Contemporary retail traders are working in a sophisticated environment with thousands of different digital assets issued by a large number of projects that all focus on one thing — autonomy. If you want to know how to invest in decentralized finance protocols, it is important to understand that their popularity is, partially, caused by the concept of self-custody where investors do not have to ever give up control over their assets.
it is a relatively novel concept that goes right along with the main argument for the adoption of Bitcoin and similar assets as an alternative to fiat money — creating an economy without central authorities. The 2008 financial crisis made it clear that banks can collapse easily and the government will only try to postpone the painful process of dissolving them completely. Some enthusiasts decided to take matters into their own hands and create a completely new type of money — decentralized and autonomous.
What is a smart contract in Bitcoin?
The initial design of the first cryptocurrency relied on a mechanism called Proof-of-Work allowing nodes (separate participants of the network) to add new information to the immutable ledger by solving complex mathematical problems. After years of trial and error, experts came to a conclusion that PoW is not the best or the fastest approach with PoS networks easily beating PoW in many metrics including throughput and transaction speed.
Nevertheless, the idea of using a completely immutable ledger as a way to conduct financial operations was novel enough to catch up quickly among libertarians and tech geeks. By 2014, many investors have started seeing the value of investing in these unfamiliar digital assets. However, users noticed that BTC is clunky and the concept could be dramatically improved.
One of the first real competitors to Bitcoin is Ethereum. Initially, it was also using the PoW mechanism but shifted course and changed consensus to PoS. One of the biggest value propositions from the founders of Ethereum was the idea of creating a framework that would allow for even more autonomy and the deployment of independent decentralized apps using the architecture and infrastructure of Ethereum as a baseline.
Blockchain smart contracts became a thing with the arrival of EVM and the ERC-20 token standard. Even Bitcoin had to go through some changes. Today, it is possible to utilize BTC in many ways initially not even imagined. For example, using the Stacks toolkit developers can roll out new Dapps that operate as layer 2 solutions for the Bitcoin network. You can stake, wrap, and otherwise interact with BTC.
Despite some new developments in this field, Ethereum remained an undisputed leader. Cardano, Arbitrum, Solana, and many other emerging blockchains tried to follow in the footsteps left behind by Ethereum. Today they comprise a thriving digital ecosystem that allows users to engage in a variety of investment activities.
What are smart contracts in crypto?
These are tiny executables that can be deployed on the blockchain and automatically perform certain actions when conditions for them are met. Since they do not require any initiation on the user’s part, all operations are considered trustless and permissionless. Crypto contracts simply execute their instructions when something that must trigger the execution happens. It is a very stable design that, in theory, significantly improves security.
All decentralized finance applications use them in one form or another. They can be utilized in lending, borrowing, liquidity provision, cross-chain swapping, and many other processes that make the DeFi ecosystem work in the first place.
The world of cryptocurrencies is not the only domain where these small programs can be used effectively. Some companies like Artelogic believe that commodities can be traded even faster and with more reliability using technology to work with real-world resources to create an interconnected supply chain that operates mostly autonomously. Luxoft is offering a wide range of solutions for financial institutions that want to experiment with decentralization.
It is also possible to use them alongside more familiar instruments like automated trading bots or manual arbitrage. Trading with smart contracts can be a fulfilling experience for investors interested in exploring new, uncharted territories and allocating capital in a trustless manner without using intermediaries or worrying about counterparty risks.
Benefits of Smart Contracts in Trading
Using autonomous applications for various purposes is a good way to create an ecosystem that does not require intermediaries and centralized entities. While it is true that these programs are neither smart nor resemble real contracts, they do have actions and conditions that are coded in a way that allows for a decent level of autonomy. This property makes them incredibly useful in finance.
Here are some of the advantages that you will enjoy by using them:
- Security and trust. Blockchains are considered inherently secure and reliable thanks to the immutability of data. The deployment of a new application means that its code and behavior are also set in stone. This rigidness is what makes them perfect candidates for executing financial operations that require the highest level of safety. The inability to tinker with recorded data on ledgers provides an additional layer of trust between market participants. Everything is happening precisely as it is described in the code.
- Lower fees. One of the biggest investment costs for any tradfi investor is the price of entering the market. Retail traders have to pay commissions. Centralized institutions like brokerage service providers and exchanges collect them to make a profit, pay their own bills, and cover corporate overheads. In the DeFi ecosystem, you don’t need middlemen with smart contract applications doing everything without ever requiring human oversight.
- Everything is transparent. The problem with centralization is that you have to rely on the willingness of a corporation to honestly disclose its operations, costs, and transactions between clients. Some institutions do it, and some do not. The idea of decentralization became so popular among fintech enthusiasts precisely because ledgers are open to the public. Anyone can verify a transaction or track its history. The accessibility of recorded data and the democratization achieved through the use of DAOs make investors quite excited about the opportunity to use blockchain-based assets.
- The growing interoperability. Programmable money is something that can exist only if various parts of the ecosystem are compatible on, at the very least, some level. Modern solutions like bridges between networks or lending protocols allowing for the use of all sorts of tokens as collateral indicate the strong shift toward a more interconnected space for all of us to participate in. Mutual integration is the next logical step for many platforms.
- Autonomy and efficiency. Since cryptocurrency contracts execute transactions when certain conditions are met, market participants do not need to use centralized authorities for settlement. Brokers and CEXes may become obsolete if everyone switches to using fully automated transaction systems. We are still decades away from this dream becoming a reality. However, some elements of automation are already in full use in the DeFi sector. For example, Uniswap uses its platform for automated market-making without any central authority overseeing the process.
It is easy to notice the upsides of using these programs for various purposes in the financial domain. Creative developers can easily create instruments capable of autonomous functionality and performing a variety of tasks in a trustless manner. The contemporary approach to building advanced fintech products that can alter the way we are looking at investing is being forged in the decentralized finance ecosystem.
Note that running a TradingView bot is not the same as implementing a tiny piece of autonomous software. These are completely different methods of engaging with the market and each has its own unique flavor. While traditional automation products are used on centralized marketplaces where connections from third parties are enabled through the use of APIs, Dapps are trying to completely remove brokers and CEXes from the game by allowing users to fully control their operations.
The future of the blockchain ecosystem
Intricate interactions between the participants of highly speculative markets can be extremely challenging to manage. Some of the enthusiasts who believe that we can achieve self-regulation within the industry are arguing in favor of focusing on continuous development and experimentation in the sector. Decentralized trading with smart contracts can be the answer financiers are looking for when contemplating the best ways to create an environment where economic growth is possible over much longer spans of time than just a century.
It is clear that the contemporary fiat system governed by central banks and other authorities is on its last breath. The rapid inflation happening all over the world indicates that people are losing faith in fiat as a concept. Yes, fundamental factors are doing what they are supposed to do and many national economies are managing their metrics quite well. However, the share of people who would like to completely get rid of centralized banking in favor of something that they can fully control is growing.
The presence of regulators, massive institutions, unchecked capital holders, and other figures capable of taking over whole economies is a bad sign for the longevity of our economic system. There is also a defined ceiling that limits the potential growth. Using decentralization as a way to democratize and restructure finance and the global economy is one of the most promising paths that the world could take in the foreseeable future.
Here are some things that we believe must happen for the world to keep going in a positive direction:
- Faster and cheaper international remittances. It is hugely important to make it easy for individuals and businesses to effortlessly interact across vast distances and facilitate productive relations within stretching supply chains. We cannot turn off regional specialization and isolate struggling economies hoping that they will sort out their issues without meaningfully engaging with the rest of the world. With the latest trends in deglobalization and onshoring, the role of international remittances becomes critical.
- The ability to operate in a trustless environment. When two absolutely foreign to each other parties can safely conduct business, it opens a whole new range of possibilities for international trade, manufacturing, and regional specialization. One of the reasons supply chains take so long to form is that their participants have to build trust before they can increase operations and scale up. This period of familiarization can take years which is detrimental to the global economy.
- The world without sanctions. Prohibitions and international penalties can be valuable instruments to limit the aggression of certain states or to pressure them to cooperate. However, many of these measures are working against all parties. For example, the pack of sanctions applied to the Russian Federation several years ago negatively affected its ability to produce new gear and finance the war effort. However, it was also a painful punch right in the heart of the EU with its reliance on natural gas primarily sourced from its eastern neighbor. Again, the international legal aspects of smart contracts allow them to be used in a variety of ways to bypass some of the restrictions.
- Moving away from fiat. National central banks are considering the implementation of fiat-pegged digital currencies that will work similarly to Bitcoin or Ethereum. Their designs also implement self-executing trustless mini-applications that can be effortlessly integrated into the currently existing DeFi ecosystem. However, the problem here is that many official authorities will keep their tight grip on the fundamentals of newly implemented systems. It is important to support fully decentralized alternatives that could serve as threats to fiat stability if we want to keep governments in check.
- Increased user activity. The adoption of digital assets and payment mediums is a slow process that has been going, with various levels of success, for roughly two decades. Interestingly enough, over 45% of people surveyed by RIF said that they desperately lack the ability to pay for goods and services directly from their wallets. The industry must improve its security without compromising utility and usability. It must be done rather quickly considering fluctuations in user counts on different protocols. Clever designs in smart contracts for trading and responsible development and QA practices should attract more investors and users.
- Addressing scalability. One of the key areas requiring rapid improvement is scalability since throughput and performance are still quite low. Some architectures are impossible to improve fundamentally. For example, increasing Bitcoin capacities is possible, but it will require such drastic changes that it might take years before they are properly implemented. However, using layer 2 solutions like Lightning Network or rollups on Ethereum is clearly working. Add to the mix sharding and the deployment of new interoperability projects and you will have an ecosystem that can perform excellently.
The blockchain domain as a whole is still maturing with some of the most promising projects being roughly 1 — 5 years old. We still have a long road ahead and some mistakes and errors on the way to the finish line are guaranteed. What we all need is a clear destination which is still absent with many developers trying to figure out the most lucrative field for the next market cycle.
The industry is also lagging in the user experience department with many Dapps offering subpar interfaces riddled with unnecessary functionality or lacking critical QoL features. Simplifying the technology to make it more approachable to newcomers is a good start. Creating comprehensible educational materials that allow novices to familiarize themselves with previously unknown systems is also hugely important.
The main takeaway
Retail traders with first-hand experience in decentralized finance should abstain from using Dapps extensively. The current landscape of the market is diverse enough to offer a variety of intriguing alternatives such as DCA and GRID trading bot systems, staking on PoS networks, and more. If you want to test your luck in yield farming or cross-chain arbitrage, it is important to dedicate time and effort to learning the nuances of the technology that powers these strategies.
For many contemporary investors, it is crucial to understand how to use smart contracts. At the same time, newcomers should not invest everything they have in projects that they do not fully understand. Practice is essential.