Understanding the Essence of DeFi: Beyond the Code
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Chapter 1: The Facade of DeFi
The contrast between the playful aesthetics of many DeFi projects and their users' focus on quick gains is quite striking. One might assume that the gamified visuals are designed to attract a wider audience. Much like the early demonstrations of steam locomotives that offered rides to the public, drawing crowds much like amusement park attractions today.
However, the hurdles remain substantial. Few individuals venture into the process of setting up a wallet, linking it to a project, and transferring tokens. Those who do find themselves in a perplexing landscape with its own unique terminology.
It's often said that one should be aware of what they are investing in. With traditional stocks, the business behind them is the primary focus. Investors generally don't delve into the intricate technological and administrative frameworks that facilitate buying, trading, and owning stock—such as how brokers manage stocks on behalf of clients or how vast amounts of shares are exchanged under specific conditions. In essence, these details are often overlooked.
Yet, having knowledge can empower individuals, as highlighted by the Gamestop episode. If you're informed and perhaps have a network of fellow investors, you could strategically acquire a heavily shorted stock using a cash account at a brokerage, enabling you to limit its availability to short sellers and potentially drive up the price.
In the realm of DeFi, however, there is no traditional business structure; the code itself represents the business. DeFi essentially involves tokens being exchanged between wallets and smart contracts, where data is transmitted across decentralized databases under specific conditions, such as IFs leading to THENs.
When you possess a token, it signifies a transaction linked to your wallet within an extensive record of exchanges facilitated by a token contract. A token contract serves as a database for these transactions, providing functions that allow wallets to send and receive tokens.
Consider the AAVE token contract, a notable borrowing and lending protocol. This contract displays transactions involving various wallet addresses and smart contracts—addresses on the blockchain capable of executing specific functions through lines of code.
AAVE's main smart contract enables users to deposit tokens as collateral and borrow another token. The process is governed by conditions: if you invoke the deposit function, you transfer a certain amount of tokens to a specified address. Subsequently, you can utilize the collateral to borrow another token.
Additionally, there's a provision for flash loans, allowing users to borrow substantial amounts without collateral, provided the funds are returned within a single block transaction. Users can trade these funds quickly, often requiring coding skills to navigate effectively.
The aim of this detailed examination is to highlight what DeFi truly represents—information devoid of real-world correlation being transferred between lines of code operating on decentralized databases.
In DeFi, fundamental analysis is virtually absent due to the lack of traditional fundamentals. This creates a disconnect between the simplistic narratives seen on project websites and the underlying code that constitutes DeFi. At best, we find post-mortem analyses from blockchain security firms following hacks, which, while informative, merely clarify the logic of smart contracts and their functionalities.
While it's not necessary for everyone to become proficient in programming or to sift through numerous smart contracts from DeFi projects, it's crucial to grasp how abstract and distanced from reality DeFi truly is—essentially just databases that update the status of certain variables.
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Discover the fundamentals of DeFi in this introductory video from the Catholic Crypto Conference 2022.