To truly understand the huge potential of DeFi, we have to look closely at the different types of cryptocurrencies that make it possible.
Native Tokens: The Lifeblood of Blockchain Platforms #
At the center of every DeFi-enabled blockchain platform is a native token. This is the main currency that keeps the whole system running smoothly.
These tokens power transactions, encourage network participation, and make the complex web of smart contracts work in the DeFi ecosystem.
Take Ethereum (ETH) for example. It’s the second largest cryptocurrency by market value and the undisputed king of DeFi.
ETH isn’t just a way to pay for things. It’s the lifeblood of the Ethereum network itself, powering every transaction and serving as the “gas” that runs the smart contracts.
Without ETH, the entire Ethereum ecosystem would stop working, and the countless decentralized apps that rely on it would fail.
But Ethereum is just the beginning when it comes to native tokens in DeFi. Other major blockchain platforms, like Binance Smart Chain (BSC), Solana, and Polkadot, each have their own native tokens that play a crucial role.
For example, Binance Coin (BNB) is the native token of Binance Smart Chain, a high-speed blockchain that’s become a big player in DeFi. BNB pays transaction fees, lets users participate in governance decisions, and encourages network participation through staking and other incentives.
Solana’s native token, SOL, powers the lightning-fast, low-cost Solana blockchain that’s attracted many DeFi projects. SOL pays transaction fees, helps secure the network, and enables users to participate in governance.
Polkadot takes a slightly different approach with its native token DOT.
Polkadot lets different blockchains connect and work together seamlessly in a decentralized web.
DOT is used for staking, governance, and bonding, which is how new blockchains join the Polkadot network.
But where do these native tokens come from originally? They’re generated and distributed in a few key ways, each designed to distribute tokens fairly and encourage network growth.
One popular method is the Initial Coin Offering (ICO).
In an ICO, some of a platform’s native tokens are sold to early investors to raise funds to support development and growth.
ICOs have helped launch many big DeFi platforms by providing necessary capital.
In an Initial Exchange Offering (IEO), tokens are sold through a crypto exchange instead of directly.
IEOs add credibility, as the exchange vets the project first. This helps avoid scams and bad projects.
There are also airdrops – the crypto version of a free sample.
In an airdrop, native tokens are given out to the community to reward participation or owning other cryptocurrencies.
It’s a great way to generate buzz for a new project.
No matter the method, the goal is to build an engaged community invested in the platform’s success. By aligning user, developer, and investor incentives, native tokens provide stability, security, and growth.
Stablecoins: Bridging the Gap Between Crypto and Fiat #
While native tokens power DeFi, their volatility can limit adoption and turn away cautious investors.
This is where stablecoins come in – the unsung heroes of DeFi.
Stablecoins are cryptocurrencies designed to maintain a steady value tied to an asset like the US dollar.
By providing reliable value, stablecoins bridge crypto and traditional finance.
There are three main types of stablecoins, each with a unique approach to maintaining stability:
1. Fiat-backed stablecoins are tied to bank reserves of fiat currency, usually dollars.
The most well-known is Tether (USDT), which is pegged 1:1 to the US dollar. Buying USDT gets you a digital dollar that’s easily used in DeFi.
The reserves ensure the stability.
2. Crypto-backed stablecoins use reserves of other crypto instead of fiat.
The popular Dai (DAI) is tied to the dollar but backed by a diverse basket of cryptos like Ethereum.
Smart contracts automatically adjust the reserves as needed to maintain the peg.
3. Algorithmic stablecoins use complex algorithms and smart contracts instead of any reserves to maintain stability. Ampleforth (AMPL) is the best known example, expanding and contracting supply based on demand to stabilize prices.
No matter the type, stablecoins are crucial for DeFi adoption by enabling easy on-ramps for users. They provide a smooth transition between traditional finance and DeFi.
But stablecoins also supply vital stability within DeFi itself. In a volatile market, stablecoins offer an anchor for trading, lending, and borrowing.
Consider a farmer who needs a loan for new equipment.
With DeFi, they can use stablecoins as collateral, and the interest rate is determined by market supply and demand rather than set by a bank.
This approach offers greater flexibility and transparency compared to traditional lending.
For traders, stablecoins offer shelter from sudden crashes. By shifting gains into stablecoins, profits can be locked in without exiting DeFi entirely.
Governance Tokens: Empowering DeFi Community Participation #
So far we’ve looked at utility tokens powering DeFi platforms and stablecoins providing stability. But governance tokens are also critical for sustainability.
Governance tokens represent voting power in a DeFi protocol. By holding and staking them, users can actively shape the platform’s future direction.
This stands in stark contrast to traditional finance where a small group of executives and shareholders make the decisions. In DeFi, everyone has a seat at the table and a voice.
Compound’s COMP token is a prime example. COMP allows holders to vote on key decisions for the lending and borrowing platform like interest rate changes or adding new assets.
Uniswap’s UNI token enables holders to vote on issues like treasury allocations and fee structures for the DEX protocol.
But governance tokens do more than just give users a say. They also align incentives between stakeholders to ensure sustainability and growth.
By giving users ownership, governance tokens create responsibility and community.
Users become active participants, not just passive consumers.
This builds collaboration as users work together to improve the platforms.
Governance tokens also keep DeFi decentralized and censorship-resistant. Distributing power prevents any single entity from taking control.
Effectiveness depends on active participation, however.
Users must be engaged in voting for governance tokens to work as intended.
Platforms need to encourage involvement through education, rewards, and other incentives.
Ultimately, governance tokens allow users to guide the future of the platforms they rely on while ensuring those platforms stay transparent, decentralized, and accountable.
