, and more.
The financial industry bases most of its activities on traditional contractual agreements, which often involve trusted third-parties to validate the fulfillment of terms outlined in the corresponding paperwork of the agreement. This method is outdated, slow, and, most importantly, not cost-effective for today’s financial institutions. Algorand’s smart contracts are basic lines of code that are stored on a blockchain and automatically execute when certain conditions are met, enabling developers to build dApps that are highly scalable, secure, and low cost to execute. An essential tool for all blockchain developers, smart contracts have accelerated the adoption of blockchain technology and contributed to the increasing momentum of the DeFi industry as a whole.
Unfortunately, DeFi developers are facing many challenges with existing smart contracts options that prevent many of their dApps from gaining mainstream adoption:
For DeFi to be welcomed into mainstream adoption and become an alternative for real-world use cases, it has to solve these issues. Otherwise, DeFi will stay on course for being a fringe use case of the financial industry and will be known simply as an experiment rather than a legitimate ecosystem.
To advance ahead, DeFi needs a next-generation open-source, permissionless blockchain that has solved the blockchain trilemma of being decentralized, scalable, and secure with a foundational network that has the built-in transactional speed and low fees to power real-world use-cases. Algorand has become that de-facto platform for many developers and is gaining traction with many dApps being built within 1-year of the MainNet launch.
Algorand is releasing its latest version of Smart Contracts (ASC1) which provide the foundational attributes of security, scale, and decentralization while adding the functionality directly into Algorand’s Layer-1 primitives. This allows developers to take advantage of the network without sacrificing the speed, cost-effectiveness, and simplicity that their applications require. Algorand also provides simplified tools and examples of custom complex dApps that can serve as the basis for a wide range of applications. Removing the technical barriers that undermine blockchain adoption, Algorand’s Smart Contracts are highly flexible and reliable in that they are executed on a tamper-proof (trustless) network providing complete transparency, with error-free, immutable, and accurate applications. Algorand’s Smart Contracts are powering developers building large scale complex programs that can rival existing financial services today.
The benefits of DeFi applications are too many, too big, and too important to be stalled by the shortcomings of the first generation blockchains. DeFi gives the world access to an essentially unlimited number of financial products and services, helping the 1.7 Billion people who are unbanked worldwide, including in the U.S. (25% of U.S. are unbanked or underbanked).
Check out Algorand’s other capabilities and learn how Algorand is designed for building scalable, secure, and fast financial applications for the future with:
Algorand was created by Turing, Gödel Prize, and RSA Prize winner Silvio Micali, a highly respected MIT professor, who helped invent many protocols that are the foundations of modern cryptography. He and a team of world-renowned cryptographers, technologists, researchers, and economists studied the first-generation blockchain, found several shortcomings, and decided to reconstruct a new blockchain – a next-generation blockchain that required no compromises on security, scalability, or technical features, with advances in speed, reliability, and usability. A blockchain that solves real-life problems that are ready for deployment. Algorand’s protocol uses Pure Proof of Stake, has no miners, and will never fork.
Algorand provides a common, scalable, and interoperable platform that speeds up application development increases iteration, and results in faster deployments with more cost-efficient capabilities. Contact us today for more information at algorand.com/contact
In traditional finance, an escrow account is one in which funds are kept locked up until some predetermined event occurs or some set of conditions have been fulfilled. An example of an escrow-based application is if Alice needs a loan, and her lender Bob provides it on the condition that she puts another asset aside in an escrow account that Bob can claim if Alice is unable to pay him back (a collateralized loan). The funds can be released in either of two conditions: 1) Alice does not pay back the loan after an expiration period and Bob can claim Alice’s asset or 2) Alice does pay back the loan prior to the expiration period and Alice can reclaim her asset from the escrow account. The event or condition that “unlocks” the funds, in traditional finance, is usually governed by a centralized, trusted intermediary, like a bank, and therefore is subject to high fees and transfer friction.
On Algorand, this same concept is implemented using Stateless Smart Contracts as escrow accounts. With this technology, the same two conditions required to release the funds are encoded, and thus secured, by the logic of the contract account itself, eliminating the need for a centralized authority to determine if a condition has been fulfilled and then have to moderate the transaction. Claiming funds when conditions are met through a contract account on Algorand is then a simple atomic transfer, taking less than 5 seconds with fees of less than a penny.
Synthetic cryptocurrency assets enable investors to use their cryptocurrency holdings to purchase stakes in various assets, such as fiat currency or commodities like gold, without leaving the blockchain ecosystem. More interestingly, it provides a way for investors to mitigate the volatility of their crypto holdings while preserving the speed and security advantages of investing in a decentralized exchange. This is all possible through the implementation of smart contracts, which peg stakes of a native token against the value of a synthetic asset and adjusts that stake by an equivalent amount when the asset goes up or down in value. Synthetics are helping drive the DeFi movement forward, as they give investors from all around the world open-access to traditional financial systems without having to ever own a real stake in the asset.
Like synthetic cryptocurrency assets, the primary appeal of stablecoins is that they minimize the risk of high volatility levels of digital currencies that are taken on by the stakeholder. This increased volatility is one of the greatest obstacles slowing down the widespread adoption of digital currencies, as people are hesitant to invest in tokens where the value is not commonly accepted as a standard. Stablecoins drastically reduce the risk taken on by investors, as the stablecoin is pegged to stable assets like the USD or EURO using smart contracts. In this way, stakeholders will be able to experience all of the same speed, security, and interoperability capabilities as a native token, without taking on more risk. Tether and USDC, two of the industry’s leading stablecoins, have already been launched on the Algorand blockchain, enabling organizations and financial institutions to build fast, scalable applications on the blockchain with reduced counterparty risk.
Credit and Lending
DeFi applications present a vast array of solutions for modern-day problems, but one of the more valuable applications is in the credit and lending space. The decentralized, secure, and scalable nature of the Algorand blockchain opens up new lending opportunities for individuals who lack access to traditional financial services. Lending in a decentralized financial environment enables borrowers to circumnavigate the normal limitations of borrowing from a centralized firm, like a poor credit score. However, lenders cannot trust borrowers blindly without an intermediary of some sort. Traditionally, this validation process would require a third party that takes out an additional fee, but smart contracts offer the value proposition of replacing that intermediary with self-executing lines of code that either accept or reject whether the conditions of the agreement were met. Due to the lack of compliance costs associated with smart contract integration, organizations will be able to offer more credit at a lower cost. As a result, more people will have access to cheaper loans that are best suited for their needs.
Exchanges and Liquidity
Decentralized exchanges are built on the blockchain and allow for seamless transactions between peers consisting of the blockchain’s native token. The smart contract built into the exchanges then automatically matches, verifies and finalizes these transactions without an intermediary. These exchanges offer increased levels of liquidity to investors, as the investors can swap digital assets in a matter of seconds for whatever use it might be needed for. For example, say Alice needs to pay Bob. Bob will only accept Algos (ALGO) as a means of payment, but Alice only has Bitcoin (BTC) in her digital wallet. However, through a decentralized exchange, Alice is able to make this swap in seconds and have access to her newly acquired Algos, which she can then send to Bob. Decentralized exchanges lead to greater interoperability between chains and will be an integral part of gaining mainstream adoption of digital currencies, but they aren’t perfect for every organization's needs. Algorand’s latest release, which introduces Stateful Smart Contracts in Layer-1, enables developers to build stateful applications that keep track of buy and sell offers and matches them up so that anyone across the network can trade with anyone else, without needing to hand over their assets to an exchange.
Powered by Algorand’s Smart Contracts (ASC1), margin trading with digital assets provides investors with the ability to use borrowed funds from a broker to trade a financial asset, which forms the collateral for the loan from the broker. ASC1s have the ability to automatically enforce custom rules and logic, making it possible to margin trade without working through traditional financial gatekeepers, cutting the cost of the trade, and improving the potential return from it. The end goal in margin trading digital currencies is to get a higher percentage return in the form of leveraged payouts. This gives borrowers the ability to further leverage their existing cryptocurrency holdings, increasing both the potential rewards gained and the risk associated with the trade. The more money that is leveraged, the more collateral that an investor must lock in to experience the leverage associated with it. For example, making a margin trade that is leveraged at 2x means that the potential value lost or gained is doubled. Margin trading allows traders to capitalize more heavily on the volatile nature of cryptocurrencies, hopefully timing their leveraged investment with a market upswing. That being said, they can also short a digital asset using margin trading, enabling investors to capitalize on both up and downswings of the market.
An Alternative savings account serves the same purpose as a traditional savings account provided by a bank, in that the funds placed into these accounts are transferred into currency pools to be lent out to willing borrowers. From this pool, borrowers gain access to the funds and lenders reap the rewards. These alternative savings accounts are built using smart contracts, offering a wide range of advantages over traditional savings accounts. Since the smart contracts self-execute in a trustless manner, there is no need for an intermediary that would otherwise take a cut out of the interest earned on lent funds. With DeFi savings, rewards will be distributed to savings account holders based on the amount of interest accumulated from the loans. Where typically a traditional savings account will result in an APY of around 1%, some alternative savings accounts can earn an APY of over 5%. Finally, these applications provide access to new investment vehicles for the unbanked and allow their funds to enter the global financial ecosystem. It also enables individuals who are not entirely familiar with digital currencies to take advantage of its benefits by accumulating higher interest rates on deposited funds rather than invest it with limited knowledge.
Payment-based applications have the primary purpose of transferring funds from one party to another. The Algorand Mobile Wallet is one example of a payment-based application. Algorand provides standard payment transactions using its native token, the Algo, as currency. Payment applications may also be implemented with a different underlying currency or token, like stable coins, that are represented as Algorand Standard Assets. Algorand transactions are final in less than five seconds on average.
Trading assets between two or more parties requires trust that the other party will hold up their end of the deal. To mitigate this risk, we often use a trusted intermediary, like a bank, to foster and guarantee the exchange. This centralized bank often comes with high fees and slow transfer times, especially for international transfers. On the Algorand blockchain, the guaranteed trade of two or more assets is simplified into a simple technological innovation that does not require the trust of the other party or a centralized intermediary. It is called an atomic transfer. Atomic transfers on Algorand are built at Layer-1 and are simply transactions that have been grouped (up to 16 transactions can belong to a group) and sent to the network together. If any transaction fails, all will fail. These atomic transfers can be used with any type of Algorand transaction, including payments, Asset transfers, smart contract calls, etc.
Prediction Markets allow users to purchase and sell shares in the outcome of an event, such as the upcoming United States Presidential Election or when a vaccine for COVID-19 will be discovered. Today’s prediction markets are centralized, meaning that generally one person is confirming or denying the occurrence of an event outcome, opening the door to potential fraudulent activity. With decentralized prediction markets, thousands of users report on the outcome of an event, ensuring the result is accurate. This “Wisdom of the Crowd” implementation creates the odds associated with a certain outcome, making these markets more fair as there is less risk for line manipulation by one bad participant.
The unique thing about decentralized prediction markets is that there are no limitations on what you can “bet” on and no limit on the amount you can bet. Oftentimes, centralized prediction markets can manipulate a user's ability to earn by putting limitations on the size of a bet. This ensures that the centralized firm will not take too heavily a loss, but it also drastically reduces the odds of turning a profit for the user placing the bet. Smart contracts remove centralized intermediaries from the prediction market industry, resulting in lower transaction fees and more secure funds as your funds are not held by any third-party and can be withdrawn at any time. Once the outcome of an event is reported, the automated smart contract will execute and, if users are correct with their prediction, distribute the appropriate amount of funds. Applying smart contract logic to prediction markets creates a frictionless user experience, where any prediction can be made into a custom market by the community.
Today’s online marketplaces are dominated by centralized entities, such as Amazon or eBay, who dictate the terms of trade on the site and take a commission from all transactions made on their platform. Decentralized marketplaces, powered by smart contracts, are peer-to-peer networks where sellers can directly sell their goods to buyers without the presence of middlemen. Additionally, when control over the marketplace is centralized, it leaves the marketplace exposed as hackers can deploy large amounts of computing power to potentially manipulate the server. Smart contracts give users the power to dictate the terms of trade between buyers and sellers and protect those terms of trade from fraudulent activity throughout the trade process. Smart contracts can be used to create independent decentralized marketplaces, or improve the current processes we know and use extensively today. For example, say there is a dispute on an existing marketplace between a buyer and a seller, the smart contract would easily be able to resolve the dispute as the assets being transacted are not released until all the conditions of the agreement created beforehand are met. Another issue that decentralized exchanges solve is that of data privacy, as there is not the need for sensitive information to be shared between the network's users and an intermediary for verification. This information does not need to be exchanged because smart contracts, executed correctly, do not allow for fraudulent behavior to take place, as the coded conditions of the contract must be met for a transaction to be finalized. All-in-all, smart contracts power the decentralized exchanges of the future which offer users open-access to a global market of goods in a cheaper, more efficient, and secure way.