Is DeFi a Component of Web3?
DeFi is a novel financial system that is rapidly gaining momentum within Web3. This system offers unprecedented value and utility that cannot be found in conventional financial systems.
Web3 represents a new internet paradigm that leverages blockchain technology to establish a fairer and more decentralized internet. It grants users authority over their personal data, identity, and funds.
DeFi is an emerging financial system that operates within the Web3 environment. It introduces unique forms of value and utility that conventional financial systems do not possess. The key difference between DeFi and Web3 is that DeFi is constructed on existing smart contract platforms, such as Ethereum, while Web3 is built on the internet itself.
In essence, DeFi and the decentralized internet (Web3) are two interconnected yet distinct areas of technological innovation. Both entail creating an alternative version of finance or the internet that is more secure and decentralized than their centralized counterparts.
Article structure:
Understanding Web3 and Its Functionality
The manner in which individuals interact with technology, especially in finance, has experienced significant changes alongside the development of the internet. These advancements are categorized as Web1, Web2, and Web3.
Web1 is the first iteration of the internet that emerged in the 1990s and 2000s. It primarily consisted of static HTML pages and lacked interactivity. There was no infrastructure in place to facilitate financial transactions.
Web2 introduced more interactive internet functionality. This era is characterized by mobile applications, social media, and online content consumption. It also enabled fiat transactions over the internet.
However, this period also had several security vulnerabilities, including data privacy breaches and significant hacker attacks. People were tired of trusting third parties with their personal information only to find out that they were selling it.
Web3 has emerged to address the fundamental issues associated with Web2. Rather than relying on corporations, Web3 leverages blockchain technology to provide users with a sense of ownership. Decentralization is the primary focus of Web3, which gave rise to Bitcoin (BTC) and other cryptocurrencies, decentralized apps (DApps), and DeFi.
Web3 empowers users to control their data once more through blockchain technology and decentralized storage. Users also have complete autonomy over which parties can access their information.
Good to know: How are Web3 and blockchain related to each other?
Understanding Decentralized Finance (DeFi) and Its Functionality
Decentralized finance is a financial system that operates independently of a central authority, such as a bank. It allows users to engage in financial transactions directly with each other, including peer-to-peer (P2P) transactions like lending and borrowing, all governed by smart contracts.
DeFi aims to combat the control exercised by centralized institutions such as banks and governments over our assets and data. The system is designed to be permissionless, enabling all users to participate without the need for institutional authorization.
Transparency is another key feature of DeFi, allowing all transactions to be visible to everyone in the system.
DeFi’s ecosystem comprises the following elements:
Layer 1
Layer 1 refers to the underlying blockchain or network upon which DeFi tokens, protocols, apps, and smart contracts are built. Examples of layer-1 networks include Ethereum, Bitcoin, BNB Smart Chain, and Polkadot.
Decentralized exchanges
Decentralized exchanges (DEXs) are platforms where users can trade digital assets without the involvement of a centralized system or authorized third party. Instead, smart contracts execute trades and ensure their validity.
Aggregators and wallets
Aggregators are decentralized interfaces that allow users to manage assets across various yield-farming platforms to maximize profits. Examples include RocketX and 1inch, which offer access to liquidity and enable easy navigation between centralized and decentralized platforms.
Decentralized marketplaces
Decentralized marketplaces allow users to undertake P2P transactions without intermediaries. Unlike exchanges, they enable direct interaction between buyers and sellers.
Web3 technology benefits
The decentralized and secure nature of DeFi is enhanced by Web3 technology, resulting in greater trust, transparency, and accessibility within the financial system.
As cryptocurrency continues to gain popularity, more individuals are seeking to participate in the system by owning, trading, or creating cryptocurrency projects. This has accelerated the development of blockchain and Web3 technology. Although there is still much to be accomplished, many believe that Web3 represents the future of the internet and has the potential to revolutionize the financial landscape.
One of Web3’s advantages is its ability to handle the growing number of potential consumers interested in supporting DeFi and digital transactions. With over 5 billion internet users in 2022, or 63% of the world’s population, the number of DeFi participants is expected to increase as users convert to Web3 from Web2.
In addition, the increasing popularity of digital assets as a form of payment is helping younger and newer generations become accustomed to living without cash. With the rapid pace of technological adaptation, Web3 and DeFi are expected to become an integral part of daily life in the near future.
Comparing DeFi and Web3: A Look at Their Different Features
Web3 technology aims to create a more equitable and decentralized internet using blockchain. The original vision for the internet was that it would be accessible to everyone and decentralized, but this vision was lost as the web became increasingly centralized. DeFi is essentially Web3’s solution for a more transparent financial system.
Permissionless
Both DeFi and Web3 are permissionless, meaning there are no restrictions on who can participate in these networks. Anyone can participate without limits or barriers.
Decentralized
Decentralization refers to the ability to function without being controlled by a centralized intermediary. Both DeFi and Web3 are designed to be decentralized. Web3 aims to create a decentralized, open network using peer-to-peer protocols. DeFi, on the other hand, is built on blockchains and is used to enable financial services without a central authority.
Interoperable
Blockchain interoperability describes how well different blockchains can communicate with each other. This allows for the exchange of data, tokenized assets, and other technology. In a centralized world, this provides easy access to one’s data across several applications through centrally stored data. DeFi services residing on a shared blockchain network are interoperable with one another.
Custody
DeFi applications are typically noncustodial, meaning users hold the private keys to their funds and assets, giving them full control and ownership. Web3 applications can also be noncustodial, but some may also be custodial, where a third party holds the private keys and controls the assets.
Cryptographically
Verifiable DeFi and Web3 blockchain systems are designed to be impervious to tampering, with records on the chain verified through cryptography. This makes the system more transparent, secure, and prevents falsifying any records on the blockchain.
Economic and Governance Systems
Both DeFi and Web3 use asset tokenization and decentralized governance mechanisms for their economies. Several blockchain and DeFi platforms use proof-of-stake (PoS) technology, giving users a voice in the platform’s future development. Digital assets are fractional, divisible, and available for purchase in amounts as small as $1. This has led to a surge in interest from new users who previously held no prior interest in trading due to the perceived high barriers to entry.
Good to know: An imperfection has been discovered in the original artwork of the Bitcoin logo after 12 years
What is the next growing trend?
The growth and success of DeFi and Web3 hinge on the continuous advancement of blockchain technology and the adoption of these innovative models by individuals and organizations. While the future remains uncertain, the potential for a significant positive impact is promising.
For DeFi, there is a growing trend towards more innovation in the space, as new financial products and services such as decentralized exchanges, yield farming, and stablecoins are introduced with the potential to disrupt traditional finance. The focus on user adoption and accessibility is also increasing, which will likely fuel further growth in the decentralized finance ecosystem.
In contrast, Web3 is expected to have a significant role in the future of the internet. Decentralized infrastructure provides numerous advantages over traditional centralized systems, including greater security, privacy, and data ownership. The development of Web3 technologies is anticipated to result in a new generation of decentralized applications that enable a more equitable and open internet.
