What will decentralized finance look like on Cardano?

What will decentralized finance look like on Cardano?

(Written by @ElliotHill of the Cardano Foundation)

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If you’ve taken even a passing interest in the blockchain space during the past year, you’re bound to have come across the phenomena of decentralized finance—often referred to as ‘DeFi’.

DeFi can apply to almost any traditional or hybrid financial product offered on top of a blockchain protocol. This could include open lending protocols, a peer-to-peer loan platform, or even the provision of services typically associated with traditional financial providers.

But DeFi has had a baptism of fire. Spiraling fees, smart contract exploits, and tales of significant user losses have necessitated a focus on improved DeFi infrastructure and processes—ones based around transparency, true decentralization, and high assurance.

With a significant milestone just around the corner for Cardano through the Mary hardfork, it’s a good time to examine the features that could make Cardano a highly attractive blockchain for building DeFi applications. Here, we’re going to explore how Cardano could soon begin to have a profound impact on today’s DeFi landscape.

Cardano’s benefits for DeFi applications

Soon, through the Mary hardfork, token forging and a multi-asset ledger will be available on the Cardano blockchain. In turn, this will pave the way for decentralized applications (DApps), native tokens, and DeFi use cases.

But why might a DeFi project choose to run on Cardano, rather than one of our peer protocols? Let’s break it down to some simple areas where the Cardano blockchain could excel for DeFi projects.

1. Lower transaction fees

Although the complex topic of gas fees is outside the scope of this article, we can summarize that high gas fees have been, and continue to be, a huge issue and stumbling block for DeFi protocols. Gas fees on some protocols have become so high due to increased network demand, that users have reported paying exorbitant fees to process a single transaction.

Not only do rising gas fees cost the DeFi protocols themselves more when moving value and executing smart contract code, but they also present another barrier to entry for new users.

As we know, if we are to attract the biggest potential user group of decentralized finance products—those in emerging economies—we must ensure that we can keep costs low. Similar to paying high fees for banking services, many users who desperately need new financial infrastructure simply won’t explore DeFi solutions if the costs are too high.

On Cardano, transactions between native tokens and assets do not incur execution fees, owing to the way they are deployed on-chain. We will discuss this in more detail below, but the bottom line is that DeFi has the potential to be much more affordable through Cardano.

2. Token and smart contract security

Tokens are an essential part of most existing DeFi protocols, used for governance, utility, or yield distribution. On other chains, such as Ethereum, tokens require smart contracts to run, and often necessitate the deployment of complex purpose-written code in the token contract.

We could say that these tokens are ‘non-native’—in other words, they are not supported on the underlying ledger. Tokens on Cardano, on the other hand, are ‘native’. This means that tokens representing assets on Cardano use token logic that runs directly on Cardano’s ledger, rather than using smart contracts. By removing the need for smart contracts to deploy tokens, Cardano removes the large burden of gas costs associated with interacting with a token smart contract.

Generating custom code for each token launched through a smart contract requires an extreme amount of confidence in that code. Human error is a real risk in smart contract-based tokens, despite many of these contracts being responsible for potentially billions of dollar’s worth of on-chain value. As a result, bugs in token smart contracts have already cost users millions of dollars in value over the years, with smart contract exploits happening somewhat regularly.

Instead, as Cardano supports user-defined native tokens, DeFi tokens could be forged without the need for custom code. The only required custom code is a minting policy, which is permanently hash-associated with its respective tokens, and there’s no way to change the policy.

Cardano does this while also supporting fungible and non-fungible tokens without the need for specialized contracts—paving the way to represent a whole host of real world assets on-chain securely and affordably.

If serious institutional entities are exploring launching DeFi products, then tokens which solve the inherent vulnerabilities and dangers of custom-coded smart contracts could prove very attractive.

3. Cardano community power—the ultimate DeFi Catalyst?

This section is about you.

Cardano’s community is immensely powerful. Together, we have achieved feats that other protocols have long aspired to—near full decentralization through community led stake pools, a thriving staking and delegation ecosystem, and bustling community channels.

More recently, the community helped Cardano achieve another major milestone through Project Catalyst, one that is of critical importance to attracting DeFi developer talent and funding new solutions on Cardano.

With over 3,000 people already signed-up to vote and US$500,000 in funding available through Fund3, Project Catalyst is one of the largest community-led funding initiatives on any blockchain to date.

By pushing power to the edges of the Cardano community, there has already been a successfully funded DeFi proposal, one of the first projects that will launch atop Cardano, and our community made it happen. Going forward, our community stands to be a driving force for development and adoption of the Cardano blockchain for all kinds of solutions.

With Mary on the horizon, we are now looking forward to seeing more ideas flourish through Catalyst, and we anticipate some of these will include more DeFi proposals.

Sign up to Project Catalyst here.

Tl;dr

Short on time or relatively non-technical? Here are the key takeaways:

  • There are no execution fees payable when transferring native tokens on Cardano,

  • There is minimal custom code required to launch a user-defined token on Cardano,

  • There is no custom code available to exploit in the deployment of user-defined tokens on Cardano,

  • DeFi will be more affordable, more secure, and easier to launch on Cardano.

Do you have an idea for a DeFi solution built on Cardano? Put a proposal into Project Catalyst via Ideascale and let the community vote! Or, visit our developer forums here to get involved with the conversation.

You can also now explore the new and updated Plutus Playground for writing smart contracts here for other development goals.


Read more about decentralized finance here:

21 Likes

Can’t wait for Mary.

3 Likes

Hello Elliot

I can’t wait for DEFI and I think it is a big deal because it could solve 2 current problems:

  • the people’s tokens centralization in exchanges by taking back some CEX’s liquidity.
  • the pool farms centralization by delegating liquidity in a ‘fair’ manner.

All the discussion around DEFI I could find are related to the first goal, which is great.

But I can’t find anything about the second point:
Each DEFI app is likely to take custody of huge liquidity, that will have to be delegated according to the app implementation.
It could be a fair delegation to the pool community, helping the block production decentralization, it could be an unfair delegation in favor a central pool farm (Like Binance does today).

As a member of the Cardano pool community, I wonder how this will be done. Is there a CIP about that ? If there going to be some guidelines, recommandations or exemples set by IOG or the Fundation ?

I’ve just started a CIP about that: CIP - DEFI apps delegation guidelines for pool decentralization

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