Intro

So what is the current state of decentralized finance? Where are we with different scaling solutions on Ethereum? How about DeFi on other chains? And what is the most likely scenario when it comes to the future of DeFi? You’ll find answers to these questions in this article. 

And one more thing before we start, Finematics has recently hit 100,000 subscribers on Youtube! This is pretty amazing and I’d like to say a big thank you to all of you watching my videos and reading my articles. Also a special shout out to all of our Patrons who actively support this channel. If you’d like to become one of them and join our DeFi community you can check it out here.  

DeFi – State of Affairs 

Decentralized Finance, together with the whole cryptocurrency space, started 2021 with a bang. 

In just a few months the total value locked in DeFi grew from around $15B to an astonishing $45B. 

The volume on decentralized exchanges has also been at an all-time high with over $50B traded each month. 

On top of this, a lot of DeFi tokens have seen a significant increase in value which attracted even more people to this still very new space. 

We’ve also seen a lot of development. 

New projects popping up pretty much every day. 

Already existing protocols launching their new versions. 

Other well-known projects migrating or announcing their migration to different scaling solutions.  

We also had some big news. For example, Visa announced they will start settling transactions in USDC on Ethereum. This is amazing not only for Ethereum but also for the whole DeFi space in general. 

Despite all of this development, it seems like DeFi is at a crossroad. 

On one hand, we have DeFi protocols on Ethereum exploring multiple different scaling solutions to alleviate high transaction fees. On the other hand, we have other chains trying to attract both the new and the already existing DeFi projects. 

Scaling DeFi 

When it comes to scaling DeFi on Ethereum we have quite a few options either already available or not being too far from a full launch.

These options belong to one of the 2 categories: Layer 2 scaling and sidechains. 

Layer 2 scaling relies on the security of the main layer – the Ethereum blockchain. 

Sidechains rely on their own security models, usually by having a separate consensus mechanism. They can also have additional security guarantees that leverage the main layer, but despite this, they are usually considered less secure than Layer 2 solutions. 

One of the most discussed Layer 2 options, when it comes to DeFi, are rollups. 

Rollups provide scaling by executing transactions outside of Layer 1 but posting transaction data on Layer 1 which allows rollups to be secured by the main Ethereum chain. 

There are 2 types of rollups: optimistic rollups and ZK rollups. 

Optimistic rollups run an EVM-compatible virtual machine which allows for executing the same smart contracts as on Ethereum. Optimism and Arbitrum are currently the most popular options. 

Optimism has been partially rolled out to the Ethereum mainnet with a limited set of partners to ensure that the technology works as expected.

Synthetix has already migrated its staking module to Optimism which allows for minting sUSD and receiving staking rewards in a fast, cheap and secure way. 

Another big partner that has already announced its launch on Optimism is Uniswap with its long-awaited Uniswap V3.

Arbitrum, on the other hand, seems to be even closer to being fully launched on the Ethereum mainnet. They partnered with a few major DeFi projects like Augur and Bancor. 

ZK rollups, although faster and more efficient than optimistic rollups, do not provide an easy way for the existing smart contracts to migrate to Layer 2 – at least not just yet. 

With ZK rollups we have a few options available, mainly StarkWare and ZKSync. 

StarkWare-based rollups are already extensively used by projects such as DeversiFi, Immutable X and dYdX. 

ZKSync is working on an EVM-compatible virtual machine that will be able to fully support any arbitrary smart contracts written in Solidity. They are targeting August for their mainnet release.

Besides Layer 2 options, we have sidechains like the Matic PoS chain or the xDai chain. 

We’ve recently seen a lot of projects launching on both of these chains. This includes Sushiswap, Polkamarkets and Aave on the Matic PoS chain and Perpetual Protocol, RealT and Gnosis on xDai. Both chains are also integrated with Chainlink oracles. 

Matic, after its recent rebranding to Polygon, also aims at expanding its available scaling solutions and add things like ZK and optimistic rollups, on top of already available solutions: the PoS chain and the Plasma chains. 

Although Layer 2 scaling and sidechains can alleviate high transaction fees and increase both the throughput and speed of transactions they come with their own challenges. 

The biggest one, that can negatively affect DeFi, is the lack of smart contract composability between different scaling solutions.

Composability is clearly one of the most important characteristics of DeFi. When it comes to the Ethereum main chain, a single transaction can interact with multiple different DeFi protocols. For example, a smart contract can borrow funds on Aave, swap these borrowed coins to other ones on Uniswap and provide the swapped coins to a yield farming aggregator – all of this in one single Ethereum transaction. 

Although composability is still possible within one scaling solution, it would break if even one of these protocols is not available on this particular scaling solution. 

Continuing with our previous example, if Aave is only additionally available on Matic PoS and Uniswap is only available on Optimism, we wouldn’t be able to compose one transaction that calls both the Aave’s and Uniswap’s smart contracts in any way outside of the Ethereum main chain.

The next issue is the interoperability between different scaling solutions.

What if we borrowed funds on Aave on the Matic PoS Chain but we later want to swap them using Uniswap on Optimism. At the moment we’d have to withdraw them to the Ethereum main chain before being able to use the coins on Optimism. This of course adds a lot of friction as some withdrawals can take a long time to be fully settled especially when it comes to optimistic rollups. 

Having multiple scaling solutions also provides us with some challenges when it comes to the existing liquidity in DeFi. Instead of having a lot of liquidity available on the Ethereum main chain in a few major protocols, we’ll see the existing liquidity being split across the Ethereum main chain, multiple implementations of rollups and different sidechains. 

Fortunately, most of these challenges are solvable. 

We’ll probably see a lot of bridges between different scaling solutions which should help with reducing friction. On top of this, the other approach is to create a whole ecosystem that is interoperable by default. This is the approach that Polygon decided to go with. 

Also, it looks like most liquidity outside of Layer 1 will concentrate around a few most popular scaling options with the biggest number of high-quality DeFi protocols available. 

Despite the existing and future challenges, Ethereum is clearly an undisputed leader when it comes to DeFi. It offers credible neutrality, decentralization and a strong community, driven not only by the recent price rise of ETH but even more about building the future of finance and web3. 

When it comes to DeFi on other chains there are also a few options available. 

BSC And DeFi On Other Chains

Let’s start with Binance Smart Chain – yes, I know, BSC is not always even considered as DeFi and more like CeDeFi and you can find more about it here in this article. 

Nevertheless, BSC attracted a lot of users and trading volume in a very short period of time. 

BSC, as a fork of Ethereum, allows for deploying the same smart contracts as the ones already available on Ethereum. 1inch and Alpha Homora are some of the projects that decided to expand their reach and launch on BSC in parallel to Ethereum.  

Besides Binance Smart Chain, there are a lot of other chains that come with their own security models and different levels of decentralization. 

Many also put a lot of effort into building their own DeFi ecosystem, including Solana with its decentralized exchange – Serum, Avalanche with Pangolin and even Bitcoin where DeFi can be built on top of sidechains. 

The challenges with all of these blockchains are similar to the challenges of different scaling solutions on Ethereum, mainly the lack of composability and interoperability. 

Fortunately enough, there are also a few other projects that focus predominantly on these problems. 

Cosmos aims at creating “The Internet Of Blockchains” by leveraging its inter-blockchain communication protocol. 

Polkadot, on top of its parachains technology that allows for creating sovereign blockchains, also aims to make bridging to the external blockchains easier.

Thorchain focuses on cross-chain liquidity and decentralized exchange of assets between different blockchains.

With all of these options within the Ethereum ecosystem, and outside of it, most people feel lost trying to answer the question – what will DeFi look like in the future. 

The Truth 

Although it seems like DeFi is at a crossroad, in practice we’re just experiencing an ongoing Cambrian Explosion of this nascent space. 

The truth is, that at this point, no one can be certain what the future of DeFi will look like.

What we can pretty much assume though is that every single potential solution will be explored. Some of them will survive and thrive while others will become irrelevant over time. 

DeFi on Ethereum with different Layer 2 options and sidechains; DeFi and CeDeFi on other chains; interoperability between blockchains or maybe something completely new: It’s almost guaranteed that all of this will be tried and after some time we’re going to end up with the most adopted and hopefully most decentralized working solution.

And even though some people may not like it, this is the beauty of DeFi and any other open ecosystems like this. 

The exact details might still be quite vague, but the future of the whole DeFi space is brighter than ever. DeFi is here to stay. We may not be 100% sure of its final form, but it is almost certainly the future of finance. 

One thing that can be used to indicate which projects and ideas are here to stay more than anything else is the next, most likely inevitable, bear market. During this time most bad ideas and projects without strong communities die off and the remaining users concentrate around the best, long-lasting protocols. 

When it comes to individual DeFi projects, some of them will thrive and capture value across multiple scaling solutions or even across multiple blockchains. Others won’t be able to do it and new protocols will be able to steal their market share.

Because of this ever-changing space, it’s really important to keep learning and expanding our knowledge about DeFi, crypto, finance and technology in general. 

Fortunately, Finematics is here for you and will always deliver fresh and relevant content to keep you up to speed!

So what do you think about the future of DeFi? What will it look like in its final form? Or maybe there is no final form at all and the whole space will keep evolving?

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

So what is Binance Smart Chain? How is it different from Ethereum? And what is CeDeFi all about? You’ll find answers to these questions in this article. 

First, let’s see how Binance Smart Chain came into existence. 

Binance Chain 

In April 2018, Binance – one of the biggest cryptocurrency exchanges, decided to launch their own blockchain – Binance Chain. 

The main idea behind Binance Chain was to create a high-speed blockchain able to support large transaction throughput.

To achieve this, the team behind Binance Chain chose the Tendermint consensus model with instant finality and instead of supporting multiple applications, decided to focus on its primary app – Binance DEX.

With DeFi on Ethereum flourishing and Binance DEX not getting as much traction as expected, Binance very quickly realised that the main feature missing from Binance Chain was the ability to run smart contracts and allowing other teams to deploy their own applications. 

At this point, Binance made an interesting decision. Instead of trying to add smart contract capabilities to Binance Chain and sacrificing its performance, they decided to launch another chain in parallel to Binance Chain and this is where Binance Smart Chain comes into play. 

Binance Smart Chain 

Binance Smart Chain launched in September 2020 and in contrast with Binance Chain, was fully programmable and supported smart contracts out of the box. 

If you’d like to better understand what smart contracts are and why they are so important you can check this article here. 

Creating a completely new smart contract platform from scratch requires years of work and research. Instead of doing that, Binance decided to leverage users’ and developers’ familiarity with Ethereum and forked Ethereum’s go client – geth. 

Of course, forking Ethereum without making any changes wouldn’t make much sense, so Binance decided to optimise the new chain for low fees and higher transaction throughput by sacrificing decentralization and censorship-resistance properties of the network. 

This was achieved by replacing Ethereum’s Proof-of-Work consensus model with the Proof-of-Staked-Authority model and tweaking a few other parameters such as the block time and the gas limit per block. 

Before we jump into the details of Binance Smart Chain, let’s see why some properties of the network had to be sacrificed in the first place. We can understand this better by revisiting the famous Scalability Trilemma. 

Scalability Trilemma 

The Scalability Trilemma is a useful model, introduced by Vitalik Buterin, that helps with visualising what trade-offs have to be made when it comes to different blockchain architectures. 

Each blockchain has 3 core properties: security, scalability and decentralization that cannot be achieved simultaneously. So in order to significantly improve one of these properties the other ones have to be sacrificed.

Sharding is an attempt at solving this challenge at the base layer by splitting a blockchain into multiple smaller chains – “shards”. Sharding is one of the scaling approaches chosen by Ethereum and it’s one of the elements of the Eth2 upgrade. 

Unfortunately, sharding by itself cannot fully solve the trilemma and even sharded blockchains wouldn’t be able to process hundreds of thousands or even millions of transactions per second without sacrificing decentralization and security.  

This is also why the Ethereum community decided to use Layer 2 solutions that can dramatically increase the scalability of a blockchain without sacrificing other properties. 

It shouldn’t come as a big surprise that there were a lot of other projects popping up that, despite The Scalability Trilemma, decided to scale up by sacrificing the other 2 properties. One of the most notable examples was EOS.

This is also the approach that Binance Smart Chain decided to go with. 

Architecture 

Binance Smart Chain, instead of using a Proof-of-Work (PoW) or a Proof-of-Stake (PoS) consensus mechanism, uses a Proof-Of-Staked-Authority (PoSA) model. 

In this model, all transactions are validated by a set of nodes called validators. A validator can be either active or inactive. The number of active validators is limited to 21 and only active validators are eligible to validate transactions. 

Active validators are determined by ranking all validators based on the amount of BNB tokens they hold. The top 21 validators with the highest amount of BNB become active and take turns validating blocks. This is determined once per day and the set of all validators is stored separately on Binance Chain.

Besides staking BNB tokens themselves, validators can also encourage BNB holders to delegate their BNB tokens to them in order to receive a share of the validator’s transaction fees. 

On this note, all transaction fees on Binance Smart Chain are paid in BNB which is the native token of the chain, in a similar way to how ETH is native to the Ethereum blockchain. 

In contrast to Ethereum and Bitcoin, there are no block subsidy rewards on Binance Smart Chain. This means that the validators only receive the transaction fees paid in BNB and there is no other fixed reward per block. 

Although the PoSA consensus model allows for achieving a short block time and lower fees, it does so at a cost of decentralization and security of the network. 

First of all, a user cannot just start validating the state of the blockchain in a similar way as they can do it in Bitcoin or Ethereum. 

On top of this, even if a user could just join the network in a permissionless way and start validating transactions, they wouldn’t be able to do it for a very long time on consumer-grade hardware as the state on Binance Smart Chain grows at a much higher rate than the Ethereum’s state.

Now, let’s see how the PoSA-based model allowed the Binance Smart Chain team to change the block time and the block gas limit.

The block time was reduced from around 13s on Ethereum to around 3s on Binance Smart Chain. This allows for higher transaction throughput and faster confirmation time, at a cost of having to store more data. 

If implemented on Ethereum, it would also increase the number of orphaned blocks as there would not be enough time to propagate valid blocks across the network from multiple different geographic locations.

When it comes to Binance Smart Chain, however, this is not a problem as validators just take turns validating blocks. 

Block gas limit is another important parameter that we discussed in our article about the gas fees. This parameter basically decides how many transactions can fit into one single block. On Ethereum, miners have to come to a consensus and decide what value they want to set it to. 

Increasing the block gas limit, similarly to reducing the block time, increases the amount of data produced by the blockchain which makes it harder for individual users to run their own nodes. 

Again, this is not a problem on Binance Smart Chain as the 21 validators can just run their nodes on institutional-grade hardware when the state of the blockchain grows beyond what can be handled by consumer-grade hardware. 

At the time of writing this article, the gas limit per block is set to 12.5M gas on Ethereum and 30M on Binance Smart Chain. 

By knowing both the block time and the gas limit per block we can quickly calculate that the amount of data on Binance Smart Chain increases roughly at a 10-times faster rate than the state on the Ethereum blockchain. 

Currently, with an average block size of 40,000 bytes, Binance Smart Chain grows by around 1.15 GB per day which is around 420 GB per year. After a couple of years, this of course eliminates most of the consumer-grade hardware. 

Now as we understand a bit more about the Binance Smart Chain architecture, let’s see what CeDeFi is all about. 

CeDeFi

As we know, DeFi stands for decentralized finance. CeFi is the opposite of DeFi and as we can probably guess stands for centralized finance. CeDeFi is a term coined by the CEO of Binance that basically describes a mixed solution between centralized and decentralized finance which Binance Smart Chain is a good example of. 

So what are the benefits of such a solution? 

CeDeFi allows users to get a feel for using DeFi without paying high transaction fees. Low fees encourage users to play with multiple different DeFi protocols such as decentralized exchanges, lending protocols, liquidity aggregators, yield farming tools and others.

On top of this, CeDeFi makes users familiar with common DeFi tools like Metamask and block explorers. 

It also allows new teams to deploy their smart contracts for a fraction of a cost when compared to what they would have to pay on the Ethereum blockchain. This way they can easily test and get feedback on their projects. Testing within an ecosystem with actual economic incentives usually works much better than just testing on a testnet. 

Binance Smart Chain and CeDeFi have recently started gaining a lot of popularity. This is mainly driven by the high transaction cost on Ethereum that priced out some of the users.

As we know, Binance Smart Chain is a fork of Ethereum and therefore allows for running exactly the same smart contracts like the ones on Ethereum. 

This allowed the network to quickly bootstrap its ecosystem by essentially either reusing or forking all popular Ethereum services and applications.

Users can connect to Binance Smart Chain based dApps by switching their network in Metamask. They can look up their transactions on bscscan.com which is pretty much a copy of etherscan.com. They can trade on Pancakeswap – a fork of Uniswap. They can lend and borrow on Venus – a fork of Compound and yield farm via Autofarm – a protocol that resembles Yearn Finance. 

Binance Smart Chain, similarly to Ethereum, also allows for creating new tokens using their BEP-20 standard – Ethereum’s ERC-20 counterpart.

Some Ethereum-based projects also quickly saw the opportunity for expanding their reach to Binance Smart Chain, at a minimal cost. 1Inch – a liquidity aggregator – has recently decided to also launch on Binance Smart Chain.

Summary

It’s clearly visible that Binance Smart Chain was able to make quite a lot of traction and attract a decent number of users and trading volume in a very short amount of time. 

A decision to fork Ethereum and allow users and developers to interact with DeFi tools and protocols they are already familiar with was quite clever. 

The timing was also extremely good. The popularity of Ethereum combined with most Ethereum scaling solutions still in progress and a roaring bull market resulted in high transaction fees that priced out smaller users and forced them to find a different option if they still wanted to participate in DeFi.

On top of this, Binance was able to leverage its position as one of the top cryptocurrency exchanges and make it easy for its millions of users to easily withdraw BNB and other tokens directly to Binance Smart Chain. 

The main question to ask here is if this is a short term growth caused only by high transaction fees on Ethereum or a longer-term user acquisition? 

At this point, it’s hard to say, but two main things pointing at the former are Ethereum’s layer 2 scaling solutions and the Eth2 scaling roadmap. 

Both of these can dramatically reduce the transaction fees on Ethereum without sacrificing other properties like security and decentralization. 

We can already get a feel for it with Matic (a.k.a. Polygon) and Loopring attracting more and more users and trading volume. This trend should only keep escalating with other layer 2 solutions getting more traction and new ones like Optimism fully launching in a matter of weeks. 

With millions of new users entering the cryptocurrency space, it’s also extremely important to make sure they are aware of the differences between DeFi and CeDeFi and are able to make their own decisions. 

At the end of the day, we have to ask ourselves the question. What’s the main point of using a blockchain if it’s not fully decentralized and permissionless? Auditability? Maybe, but is this really the main value proposition of the whole cryptocurrency space?

It will clearly be interesting to see how DeFi and CeDeFi play out. 

So what do you think about Binance Smart Chain? Does CeDeFi have a future? 

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.