A protocol is a set of rules that governs how a system operates.
The rules establish the basic functioning of the different layers, how they interact with each other, and what conditions are necessary for running the protocol.
The different parts of a Governance Protocol in DeFi are not dependent on order or chronology.
In fact, a Governance Protocol in DeFi does not tell the system how to produce a result.
It does not have any other objective other than to execute the set of rules.
What is the need to have governance protocol in Defi –
Governance Protocol in Defi or decentralized finance has jumped into prominence because of COMP (compound token) whose price and actions and liquidity mining program resulted in the increased public interest.
Governance Protocol in DeFi lend themselves to a more fundamental based analysis.
Governance Protocol in Defi projects usually has a well-defined revenue at a protocol level in the form of trading fees or interest rates.
Below are some real-world Governance Protocol in DeFi.
Some of the real-world projects of decentralized finance :
Stable Coin Project ( Providing a stable digital asset ) –
The original Governance Protocol in Defi, MakerDAO, is an established player and a pioneer of on-chain governance.
Recently, the Maker foundation has just been demoted to being a governance participant.
The programmable Maker stable coin called DAI, which is pegged to the USD (1 DAI = 1 USD), is generated when a user sends Ether as collateral in a Maker smart contract and takes DAI out of it.
In order to ensure price stability, the created DAI must always be secured with at least 150% collateral (Ether).
The changes for the protocol lies in the hands of token investors.
Implementation of a proposal is only possible after ratifying with on-chain votes.
MakerDAO has now become the sole decision-maker for maker’s risk parameters and collateral asset inclusion.
Borrowing/Lending Crypto asset ( Providing the possibility to earn interest on unused assets ) –
The launch of the COMP token by compound kicked off the liquidity mining circus this June and was a prime catalyst for the rise of Governance Protocol in Defi.
Holders of the governance token can propose and vote on changes to the Compound protocol.
A few days after the release of the token, the price soared to an astronomical 427 USD per token2 but later fell to 170 USD in July.
The trading of governance token is about to become an interesting investment opportunity for some tech-savvy traders.
Users can use the compound protocol not only to borrow crypto assets but also to lend them.
Borrowing crypto assets makes them pay interest whereas lending them makes them receive interest.
When borrowing, collateral must always be deposited with a collateralization rate of higher than 100%, similar to the ratio of the Maker protocol.
Every token on Compound has a dynamic interest rate that is determined in real-time according to supply and demand.
The interest is not simply credited once a year or monthly (compared to bank interests), but always at the time of a new Ethereum block, i.e. approximately every 15 seconds.
Loans on Compound have unlimited duration. Similar to Maker, Compound also has a liquidation penalty.
However, it is only 5% compared to Maker’s 13%. Other borrowing and lending platforms include dYdX and Dharma.
Exchange ( Providing the possibility to swap two digital assets ) –
Uniswap is a completely decentralized exchange for ETH and other tokens that are issued on the Ethereum blockchain, for example, Compound’s COMP token.
Uniswap provides two main use cases: users can provide liquidity for others who want to exchange tokens or they can exchange tokens against each other.
If you provide liquidity, you earn a commission fee of all trades being made by traders.
Uniswap does not aim to replace centralized exchanges but to complement them.
Its price correctness is based on arbitrageurs.
Large sums of money will not be traded probably in the next few months on Uniswap and certainly not in currency pairs with low liquidity as it is highly likely that they would have to pay more for their tokens than on other exchanges.
Uniswap will, however, contribute to the efficiency of the pricing of the entire crypto-market as it is another exchange that functions completely decentralized and is, therefore, less vulnerable to manipulation.
Another benefit of Uniswap is that every pair would be able to open a new swap pair i.e a new uni swap exchange.
4. yEarn Finance ( YFI )
This is one of the most promising projects in Defi.
It was launched by Andre Cronje in February 2020.
YFI yields revolve around yvaults but it’s the grassroots governance movement that sparked further involvement.
It is the most equitable token distribution since bitcoin.
There was no pre-mine or token allocation to developers and investors.
Instead, the entire supply was up for grabs during yEarn’s liquidity mining initiative.
Large amounts of capital to spare always dominate token farming events.
YFI was no stranger to this as token concentration with large entities is reasonably high.
For its fair distribution, alignment of governance and financial incentives with a token, and use of a community-owned multi-signature, yEarn Finance is the top Governance Protocol in Defi project based on decentralization.
Decentralized Finance is clearly still in its very early days.
In 2020, the monthly number of Defi users ranged between 40,000 – 60,000, with 90% using decentralized exchanges.
Even compared to central crypto-exchanges with several hundred thousand daily active users each, that figure looks tiny, not to mention applications of our well-known and established traditional financial system.
For now, Governance Protocol in DeFi remains a visionary side-ecosystem in the blockchain space.
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How does decentralized finance work?
Defi is gaining momentum as a sector which refers to an ecosystem of financial applications that are built on top of blockchain networks.
The ecosystem works through peer to peer dapps and users have full control over their assets.
What does decentralized mean?
To distribute the administrative powers or functions of (a central authority) over a less concentrated area: transfer from the centre to local government.
Why do we need decentralization?
Decentralization is needed because to accomplish the local governments’ need for certain security in their existence, sufficient resources, and autonomy.
Also, people can have better knowledge and idea about their problems and would have a better idea about where to spend the money.
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