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Mintable Tokens vs Minable Tokens: What's the Difference?
Mintable and mineable tokens are two types of digital assets that are used in the world of cryptocurrency. The major difference between both types of tokens is that producing minable tokens requires more time, effort, and resources compared to minted tokens. ## Difference Between Mintable Tokens and Minable Tokens
### Mintable Tokens Mintable tokens are digital assets that can be created on a smart contract platform, such as Ethereum, without the need for any consensus-related activities. These tokens are created through the use of a minting function within the smart contract, which generates a new supply of tokens. Mintable tokens can then be distributed and traded in the market. Token minting is the process of creating new tokens on a smart contract platform, such as Ethereum. These tokens, like ERC-20 and ERC-721, do not require the same resources or validation process as traditional mineable tokens like Bitcoin and Ethereum. Mintable tokens can have caps on their total supply, and the supply can be adjusted through the minting or burning of new tokens. It is a technique that is often used with algorithmic and crypto-backed stablecoins to manage their supply and value. ### Mineable tokens Mineable tokens are digital assets that are generated through the mining process on a proof-of-work or proof-of-stake blockchain. On proof -of work-models, Miners have to solve challenging equations while Validators verify the validity of blocks by staking their own tokens. Miners or validators play a crucial role in securing the network and producing blocks, and as a reward for their efforts, they are issued new tokens that have been minted by the protocol. The issuance of mineable tokens follows certain consensus rules, and the supply of these tokens can be capped (hard cap or soft cap) or subject to a decrease over time through processes like halving. For instance, the Bitcoin network has a fixed supply of tokens and a block reward of 6.25 BTC per block, while the Litecoin has a block reward of roughly 12.5 LTC per block. ## What is a Minting Function A minting function is a feature in some cryptocurrencies that allows users to create new tokens and add them to the blockchain. The process of creating new tokens is often referred to as "minting." ### Continuous Token Supply In most cases, minting requires the user to have a certain amount of tokens already in their possession, as well as meet certain other conditions specified in smart contracts. For example, they may need to prove that they have completed a specific task or contributed to the network in some way. The minting function is typically implemented as a smart contract, which is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code. The smart contract can automatically enforce the conditions of the minting process, ensuring that new tokens are only created in accordance with the specified rules. Some examples of cryptocurrencies that have a minting function include Ethereum and Binance Coin. Minting can be used for a variety of purposes, such as incentivizing users to contribute to the network, or as a way to fund the development of a project. ## Mintable Tokens Supply Types:
### Fixed Token Supply A mintable token with a fixed supply is one in which the total number of tokens that will ever be produced is set and cannot be increased. This means that once all the tokens have been mined or created, no more will be added to the supply. This type of token is often used as a way to increase the value of the tokens over time, as the fixed supply model can lead to demand exceeding the limited supply available. The fixed supply model can also be seen as a way to combat inflation, as there is no possibility of new tokens being created and diluting the value of existing ones. Examples of cryptocurrencies with a fixed supply include Bitcoin and Litecoin. In the case of Bitcoin, the total supply is capped at 21 million proof of work tokens, while Litecoin has a maximum supply of 84 million tokens. ### Continuous Token Supply This is a type of mintable token where new tokens can be created and added to the supply on an ongoing basis. This means the total number of tokens in circulation is not fixed and has a continuous supply. A Continuous supply model is often used to fund project development or incentivize network contribution. However, they can also be prone to inflation, as the creation of new tokens can dilute the value of existing ones. Examples of cryptocurrencies with a continuous supply model include Ethereum and Binance Coin. In the case of Ethereum, new tokens are created through the minting function, which is implemented as a smart contract. In the case of Binance Coin, new tokens are created through a process called "coin burning," in which a portion of the supply is permanently removed from circulation. ## Examples of Mintable Tokens
### Stablecoins Stablecoins are a type of mintable token that is designed to maintain a stable value relative to a specific asset or currency. They are often pegged to the value of a stable asset, such as the US dollar, and are designed to maintain a 1:1 value ratio with the underlying asset. Stablecoins are often used as a way to provide a stable store of value within the volatile cryptocurrency market. They can also be used for cross-border payments, as they allow users to transfer value without being subject to the fluctuations of traditional cryptocurrencies. Examples of stablecoins include Tether, USDC, and Paxos Standard. These stablecoins are backed by real-world assets, such as cash like the US dollar, or gold, and are intended to provide a more stable alternative to traditional cryptocurrencies. ### NFTs NFTs (Non-Fungible Tokens) are a type of mintable token that represents a unique digital asset. They are often used to represent things like art, music, videos, or other types of media. NFTs are stored on a blockchain and are unique because they cannot be replaced or exchanged for another asset of equal value. One of the key features of NFTs is that they can be bought, sold, and traded just like any other asset. They have gained popularity in recent years as a way for artists and creators to monetize their digital content and for collectors to own and trade unique digital assets. NFTs are minted using smart contracts, which define the terms and conditions of the asset and ensure that it is properly registered and tracked on the blockchain. Some popular examples of NFTs include Cryptokitties and BAYCs. ## The Bottom Line In summary, minable tokens are those that are generated through a process called "mining," which involves using computer power to solve complex mathematical problems and add transactions to a blockchain's public ledger. On the other hand, mintable tokens are created and issued by a central authority through smart contracts, such as a company or organization, and do not require mining to enter circulation. There lies the difference between mintable and mineable tokens. Both minable and mintable tokens have their own unique characteristics and uses, and the decision to use one over the other will depend on the underlying business model, specific needs and goals of a project.
What is Etherscan and How To Use It?
Most cryptocurrencies such as Ethereum have an open, transparent database. Anyone can see the digital ledger of transactions as everything that happens on-chan is published. That said, querying data from blockchain technology is an uphill battle. Therefore, you can use block explorer to simplify your search instead of looking at the raw data that is nearly impossible to decipher. Etherscan is one such effective block explorer that abstracts the complexity of retrieving data on the blockchain by providing a simple interface for Ethereum blockchain. Before having a closer look at Etherscan, let’s understand block explorers first. ## Block Explorers Although the blockchain contains all information about your transactions, it is very time-consuming to go through the entire blockchain to know what’s going on there. Thanks to block explorers, you can browse and search this open database to know the transaction details and the amount of crypto owned by a specific wallet. Moreover, some block explorers display the sender and receiver address as well as the amount of “Gas” paid for a particular transaction. Let’s learn about Etherscan; how it works, how it simplifies the blockchain data, and how to use it in a blockchain strategy. ## What is Etherscan? Etherscan serves as a blockchain explorer that allows users to look through the transactions, smart contracts, wallet addresses, blocks, and other on-chain data related to Ethereum-based trades and assets. You can access many features without opening your account or connecting to your wallet. Like other cryptocurrencies, all Ethereum interactions are publicly recorded on Blockchain. Etherscan is a block explorer software to visualize past transactions on the Ethereum network that spans from transferring coins to purchasing non-fungible tokens (NFTs). ## Why Do You need Etherscan? Etherscan allows users to search and explore the Ethereum blockchain for transactions, tokens, addresses, and other activities. Ether, an Ethereum token, is the world’s second-largest cryptocurrency for market capitalization. Etherscan provides Token Tracker for this widely used token by providing information, such as price, holders, total supply, and transfers. There are numerous use cases of Etherscan that make it a powerful block explorer. It allows you to monitor high-profile NFT holders’ portfolios. Moreover, you can track what a certain NFT project or company is doing with its funds. For instance, Gamestop dumped $42 million worth of NFX tokens, shortly after it received a $100 million grant from Immutable X. The proof of this incident was provided by Etherscan. By tracking the transaction of NFT projects' potential rug pulls and NFT scams, Etherscan helps the victims of crypto scams. Along the same line, Etherscan tracks the “whales” wallet which holds a large amount of ETH. Monitoring their movement is quite helpful as you can predict the price movement with this information. Anyone can use Etherscan to search for and validate Ethereum transactions. The use cases may involve: - Searching and viewing wallets and transactions - Tracking gas fees - Interacting with smart contracts - Revoking or reviewing your token approvals - Using Token ignore list feature to hide your tokens - Staying up-to-date with the Ethereum ecosystem Note that Etherscan is not a wallet; you can use Etherscan to search your Ethereum wallet and track the transactions but if you want to enter into a transaction or use ETH, you have to access your crypto exchange or wallet.
The Ethereum Shanghai Upgrade Explained
The successful completion of the Ethereum Merge brings forth the Shanghai Upgrade, also known as EIP 4895. The upgrade will introduce reduced transaction fees, and the transition to a proof of stake model, and it will also enable withdrawals for staked ETH. The upgrade acts predominantly as a precursor to the improvements to scalability that the Ethereum Foundation has proposed in the upcoming year. ## What is Ethereum Shanghai Upgrade? The Shanghai Upgrade transition is the network's next upgrade of the Ethereum mainnet. It primarily aims to transition to proof of stake, consequently allowing validators to finally withdraw their staked ETH both partially and fully. This is a major improvement and will further incentivize the crypto community to shift towards ETH accelerating network participation. As of yet, the pre Shanghai testnet allows for both complete and partial validations to be withdrawn. The upgrade also introduces Layer 2 fee reductions with the implementation of proto-danksharding aiding in the network's overall scalability and sustainability while also reducing gas fees. Moreover, the upgrade will also introduce EOF, separating code and data, which is significantly helpful for code validation. The release date of the Shanghai Upgrade is expected to be around March and April. However, there's no confirmation and developers agreed that this date may be pushed forward to as late as September 2023, especially with EIP-4844 (proto-danksharding) already being delayed to a March 2023 update. ## Ethereum Improvement Proposals to Look Forward To The Shanghai Upgrade consists of a number of EIPs (Ethereum Improvement Proposals). While most of them can be considered as minor upgradations, there are three EIPs that are the most interesting out of the bunch: ### EVM Object Format The Ethereum Virtual Machine object format, commonly referred to as EVM object format or EOF, will essentially upgrade the network to separate code from data. Highlighted in EIP-3540, this is extremely advantageous for on-chain code validation. This distinction can also lead to ease of use and a significant reduction in gas fees. While off-chain tools already deal with existing code, static analysis tools can also benefit from the separation. However, the advantages to the latter are relatively minor. Moreover, EIP-3670 is also expected to be included in the Shanghai Upgrade, extending the deploy time validation of the separated code section. This allows for unassigned instructions and truncated PUSH requests to be rejected. ## Beacon Chain Withdrawals Stakers who locked their Ether in the network's Beacon chain smart contract were eligible for rewards. Now, EIP 4895 will finally enable beacon chain push withdrawals as operations for all staked ETH. Moreover, the update will also allow Beacon Chain holders to finally withdraw their rewards, adding an operation that will push all validator withdrawals from the Beacon Chain to the wider Ethereum Virtual Machine (EVM). ## Layer 2 Fee Reductions With rising competition from Solana, it was only a matter of time before the Ethereum Foundation took major steps to combat ever-increasing block sizes. With Layer 2 fee reductions, a maximum limit to CALLDATA in a block is introduced with further proto-danksharding implementations in EIP-4844 which should drastically reduce gas fees on the Ethereum network. ## Will Ethereum Fees Decrease After The Upgrade? Yes, Ethereum fees will decrease after the Shanghai upgrade. This is because the upgrade will equalize block size and also increase overall call-data efficiency in the Ethereum network. Galen Moore, content lead at Axelar had this to say about the reduced gas fees after the Shanghai upgrade: “When specialized chains can build on a layer-2 like Polygon and reduce the cost of communicating with the base chain Ethereum, that reduces gas prices for users everywhere in the ecosystem — by making it more efficient to scale horizontally in a way that spreads demand.” - Galen Moore The lower transaction fees is great for the overall longevity of the network. the Ethereum Shanghai update is also expected to introduce a WARM coinbase which will slightly lower fees paid by prominent builders like Flashbots and BloXroute. ## Conclusion While there's no concrete release date for the upgrade in sight, it's quite clear that the crypto community has provided an overall positive response to the public test net. With staking rewards now soon being able to be withdrawn, its clear that Ethereum will be undergoing a paradigm shift in the upcoming years with the Merge and the Shanghai Update turning into the first two EIPs that will dictate the future of Ethereum and Ether. ## FAQ (Frequently Asked Questions)
### What is the Ethereum Shanghai upgrade? The Ethereum Shanghai upgrade is Ethereum's second major upgrade after the Merge which offers critical infrastructure and elemental updates to the blockchain's EVM. This will include reduced gas prices, staked ETH for early client testing of the PoS beacon chain to finally be allowed, and updates to smart contract facilities as well. ### What changes are in the Ethereum Shanghai upgrade? Amongst many other minor changes in the network, Ethereum developers have focused on three key aspects, the EVM object format, allowing staked beacon chain withdrawals and te ability to process more data concurrently on the network lowering gas prices substantially. ### Will Ethereum price increase with the Ethereum Shanghai Upgrade? Yes, akin to most other crypto network updates, the major upgrade should lead to an overall price increase of Ethereum. However, the extent of this increase is yet to be determined. This is because events such as the Merge, which typically lead to an increase have instead led to a gradual drop instead with a price reclaim not in sight as of yet. ### What is the release date of the Ethereum Shanghai Upgrade? According to core developers of Ethereum, the Shanghai Upgrade is expected to roll out in mid-2023, somewhere around March and April. As of yet, there's no finite date for the upgrade with the latest date being September 2023 for the complete rollout.
What Is a Smart Contract Security Audit?
While blockchain technology is secure, vulnerabilities may be found in the blockchain application. For instance, the smart contracts that are built inside these applications may have errors in them. The code is the law in smart contracts. Hence, there is no room for even minor errors. Once the code is deployed, developers can’t fix it back. Therefore, it is imperative to have a system that timely identifies the vulnerabilities and critical bugs that may be present in the underlying smart contracts. A smart contract audit is a process where blockchain security engineers pay attention to the code line of a crypto or blockchain project to identify security issues and inefficient coding. ## What are smart contracts? Smart contracts are digital contracts that use blockchain technology to enforce the terms of an agreement. The execution of an agreement is automated in smart contracts, and the participants are certain of the outcomes. The program ensures that the predetermined conditions are met and verified during cryptocurrency transactions. Businesses from various sectors benefit from smart contracts' applications, including supply chain, healthcare, and international trade. ## History of smart contracts Smart contract technology was introduced in 2014 as a part of the Ethereum specifications. So when it comes to smart contracts in financial transactions, Ethereum is the key to the game. The smart contracts reside at a specific address on a blockchain and are composed of code (functions) and data (state). This is one of the reasons why so many dApps are meant to run on Ethereum and Ethereum-compatible blockchains. ## Working of smart contracts Smart contracts quickly resolve disputes among the vendors, thus helping them build strong relationships. Besides being able to self-execute and reduce time and resource costs, smart contracts have the advantage of being integrated into the Blockchain. Smart contracts started out as simple IF/THEN statements. The developer who coined the term “smart contract” wanted to describe a smart contract as the blockchain version of a vending machine: IF the right coins are deposited, THEN it dispenses a snack. In a sense, the vending machine is intelligent, i.e., it can perform its task automatically and independently. On Ethereum, a smart contract could specify that IF an amount is received in the user's wallet, THEN 10% is transferred to a second wallet set aside for long-term savings. Like other information on the blockchain, smart contracts are immutable, i.e., cannot be altered after being distributed, and irreversible, i.e., cannot be deleted. Most developers make the source code of their smart contracts available for inspection so users can be sure that the entire contracts don't divert some or all of their funds to the developer's wallet. ## Use of smart contracts in cryptocurrencies While smart contracts can be used for various purposes, they have found wide popularity and application in the context of blockchain-based cryptocurrencies. Bitcoin and Ethereum, for example, are two cryptocurrencies that use smart contracts to enforce the terms of their transactions. When someone sends Bitcoin to another person, a smart contract is used to verify that the transaction is valid and executes it accordingly. This allows the developers to offer a number of benefits, including safety, efficiency, and cost reduction. When talking about smart contracts, actual contracts are not referred to, as one might mistakenly think. These are IF/THEN functions that are found within computer or software protocols, which, when certain conditions occur, give a very precise answer. ## The technology behind smart contracts These "contracts" are called smart, i.e., intelligent, because they are based on blockchain technology. In practice, they work exactly like a standard contract. For example, if a rule set forth in the contract is broken, the system automatically applies a penalty. These contracts are smart because, in theory, they allow people to carry out many activities without resorting to intermediaries such as lawyers or notaries. To have a true smart contract, the execution of consequences under certain conditions should be automatic. The software takes care of everything in smart contracts without human intervention. Since smart contracts work within the blockchain, most of the ones used today are related to cryptocurrencies and the financial market. However, these could probably be extended to other areas with the refinement of the discipline. ## Why should one choose a smart contract over a standard contract? The smart contract provides a high degree of safety in the blockchain. In addition to eliminating intermediaries, the internal encryption system further adds security. This makes the contracts indecipherable to those not involved in the deed. A second benefit concerns the economic side. Paying a notary or a lawyer is more expensive than creating a contract independently through one of the platforms that allow it, such as Ethereum. To draw up a normal contract, you must entrust yourself to a lawyer or a notary, while you can manage a smart contract with total autonomy. When the contract is loaded, the software automatically generates the response. To write a smart contract, you need to know the programming language and the basics of smart contract deployment. This allows all information to be recorded and made immutable, secure, and accessible. Some of the benefits of smart contracts and blockchain include transparency, traceability, integrity, elimination of bureaucracy, and elimination of authority figures. ## What is a smart contract audit? The smart contract auditing process involves a methodical examination and detailed analysis of the smart contract code to identify any incorrect coding or any security issues that may be present. This ensures the reliability of the blockchain applications and provides ways to resolve problems. Usually, smart contract security audits involve running tests through analysis tools and manual code analysis. With the boom in DeFi, more and more financial applications are now being built with blockchain technology. The investors and users of these applications expect them to be non-custodial, open, transparent, composable, and above all, secure. A smart contract audit is a way to ensure that all the contracts are fully performance-optimized and there are no vulnerabilities or security issues. ## Why do we need smart contract auditing? Since blockchain applications have to manage large sums of money, security is one of the most pressing problems for deploying smart contracts. Considering the damages that might occur due to errors in blockchain applications, a security audit must be considered an integral part of smart contract development. For example, a theft of around $60 million in Ether (ETH) occurred during The DAO breach on the Ethereum blockchain. Also, smart contracts are irreversible in nature. If a vulnerability is identified after deploying smart contracts, you could risk losing the entire project and the related assets. Through smart contract security audits, you can get your application checked by veteran security auditors who will double-check your code to find the bugs and errors. ## Possible security vulnerabilities in smart contracts Considering that smart contracts are made up of code, there’s always a chance of error or negligence while designing the security architecture. Here are a few possible security vulnerabilities that may be found in smart contracts: ### Function visibility errors Solidity is a high-level programming language for implementing smart contracts. The default visibility property in this language is set to public. If the developer forgets to define a private function’s visibility, there is a big chance that anyone can destroy the contract by calling the Destruct function. ### Timestamp dependency The contract’s logic is dependent on the current time. This means that the miner can manipulate the execution results by simply changing the current time in the device. ### Random number vulnerability The attackers can use random number generation (RNG) to accurately guess the random number generated by a smart contract that employs a publicly known variable as a seed. ## Failure to differentiate humans and contracts The smart contract may fail to identify whether the smart contract caller is a person or a contract. For instance, hackers can exploit the FoMo3D game by accurately predicting a contract's timestamp (using the airdrop function). ### Spelling mistakes Constructors are commonly used to initialize the contracts and determine their owners. In Solidity, the function to set the state variables is invoked when the contract is constructed. At times during programming, the compiler would not notice the misspelling of the function hence resulting in anyone from the public being able to call the function in public constructors. ### Reentrancy attacks A reentrancy attack occurs when a function makes an external call to another untrusted contract. This can occur due to the developer’s uncaring attitude and negligence. As a result of this attack, the untrustworthy agreement can make a recursive call back to the original function in an attempt to drain the funds. ### Gas Griefing Attack If your Ethereum smart contract cannot check the required gas to execute a sub-call, you can be vulnerable to the gas-griefing attack. ## Types of smart contract audits The types of smart contract audits may vary depending on the nature of the projects. Below, we will discuss both manual and automated smart contract auditing techniques. This can cause the attacker to bypass the payments and fool the smart contract. ### Automated smart contract auditing Automated smart contract auditing ensures a much faster response time by removing human auditors from the process. The program used in this audit is designed to identify the parameters that run the program, thus making it easier to spot common coding errors. This type of audit is as effective as the automated analysis tool used. ### Manual smart contract auditing While the automatic flaw detection software effectively identifies the common errors in the code, it disregards the underlying motives of the developers for having the audit conducted. Manual inspection is a crucial prerequisite for enhanced discovery of security flaws in the smart contract code. This audit is carried out as a unique project under the supervision of qualified smart contract auditors. In such an audit, the engineers inspect the code, carefully assess the application's specifications and ensure that the project performs as per the anticipated functions. ## Key benefits of auditing your project’s smart contract Auditing your project’s smart contract is of utmost importance to improve its security, usability, and trustworthiness. ### Fixing potentially costly security vulnerabilities Coding flaws, if not identified timely, can result in significant losses. For instance, hackers managed to steal 120,000 wETH or $326 million from an escrow system called Wormhole due to a vulnerability in the signature verification protocol. Therefore, conducting a smart contract audit is more of an investment than a cost. ### Receiving actionable suggestions from industry leaders and experts Once the audit is completed, the audit providers carefully critique the code. Based on the identified concerns, the audit team provides the project team with suggestions and recommendations to make the necessary modifications. ### Giving your community extra peace of mind Having your project audited by industry experts and tweaked for enhanced security gives your community extra peace of mind. There is increased trustworthiness, and they use the applications more confidently. ## What are the steps of a smart contract audit? Most of the smart contracts are built using the Solidity programming language. Before the smart contract audit starts, the code errors and difficulty of exploitation are classified according to their severity. While many smart contract audits follow a standard procedure, there might be differences based on the project's nature and the auditor's style. Following are the steps that are involved in the security audit process: ### Defining the audit’s scope In this step, access to the Ethereum smart contracts is given to the audit team to conduct a preliminary examination and define an audit scope. The auditor collects the necessary data to audit your blockchain application and starts working on an executive summary. This mainly includes going through the smart contract security specifications, including the project’s architecture, development methodology, and design decisions. The code specifications are gathered, and the architecture is examined. Also, the auditors try to determine the audit's scope and understand the project's goals. ### Conducting unit testing The auditors use specialized tools to test each smart contract function. The entire contract’s code may be included in the unit tests. Unit testing concentrates on specific functions and examines the whole code using integration tests. ### Running a manual audit In this stage, the auditors don’t rely on using the software. Instead, they use their professional experience and expertise to identify potential smart contract vulnerabilities. It might involve simulated cyberattacks like penetration testing. This helps the auditors in detecting front-running attacks efficiently. ### Running an automated audit Automated auditing is the analytical phase of the audit and involves using bug-detection software. This stage includes the smart contract’s overall code. Considering that the code cannot be changed once it’s deployed, the auditors look out for the “code freeze” now. There is no room for any inconsistencies and flaws at his particular time, and no modifications will be made after the final draft stage. Automated auditing is much faster as compared to manual audits. ### First audit report with suggestions After the auditors are done with auditing smart contracts, they document the discovered code flaws and provide feedback to the project team so that they can resolve the errors. Some smart contract audit companies may help fix each vulnerability found. ### Final audit report with post-fixing evaluation In the final report, the auditor will provide detailed findings and recommendations based on their analysis. This audit report is a valuable resource for anyone involved in developing the blockchain application. It lists potential security concerns and a roadmap for fixing weak smart contracts. ## How long does it take to audit a smart contract? The time it takes for a successful security audit depends on the project's complexity, unit test cases, and size. It also depends on the type of audit process that is being conducted. While an automatic audit can take up to one day for ERC20 and BEP20 contracts, the manual audit may take much longer. The audit process can take anywhere from two to 14 days for a normal-sized project. However, it could take up to a month for complex projects. ### How much does a smart contract audit cost? The smart contract audit cost depends on the application's complexity and size. Depending on the nature of the project, the cost of each step of the smart contract audit varies. These steps include a collection of code design, unit testing, auditing approach, initial draft, final audit report, and audit assessment. The smart contract audit companies decide this cost. Usually, the total cost is between $5000 to $15,000. In exceptional cases, the cost may be even higher. Once the audit is complete, the auditing firm will provide you with an audit report detailing the faults in the code and proposals to improve the application's overall security. ## Conclusion A smart contract audit for your blockchain project can help you avoid costly errors and receive a detailed vulnerability report and mitigation guidance from security engineers. This can help you in improving the functionality of your smart contracts and application. It should be a necessary part of the project before the launch of the blockchain applications.
What is DeFi 2.0?
DeFi, or Decentralized Finance, is a powerful blockchain-powered innovation that disintermediates traditional financial services. DeFi protocols are constantly evolving, and the existing models of agreements in the financial services domain are undergoing continuous improvements. This has led to the creation of DeFi 2.0, which is an umbrella term for the new generation of decentralized finance platforms and functions. DeFi 2.0 protocols are made keeping in view the existing flaws and limitations in DeFi models, which are mostly associated with liquidity, scalability, and security. The DeFi ecosystem was created by the pioneers of DeFi protocols such as Compound, Uniswap, and MakerDAO. These platforms introduced decentralized stablecoin and laid the foundation for the thriving DeFi ecosystem. The DeFi 2.0 ecosystem promotes an open-source development culture and transparency by eliminating the need for a central administrator.
## What is DeFi 2.0? One of the distinguishing financial elements of Web 3.0 is the concept of Decentralized Finance (DeFi). By DeFi solutions, we mean the programs and functions that work in a financial system that is no longer based on the centrality of its traditional intermediaries, such as banks, etc. Rather, it is organized and built on new technologies capable of disintermediating the exchange of information and finances between multiple subjects. Underlying DeFi is blockchain technology, on which new paradigms are being studied and developed with the aim of revolutionizing traditional finance and the global economy. ### DeFi 2.0 protocols DeFi 2.0 protocols are built based on the concepts like yield farming and lending which are the prior DeFi breakthroughs. The DeFi pioneers were able to access dependable exchanges through these DeFi protocols. DeFi 2.0 provides better protection from financial losses and unlocks greater value from stakes funds. Also, DeFi 2.0 offers greater scalability by leveraging a variety of blockchains. ### DeFi 2.0 Products A product's ability to be available free of charge without any intervention from governments, internet infrastructure providers, or even the program developers is an excellent litmus test for determining whether a product is decentralized or not. Another critical component in DeFi 2.0 products is the automated self-executing programs called smart contracts. Their main purpose is the fast and transparent execution of financial agreements on the blockchain. Using smart contracts managed on a distributed ledger makes it possible for the software to continue to be accessible to anyone. All users need are resources and knowledge to engage in a smart contract. ## Application of Blockchain Technology in the Financial Services Industry Blockchain, the technology behind the digital currency Bitcoin, has been a source of inspiration for most DeFi solutions and projects. Public blockchains allow anyone to access the history of transactions, which means that it is not controlled by one centralized source. This is important because centralized systems and human gatekeepers can limit the speed and complexity of transactions while also providing users with less direct control over their money. By extending the use of blockchain beyond simple money transfers and to more complex uses in the financial sector, DeFi projects are revolutionizing how the client’s data is managed and how the transactions are handled. For instance, the blockchain technology used in DeFi can be used to put the client’s information on the blockchain so that various financial companies can access it for their know-your-customer (KYC) processes. This will save resources for both the client and the financial institutions since they would not have to go through the KYC process for every new financial account. ## DeFi 1.0 vs DeFi 2.0: What’s the difference? In DeFi 1.0, the structure of the model is quite complex, which makes it difficult for new members to use the products of decentralized nature. Hostile user interface and scalability challenges impacted how early DeFi protocols worked as the Ethereum blockchain powered most solutions. DeFi 2.0 has resolved this problem by enhancing the user experience (UX), thus allowing everyone with a computer or smartphone to navigate the applications easily. Furthermore, DeFi 2.0 protects users from the risk of temporary losses, such as impermanent losses caused because of the volatility of a trading pair. Eventually, the second generation of DeFi also mitigates the risks associated with lending processes and eliminates the interest payable on loans. The huge gas fees and long hours of waiting to transact in the DeFi 1.0 space further add to the already-mentioned problems. DeFi 2.0 has reduced the costs involved in executing transactions by lowering gas fees and improving the transaction processing speed. Furthermore, DeFi 2.0 promises a reliable supply of liquidity through the introduction of liquidity pools (LPs) which provide incentives to the liquidity providers. DeFi 2.0 aims to give more decision-making authority and ecological governance to the community members as compared to DeFi 1.0. ## The problems of DeFi 1.0 Difficulty in attracting liquidity, high volatility, and lack of regulation are some of the problems associated with DeFi 1.0. Furthermore, the more massive a platform becomes, the most vulnerable it gets to security challenges. ### Liquidity DeFi 1.0 relies heavily on liquidity mining funded by the users. In DeFi 1.0, there is always a risk of impermanent loss for the investors due to the general uncertainty and volatility of the token price. Furthermore, capital allocation is inefficient, resulting in long-term consequences in yield farming. Therefore, it becomes extremely difficult to retain long-term investors in the project, thus increasing the chance for financial risks. There needs to be a long-term reward mechanism to attract liquidity in a sustained matter, like providing the investors with liquidity provider tokens. In this way, people will actually take an interest in the project and not focus on the collection of tokens only. This is also not a long-term solution considering that people remove their capital as soon as they find a better project. Security A hacker getting unauthorized access to the DeFi applications can result in a major loss of funds. Unlike traditional finance, DeFi 1.0 lacks any consumer safeguards. DeFi can be heavily used in money laundering and fraud because it is unregulated. Since most users don’t understand these risks, sending security updates on smart contracts is the only option left to safeguard people from cyber criminals. ### Scalability Another problem with DeFi 1.0 is scalability. This issue is found on its most extensive Layer 1 network, Ethereum. High gas fees and long waiting times due to the excessive traffic contribute further to this problem because it strains the user experience. ### Oracles One of the problems with DeFi 1.0 is the delay in transactions and network congestion due to the massive traffic of the DeFi protocol on the Blockchain. This is where the oracles have to play their part. Oracles are middleware entities that link smart contracts to resources outside of their native blockchains. Apart from prioritizing the transactions and catering to the needs of smart contract developers, oracles can also function as autonomous auditors. Without secure oracle networks, DeFi 1.0 protocols are unable to use any off-chain data. The DeFi 1.0 “oracle problem” refers to the conflict between authenticity, security, and trustworthiness in third-party oracles. ### Centralization Many DeFi 1.0 projects don’t follow the principles set by the Decentralized Autonomous Organizations (DAOs). These principles follow the bottom-up management approach of decision-making to ensure decentralization. To ensure higher scalability and security, the DeFi 1.0 project must compromise with decentralization. This creates a dilemma and leads to a loss of faith among the DeFi users considering that the decentralization aspect is not prioritized. ## Innovation in DeFi 2.0 Decentralized finance has been providing services for the cryptocurrency ecosystem for many years. However, its boom began in 2021, thanks to various lending platforms and decentralized exchanges that managed to unify this system to make it grow despite the problems. Therefore, despite having used a system with an imminent need for improvements, everything indicates that its growth will continue to be exponential for the second generation. ### Yield farming Yield farming is a practice of bootstrapping liquidity for new DeFi protocols. It allows yield farm LP tokens to be used as collateral for loans. This eliminates the usual slippage in pricing and is a good way to attract liquidity.
In these second-generation projects, popularity can be generated from the improvements implemented within DeFi, such as the liquidity mining system. By gaining investors' confidence, they can request loans with lower collateral and may be audited to ensure the safety of the funds. And for those concerned about volatility, it will mostly be arranged to add long-term liquidity through the use of a stablecoin. A long-term issue with yield farming is that it is very difficult to retain users. As soon as they find a better option, they will move their entire capital to other protocols. ### Decentralized autonomous organizations Decentralized Autonomous Organizations (DAOs) play a great role in improving the DeFi models. They present a fresh perspective on the legitimacy of governance. It enforces the decentralized aspect of DeFi 2.0 by allowing anybody to vote on the project's evolution. ### Layer 1 & Layer 2 blockchains A growing number of DeFi protocols are available on the Layer 1 and Layer 2 blockchains. Innovations are being made in Layer 1 & Layer 2 blockchains by making advancements in cross-chain bridging and blockchain scaling. The protocols are easily deployed on Ethereum Layer-2 solutions like Arbitrum, Optimism, and Starknet and Layer-1 networks like Avalanche, Solana, and Gnosis Chain, etc. Layer 2 blockchains offer increased privacy as opposed to Layer 1. ## The goal of DeFi 2.0 The goal of DeFi 2.0 is to turn people away from the traditional financial system by democratizing finance and making DeFi products as user-friendly as possible. DeFi 2.0 removes the intermediaries and third parties from the financial services. Another goal of DeFi 2.0 is to remove any shortcomings that were present in DeFi 1.0. These shortcomings include elements of centralization, confusing interfaces, unattractive liquidity, and capital inefficiency. DeFi 2.0 provides enhanced user experience, greater scalability, better protection, improved capital efficiency, and excellent value from staked funds. ## Investing in DeFi 2.0 Investment opportunities offered by DeFi 2.0 come with a much broader scope. DeFi 2.0 simplifies the processes on the front end and adds a layer of complexity to the use cases for DeFi. Before choosing a DeFi project, it is imperative to ensure that it complies with your financial expectations and goals. While investing in DeFi can generate handsome profits, it is also risky and requires utmost vigilance. Seeking professional advice before investing in such a venture is the way to go. ### Yield farming DeFi 2.0 provides additional incentives through yield farming by allowing yield farm LP tokens to be used as collateral for loans. This type of investment involves using DeFi to maximize the returns that are usually calculated in APY. For instance, in “farming.” the investors might shift from one loan platform to another for better returns. ### Staking tokens Users can generate passive income for themselves by staking tokens earned through locking up crypto holdings. They can earn block rewards by becoming a validator on a blockchain network that uses proof-of-stake as its consensus mechanism. ### DEX Trading DEX stands for Decentralized exchanges. It involves crypto transactions without involving any third-party organizations. This type of trading is much cheaper as compared to traditional centralized exchanges. Although DEX Trading is decentralized in nature, it occurs in highly regulated environments because of the local laws of different states and countries. DEX trading also supports margin trading, which involves trading a financial asset using borrowed funds from a broker. ### Liquidity mining This type of DeFi 2.0 investment is also known as liquidity provision. In this investment, crypto enthusiasts earn rewards for lending their assets to liquidity pools in decentralized exchanges. These rewards are based on the share of lenders in the liquidity pool. The amount is derived from the trading fees which the traders pay who are swapping the tokens. ### Lending tokens In this type of DeFi 2.0 investment, DeFi loans are offered in exchange for interest payments. Lending tokens can offer peace of mind to both the borrowers and lenders considering the DeFi 2.0 self-repaying loans. Moreover, lending platforms can also help in improving capital efficiency. ## Conclusion In this article, we have attempted to cover all the aspects pertinent to what DeFi 2.0 is. In a nutshell, we have concluded that it offers a much better user interface and scalability than DeFi 1.0. Also, it offers good liquidity options for crypto exchanges and provides much easier ways to manage smart contracts.
What is Token Burning?
With so many new tokens emerging, one would expect the cryptocurrency community to contain many tokens with little to no value, but with the help of token burning, that’s not the case. Burning tokens is a not-so-new concept that has become popular in the crypto community, and new users are interested in it. But the method in which a project partakes in token burns can be a little complex, and you should ensure you fully understand what a token burn means for you. Reading this article will help you learn about the token burning process, how token burning can be executed, and what token burns might result in depending on how they are executed. ## What is Token Vurning? Token burning is the process by which a crypto coin project burns a certain amount of its crypto coin digital assets. The process involves transferring some amount of Cryptocurrency (specifically Token Coins) into a burn wallet address (also known as burner wallet) with no private key. Some may believe that sending tokens to a wallet address is all it takes to participate in coin burning. But coin burns are more complex than a transfer. Many projects have made several methods, terms, conditions, and incentives available for users burning cryptocurrency at a small portion. But one thing is sure; coin projects often burn large portions of their coins. Coin burning means once coins have been sent to a burn address, they become permanently excluded from the overall circulating supply of coins in the crypto coins market and, therefore, forever inaccessible for exchange or other transactions. Coin burning is similar to a company buying a large number of its shares, but it's different because coins burnt can not be resold, unlike shares. ## How Does Token Burning Work? Burning crypto is a process that can and has been executed by many individuals and developers in the coin market for several years. Some token developers like Binance have been partaking in a periodic burning of their tokens and have executed this in quarterly burns since 2020. Binance has burned around half of its total coin supply since it began partaking in cryptocurrency-burning procedures. Over 860 BNB is burned daily on the Binance platform, and a portion of the BNB burned coins are gas fees spent through the Binance BSc platform. Binance has destroyed around 2,065,152 BNB coins to partake in burns. Private keys are the only secure way of accessing coins stored in a wallet address. Therefore no one can access a wallet address with no private key. A cryptocurrency project can burn tokens by transferring them to a frozen private address; anyone can do the same with their own tokens. Various projects may differ in their methods of allowing users to partake in token burning, but the idea remains the same. By burning cryptocurrency, a project can reduce the total supply of its tokens in circulation and gradually increase its value over time. A frozen private address is a burn address with no private keys for granting access to coins. Once tokens are sent to a frozen private wallet, those tokens are automatically burnt from the overall circulation tokens in the coin market and therefore become inaccessible to any user. Another example of a method created for burning cryptocurrency is the burn portal created by Shiba Inu for burning Shib tokens and rewarding anyone who uses it. ## Why Do Crypto Projects Burn Tokens? Cryptocurrency projects burn their tokens for several reasons. However, the main aim behind such an activity is to add value to tokens still in circulation by having more personal control of the overall supply of tokens demanded. Markets function through demand and supply, and crypto projects use burning to reduce supply, increase demand and potentially add value to their crypto. Below are some reasons why projects burn crypto: ### Burning tokens Increase Value Demand and supply are economic factors that can influence the value of commodities, and those commodities can also be tokens. Cryptocurrency projects believe that the total available supply of token coins in circulation can alter the value of new coins added to the circulation supply. Such projects partake in cryptocurrency burning at large amounts that help increase the value of their tokens. Reducing the supply of token coins in the crypto market is a great way to generate value when implementing the laws of demand and supply. The value of the token coin will continue to increase as users keep requesting them even when they are few in the circulating supply. Token burning makes coins scarce. A cryptocurrency project can use scarcity to create an urgency for their community members to buy more coins, increasing value and demand over time. ### Proof of Burn Proof of Burn (also known as PoB) is a consensus mechanism that validates and adds transactions to any blockchain that implements it. With PoB, coins get burned without energy waste by consuming a few resources to mine the coins you burn, and it also grants you the ability to write blocks equivalent to burnt ones. The PoB also helps to prevent fraud by verifying the transactions of new blocks added to a blockchain network. ### Promote Mining Balance The periodic burn of sizable digital asset coins has provided a more balanced mining ecosystem by reducing the advantage early investors had over more recent investors. Now the blockchain network can benefit investors equally and provide value everyone can access. ## Pros of Token Burning
### Supporting the token value The change in the value of tokens can be significantly affected by a reduced supply of that token in circulation. This result is one that many projects achieve as they burn large amounts of their coins in circulation. ### Coin burning strengthens the Community The process of coin burning is a journey that can help a cryptocurrency community feel more involved. It builds trust in the road map and the system designed for its token community. ## Cons of Token Burning
### Permanent loss of token supply Burnt tokens are permanently excluded from the overall circulating tokens on the blockchain network, making them impossible to recover. Although the scarcity of a token may add value, that value comes from the continuous burning of large amounts of that token. Such activity leads to a constant loss of coins over time. Large amounts needed to impact the token price For burns to impact price significantly, large amounts of that token are required to be burned. Although token burning may be effective, it is expensive and can easily lead to a token project’s demise. ## Token burning risks
### Hidden whales Some companies seek a considerable gain from the devaluation of a token. These companies wait for moments when a token experiences a dip, and they buy a considerable amount of that token, only to sell it all after a little pump. Companies that partake in this are called hidden whales, and they can lead to a token burn backfiring against a token project. ### Rug pulls Some projects may pretend to strengthen their network by transferring vast amounts of their tokens to a wallet. Although these projects claim to send their community token to a burn wallet address, they send it to a wallet address where they can retrieve it. Some projects crash their tokens by doing this, which can be tragic for community members. ## Conclusion By burning, projects are providing a stable token value that can benefit investors greatly, and as we all continue to partake in token burns, the blockchain network strengthens. But the burning process can differ across several platforms, and before partaking in it, it would be best if you fully understood what it means.
What Is The Blockchain Trilemma?
The world of trading and business has seen a massive shift toward the blockchain from online banking. People prefer blockchain transactions and cryptocurrency over other forms of currency because they offer numerous benefits, such as security, anonymity, decentralization, transparency, and scalability. However, with multiple advantages, some concerns regarding blockchain networks also emerge. One of the most critical problems in the blockchain world that must be solved as soon as possible is the blockchain trilemma in addressing decentralization, security, and scalability. Only then can this industry gain true mainstream adoption. Let us have a look at this major concern known as the Blockchain Trilemma. ## What Is the Blockchain Trilemma? Blockchain technology has three major aspects: security, decentralization, and scalability. The concept of blockchain trilemma revolves around the "opportunity cost" when working with blockchain technology. It is observed when building blockchains, creators are limited to achieving only two of three benefits of the blockchain network. The concept was first introduced by Vitalik Buterin, one of the co-founders of the Ethereum network. Vitalik Buterin also proposed that Ethereum 2.0 will be the solution to this trade-off. ## What Is Decentralization? Decentralization refers to the dispersion of supervision and decision-making power from a central governing body to individual entities. Every new transaction that takes place requires verification before creating its block and adding it to the chain. The decentralized system makes sure that control over the blockchain is distributed across each individual, not in the hands of a specific group or individual. The decentralized system removes any factor of misjudgment or bias. If any validator is found accomplice in foul play, punishment proportionate to the act is directed. The authenticity of a new block is verified through a number of scattered nodes before adding the block to the chain. Hacking or altering a block is next to impossible in blockchains. All blocks need to be tempered to change something in a single block. ## What Is Scalability? The ability of a blockchain network to manage a high number of transactions by increasing the number of nodes on the platform is known as scalability. Transparency and security are the two major benefits of blockchain scalability. In many real-world scenarios, it is very hard to establish public blockchains due to the barriers to scalability. To understand the concept of scalability, let’s look at the example of bitcoin. Satoshi Nakamoto, the creator of bitcoin, set the initial size limit of bitcoin to 32 megabytes. However, others suggested that it was a waste of memory and resources because the number of bitcoin users is very low. Additionally, it is very prone to DDOS attacks. Hence Nakamkoto reset the block size to 1 megabyte to ensure stability and security in the BTC network. Up until 2013, the number of BTC transactors and the volume of transactions was very low, and due to that, there was no network congestion. However, after the dramatic rise in the popularity of cryptocurrency, the number of users has increased dramatically. This has led to many problems, such as raised transaction fees and network congestion. Scaling of the bitcoin blockchain has been the most sought-after solution. It increases the capacity to manage huge transactions. It is done by updating the code underlying the network. ## What Is Blockchain Security? Security in blockchain basically refers to integrating a complete risk management system. Trust in transactions is ensured through the core principles of a blockchain security framework, which are consensus, cryptography, and decentralization. New transactions are connected to the previous ones in a cryptographic chain, and validation of all transactions is done in a decentralized manner by a consensus mechanism. Security protocols in a blockchain can differ according to the type of blockchain. There are three main blockchains: 1. Public blockchains A blockchain with no center of control and an architectural central point-of-failure is called a public blockchain. The decentralization of a blockchain through crypto economics ensures cooperation in the public blockchain network. Usually, it uses POS and POW consensus mechanisms. 2. Private blockchains In a private blockchain, a starter/central administrator must verify and validate a user on grounds of the rules as stated by the network administrator. Businesses use private blockchains for authentication, record-keeping, and access. POA approach is commonly used for private blockchains. 3. Consortium blockchains The consortium blockchain is an amalgamation of private and public blockchains. Participants that are approved by a central entity constitute a consortium. Consensus is achieved via POS, POW, and POA. There are three factors that are used to develop a fully dynamic system. - Fraud prevention best practices. - Cybersecurity frameworks. - Assurance services. ### Solving the Blockchain Trilemma It is believed that the blockchain trilemma is a permanent problem with no solution, and developers must opt for two of three benefits to create a blockchain. However, a multitude of recent innovations across the decentralized ecosystem has introduced some solutions that have the ability to overcome these hurdles. These solutions include advanced concepts like random delegation, side chains, sharding, and Layer-1 and Layer-2. Cryptocurrency project Algorand claims that their network equally uses all three advantages by adopting the concept of randomness and solves the Blockchain trilemma. Other blockchain developers are working non-stop to try and mitigate this issue. Let us see what other potential solutions are under development. ## Layer 1 Blockchains Layer-1 (Implementation layer) is responsible for maintaining blockchain security and comprises coding rules, language, and consensus mechanisms. This layer only handles two functions: - Process of block creation. - Addition of the created block to the main blockchain. ### Consensus Protocol Improvements A consensus mechanism is used to maintain security and validate the transactions of a blockchain. Proof of History (POH), Proof of Stake (POS), Proof of Authority (POA), and Proof of Work (POW) are typically used as consensus mechanisms. Adopting a good consensus mechanism is necessary to solve the blockchain trilemma. Here are the two widely used mechanisms with recent consensus protocol improvements. ### Proof of Work (PoW) New transactions are continuously happening in the blockchain, and it is equally important for the developers to verify each one of these transactions. One central entity responsible for the verification of the integrity of a transaction is absent on decentralized platforms. To compensate for the absence of a central authority, the accuracy of a new transaction is verified using the Proof of Work technique in a decentralized network. POW networks are very energy exhaustive, meaning that the consumption of energy will only increase as more and more miners enter the network. Bitcoin and other blockchains use the POW to securely process peer-to-peer transactions without the involvement of a third party. ### Proof of Stake (PoS) The lucrative task of verifying a new transaction and creating a new block for each transaction, respectively, is delegated to a validator using the POS system. The validators stake their crypto assets in a set amount on the network and are required to validate incoming transactions on the blockchain and add new blocks. As a reward for their honest services, they are given additional crypto. On the other hand, if a validator is found trying to cheat the system or validate malicious or bad data, the network imposes penalties on them according to the severity of their actions. The POS solution consumes less power making it an environment-friendly technique as compared to POW. Additionally, due to its low power requirements, proof-of-stake is accessible to a larger audience. The costs of expensive computing systems and electricity are cut off with POS. ### Sharding Sharding is a popular scaling solution for Layer-1, the concept is taken from the distributed databases. The theme behind this method is basically "divide and conquer." The main blockchain is split into several parts, and the shards are assigned separately to individual validators. The reason for doing so is to avoid putting an excessive burden on a single central entity. Sharding poses certain risks as well because there is a theoretical possibility of all validators going down. Resulting in the loss of an entire piece of the blockchain. This issue is tackled in many ways, such as horizontal splitting of the blockchain as done by the Ethereum network. ## Layer 2 Blockchains To scale Layer-1, it is necessary to first move the processes to Layer-2, which is built on top of Layer-1. Layer-2 authenticates the transactions in Layer-1 and caters to network congestion issues. Congestion issues come into play when the user increases the network's processing power by adding more nodes. Continuous communication between the two Layers is the key to managing the main blockchain. ### Nested blockchains Another popular technique to solve the blockchain trilemma is to use nested blockchains. The parent chain defines the parameters and rules of the nested blockchain operation. However, the execution of the transaction is performed solely by the nested chain. Nested blockchains are secondary chains anchored to the main blockchain. Ethereum Plasma is the biggest example of the use of nested blockchains, this chain can arbitrate disputes by offering proof of fraud. ### Sidechains A transactional chain for large batch transactions that connects with the main blockchain through a two-way peg is known as a sidechain. The scalability and speed of the chain are regulated by a separate consensus protocol in a sidechain. The main chain manages blockchain security, and disputes in the sidechain. Sidechain transactions are recorded on a public ledger, making them visible between participants. Setting up a sidechain requires extensive infrastructure and work. On the plus side, if a security breach is observed in a sidechain, the parent chain remains unharmed. An example of the implementation of sidechains can be seen in the Bitcoin blockchain, enhancing the performance of the blockchain and reducing transaction times. ### State channels A State channel allows the transacting parties to create new channels instead of using the main blockchain. Smart contracts run the state channels, making direct P2P transactions possible. Transaction privacy is ensured in a state channel. The instant a channel is closed, the information within the channel is censored, and the main blockchain only receives the starting and ending information. Simply, a state channel enables private, off-the-chain transitions that enhance the network's security and transaction speeds. Some renowned examples of state channels are the Raiden network by Ethereum, Celer, Liquid network, and Bitcoin Lightning Network. ## Is Blockchain Trilemma Solved? There is no one-stop shop that can solve the blockchain trilemma completely. Achieving the Holy Grail is an impossible feat for developers, as of now. Optimizing a blockchain as much as possible is the best that one can do thus far. It is possible that faster network speeds and infinite virtual computing will be observed in the near future. Solving the blockchain trilemma could be very easy in such an environment. Although one cannot deny the significant strides that are made in this industry to tackle the related issues. However, at the same time, the road ahead is very hard and long, and the blockchain world is still in its amateur stage. As of now, it is safe to say that there are no projects that claim to have completely solved the trilemma of blockchain. ## Conclusion The blockchain trilemma is currently a major problem for most developers. Knowing the nature of the trilemma problem, its consequences, and its causes can help find a suitable solution. Developers are working day and night on the complexities of this trilemma and are very optimistic that it will be solved in the foreseeable future. Right now, blockchains can handle huge piles of data without any problem. However, problems in the merits of POS and POW in decentralization and security are still challenging for developers. In the near future, blockchain developers believe that the trilemma will stop being a problem for blockchain creators as the transaction speeds and security protocols will be unmatched.
What Is An Automated Market Maker (AMM)?
Automated market makers were among the first decentralized finance applications and are still among the most well-known DeFi products today. In 2018, Uniswap became the first decentralized platform to effectively use an automated market maker (AMM) system when it launched. Before then, traders could only make use of order books, which pair traders based on their bids and offers to facilitate trading on conventional centralized exchanges. This required the exchange operator to keep a price-organized list of all active buy and sell orders for each asset. Each trading pair handled by the exchange had a corresponding order book (a pair of assets that can be traded for one another). It was an effective and popular strategy except that it required that you rely on and follow the directives of a central authority. However, the need for more decentralized methods of exchange drove companies to the drawing table and that was the founding of Automated Market Makers. ## What is an Automated Market Maker (AMM)? Simply put, an Automated Market Makers (AMMs) is a decentralized exchange (DEX) protocol that uses formulas to determine the price of assets. Where centralized exchanges like Binance value assets using an order book, Automated Market Makers use a pricing algorithm. Platforms that use AMMs automated cryptocurrency trading and make it fully decentralized through the use of smart contracts and deft tokenomics. Users essentially trade against the liquidity locked within smart contracts, not the counterparties, as is traditionally the case. Liquidity pools are a common name for these smart contracts. It should be noted that in conventional exchanges, the position of a liquidity provider is only open to Businesses or the affluent. However, with AMMs, any entity that satisfies the conditions programmed into the smart contract is eligible to become a liquidity provider. Uniswap, Balancer, SushiSwap, and PancakeSwap are a few examples of AMMs. ## How do Automated Market Makers work? An AMM's primary goal is to guarantee that users can always trade cryptocurrency, even in the absence of counterparties with matching offers. Because of this, AMMs do not rely on order books to set up trading pairs. Instead, they use smart contracts to manage unique crypto asset pools created especially to supply the liquidity required to support frictionless trading. For example, when trades take place on a decentralized exchange like Kraken, it is directly between user wallets. In other words, if you sell BTC for ETH or SOL, there is a buyer of ETH using BTC on the other side of the exchange. This transaction can be described as peer-to-peer (P2P). AMMs, on the other hand, might be thought of as peer-to-contract (P2C). Since trades take place between users and contracts, counterparties in the conventional sense are not required. There is nothing like order types on an AMM because it doesn’t use order books. Instead, a formula determines the price you will receive for an asset you want to buy or sell. Though it's important to note that some potential AMM designs in the future might overcome this restriction. Furthermore, what are called trading pairs on centralized exchanges exist on DEXes as Individual "liquidity pools". For instance, you would need to locate a BTC/ETH liquidity pool if you wanted to exchange Bitcoin for Ether. AMMs employ predetermined mathematical calculations to ensure that the ratio of assets in liquidity pools is as balanced as possible and to get rid of inconsistencies in the pricing of pooled assets. For instance, top DeFi exchange protocol, Uniswap, and many other DeFi systems establish the mathematical relationship between the specific assets maintained in the liquidity pools using the straightforward x*y=k equation. Here, x signifies the value of Asset A, y stands for Asset B, and k remains a constant. In essence, the liquidity pools of Uniswap always maintain a condition in which the result of multiplying the prices of Assets A and B is always the same. This guarantees that consumers can always get a quoted price for their chosen deal as long as there is enough liquidity in the pool. This leads to the next question: ## What is a Liquidity Pool? From the above definitions, it is clear that Automated Market Makers rely heavily on Liquidity pools to facilitate trade. Let us now examine what liquidity is and the process through which these DeFi Protocols maintain their liquidity. A liquidity pool is a reserve where individuals or businesses can deposit crypto assets which will then be used to enable future transactions. Similar to how FX traders buy and sell currency pairs, liquidity pools normally accept two cryptocurrency pairs. For instance, a trader can use an AMM to sell Bitcoin (BTC) and buy Ether (ETH) from a BTC/ETH liquidity pool, and vice versa. Some liquidity pools and AMMs simultaneously manage multiple cryptocurrencies depending on the AMM and decentralized exchange. ## What is a Liquidity Provider? As mentioned earlier, centralized exchanges usually only accommodate dedicated market makers, companies, and extremely rich individuals. However, Automated Market Makers have made it possible for literally anyone to deposit assets in their liquidity pools. These individuals or business entities are called liquidity providers. With AMMs, anyone who satisfies the necessary criteria can act as a liquidity provider. Although the specifications differ amongst liquidity pools, most smart contracts demand that you deposit a specific amount of tokens which is usually a substantial amount, typically in the form of cryptos like Ether, Bitcoin, or Binance Coin. In turn for providing this liquidity, providers get network fees from all trading activity taking place within their liquidity pool. It's one of several ways bitcoin owners can use their holdings to generate passive income. ## Impermanent loss Notwithstanding although, passive income is always attractive to investors, there are dangers connected to contributing to liquidity pools, one of which is Impermanent loss. This occurs when the same tokens have different values within and outside of a liquidity pool. Since the price-adjusting algorithms of liquidity pools only care about maintaining a balance between the values of the assets within a pool, when the price ratio changes, the pools adjust to fit. Withdrawing your assets from a liquidity pool when this adjustment is unfavorable can result in a loss. Of course, the loss only occurs if you remove the assets from the pool which is why it is called impermanent. However, Keeping your assets locked in a liquidity pool for fear of impermanent loss also prevents you from taking advantage of other profitable chances. Hence stablecoin or wrapped token pairs, as well as other token pairs with similar values, operate well with AMMs as opposed to those with larger ratio gaps. Impermanent loss is usually insignificant if the price ratio between token pairs remains within a modest range. Just be sure you understand the concept of impermanent loss in relation to your preferred AMM before locking your funds into their liquidity pools. ## Concentrated Liquidity Concentrated liquidity is one of the newest developments in AMM development. In fact, it is one of the hallmarks of the most recent version of Uniswap, v3. This particular feature is intended to increase the effectiveness of the price-adjusting process, reduce slippage, and enable liquidity providers to charge larger fees. With concentrated liquidity, Liquidity Providers can allocate assets to particular price points. Liquidity Providers can design unique price curves that suit their preferences by combining various concentrated liquidity positions. Additionally, this enables them to get trading commissions based on the liquidity offered at particular price ranges rather than the liquidity of the entire pool. ## Constant Product Formula The Constant product formula is a mathematical formula introduced by Ethereum founder Vitalik Buterin which is as follows: tokenA_balance(p) * tokenB_balance(p) = k Uniswap later adapted it to the more popular x * y = k formula In practice it works like this; token price in a liquidity pool is determined by the constant, "k," which denotes a constant asset balance. In an ETH/BTC Liquidity pool, the price of ETH increases every time it is purchased since there is less ETH in the pool than there was before the purchase while the corresponding BTC in the pool decreases in price. In contrast, when more ETH is added to the pool, the price of BTC increases. This allows the pool to maintain a steady balance where the combined value of ETH and BTC in the pool is always equal. In the end, whatever the level of price volatility, there will eventually be a return to a condition of equilibrium that reflects a fairly accurate market price. The strategy encourages traders to profit from price discrepancies between the AMM and other crypto exchanges until it is balanced again if the AMM price strays too far from market pricing on other exchanges. ## Automated Market Maker Variations 50/50 token pair pools: This is the type of AMM operated by Uniswap. This ground-breaking technology enables users to construct a liquidity pool using any pair of ERC-20 tokens in a 50/50 ratio. It is, so far, the most reliable and oldest AMM model on Ethereum. Multiple assets liquidity pools: Instead of having just a trading pair in one liquidity pool, some Protocols find a way to stretch it. For example the Automated Market Maker, Balancer goes one step further than Uniswap. By enabling customers to build dynamic liquidity pools of up to eight different assets in any ratio, Balancer pushes the boundaries of Uniswap and increases the adaptability of AMMs. Similar Assets Liquidity pools: Another AMM model is the type operated by Curve where digital assets of a similar class such as stablecoins get locked in the same liquidity pool. This enables it to provide effective trades, and offer some of the cheapest deals and rates in the market while addressing the liquidity issue. ## Popular DeFi Platforms Using AMM
### Uniswap
What Are Liquidity Pools? DeFi Liquidity Explained
The cryptocurrency market is a very active community that initiates thousands of transactions to be verified daily, but verifying transactions can be pretty slow. Crypto liquidity pools provide a faster means of turning digital assets into cash, and this option can be helpful for people who make frequent transactions. This article will inform you about liquidity pools, how they work, and several other things you should know about them. ## What is a liquidity pool? A liquidity pool is a smart contract containing large portions of cryptocurrency, digital assets, tokens, or virtual coins locked up and ready to provide essential liquidity for networks that facilitate decentralized trading. A decentralized exchange relies greatly on liquidity because of the regular rate at which transactions are made on their network; for this reason, decentralized exchanges need to be connected to liquidity pools that can help maintain a steady functional network that doesn’t delay transactions made by traders. In crypto liquidity pools, digital assets are locked and ready for exchange. Liquidity pools serve as a digital asset reserve that can provide liquidity to help speed up transactions for decentralized finance (also known as DeFi) markets such as decentralized exchanges (also known as DEX). Unlike traditional finance, which pairs buyers and sellers to complete a transaction, liquidity pools do not need to connect users to complete a trade. Instead, they function automatically through automated market makers (amms) that connect you to the smart contract with your requested digital assets locked up in them. Automated market makers are algorithmic protocols that determine digital asset prices and automate asset trades on liquidity pools. A liquidity pool gathers its assets through users called liquidity providers (also known as LPs), who contribute to a percentage of the crypto asset in a typical liquidity pool smart contract. ## How do liquidity pools work? Liquidity pools use automated market makers (AMMs) that connect users aiming to trade pairs with the appropriate smart contracts for them. AMMs are the protocols used to determine the price of digital assets, and it does a great job of providing the most reasonably accurate market price on liquidity pools. Before liquidity pools can achieve their principal function of providing enough liquidity for crypto markets worldwide, they will require the tokens of liquidity providers. To become a liquidity provider, you can adapt the steps below to any liquidity pool platform of your choosing: 1. Credit your crypto wallet with the crypto tokens you aim to lock up in a liquidity pool and connect it to the liquidity pool platform of your choosing or sign up on a liquidity pool platform and credit the liquidity pool wallet of your account on that platform’s wallet. 2. Find the trading pairs you’d like to invest in and deposit an equally divided portion of your crypto investment into that trading pair; for example, to invest $1000 into an ETH and USDT trading pair, you would need to deposit $500 each in both ETH and USDT on that liquidity pool. Once you’ve made your deposit, select the period you want to have it locked up in the pool. After the period of lockup has elapsed, you, as a liquidity provider, will be rewarded with liquidity pool tokens according to your selected trading pair and liquidity pool platform. However, during the lockup period, you will also acquire an earning portion of the transaction fees paid to make exchanges with the pool you committed your crypto. Some crypto liquidity pools also provide the option of staking liquidity pool tokens in exchange for earning the platform's native token. ## Why are liquidity pools important? Liquidity pools play a significant role in providing liquidity in illiquid markets and boosting the DeFi ecosystem. The low liquidity that peer-to-peer exchanges offer can slow down the speed of transactions in financial markets. Still, with the help of liquidity pools where tokens are locked up in smart contracts, people can make transactions quickly. The price of assets on crypto liquidity pools is also very fair. They can only be influenced by the current market exchange rate, which offers relatively accurate prices for the assets they supply to liquidity pool intelligent contracts. Unlike traditional exchanges, where buyers and sellers can influence the bidding price of their transactions with other traders, liquidity pools provide a more consistent environment where prices can be more accurate. ## Pros of liquidity pools
### Faster transactions With sufficient liquidity being provided through liquidity pools, you can make faster transactions and turn your tokens into cash within a shorter period. Liquidity pools provide a faster means of making transactions than P2P exchanges, which require traders to release assets, verify trades and spend some time making transfers needed to complete the exchanges. Liquidity pools already have reserves of the crypto pair you wish to exchange, allowing for faster, trustworthy exchange. ### Secured exchange with reduced possibility of scam The process through which users of liquidity pools acquire their crypto pairs is secure compared to that of a P2P transaction. P2P transactions require two users to trust each other to complete their end of the contract. Still, with liquidity pools, automated market makers (amms) automatically connect users with contracts containing their trading pairs. Amms also releases the crypto already locked up in smart contracts. With such a system, people making transactions on a crypto network can quickly receive their assets without the possibility of the other trader refusing to release them. ### Fair price on exchanges Prices offered for exchanges on liquidity pools are not influenced by bias or greed, which P2P exchanges can be affected by because traders determine the trading price of their exchanges. Amms provides the market price for making exchanges on liquidity pools, and the prices amms provide are based on authentic information that users can trust. ## Cons of liquidity pools
### Scam Liquidity Pools The smart contract code of a liquidity pool may be accessible to developers. Developers with such access can breach the smart contract by obtaining all your assets locked in the liquidity pool without your permission. For this reason, users of liquidity pools are advised to do extensive research on the integrity of the liquidity pools they connect to their wallets and read the terms and conditions of the smart contract they join. ### Risky price change Since Automated Market Makers (AMMs) determine prices on liquidity pools, assets locked up in their smart contracts are subject to constant change. Amms constantly update the prices of trading pairs on the list of trading assets they offer on pools. ### Impermanent Loss The change in prices offered by liquidity pools can lead to a significant loss or gain of assets stored in the pool. The crypto market is volatile, and a tremendous price change can lead to losing assets locked up in a pool. Volatile changes can easily affect small asset portions, and lost assets may be unrecoverable for investors who only lock up a small asset portion to a liquidity pool. ## Trending liquidity providers
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