Trust mechanism based on blockchain technology
Decentralized ledger: As the underlying technology of DeFi, blockchain provides a decentralized ledger. All transaction records are stored openly and transparently on the blockchain. Anyone can view them, but they cannot be tampered with. This makes the transaction process more transparent and reduces the possibility of fraud and fraud.
Cryptographic security: Cryptographic techniques such as public key encryption and digital signatures are used to ensure the security of user assets and the immutability of transactions. Users have their own private keys, and only transactions signed by private keys can be recognized by the blockchain network, thus ensuring the user's full control over assets.
Automatic execution of smart contracts
Preset rules: A smart contract is a piece of code deployed on the blockchain that predefines the rules and conditions for a transaction. Once these conditions are met, the contract will be automatically executed without human intervention. For example, in a lending scenario, after a user pledges an asset, the smart contract will automatically issue a loan based on the preset mortgage rate and interest rate.
Reduce trust costs: The automatic execution feature of smart contracts means that both parties to a transaction do not need to rely on a third party to establish trust. As long as the code of the smart contract is correct, the transaction will proceed according to the established rules, thereby reducing trust costs and transaction risks.
Overcollateralization mechanism
Risk control: In DeFi lending scenarios, an over-collateralization mechanism is usually used. Users need to pledge assets with a value higher than the amount borrowed to ensure that there is enough collateral to repay the debt even if the asset price falls. For example, a user may need to pledge $150 worth of ETH to borrow $100 in stablecoins.
Stablecoin issuance: The overcollateralization mechanism is also the basis for the issuance of many decentralized stablecoins. For example, in MakerDAO’s Dai stablecoin, users generate Dai by mortgaging crypto assets such as ETH. As long as the value of the collateral is always higher than the total amount of Dai, Dai can be kept stable at around $1.
Liquidity Pool and Market Maker Mechanism
Liquidity provision: In decentralized exchanges (DEX), liquidity pools are the core of transactions. Liquidity providers deposit assets into liquidity pools to provide liquidity for transactions. When users trade, they obtain or deposit assets from the liquidity pool, and liquidity providers receive a share of the transaction fee based on the transaction volume.
Automatic market making: DEX adopts the automated market maker (AMM) mechanism to automatically price and match transactions through mathematical models such as the constant product formula. Unlike the order book model of traditional exchanges, the AMM model does not require waiting for counterparties, and transactions can be completed immediately as long as there is a liquidity pool.
Decentralized Governance
Community decision-making: DeFi projects usually adopt a decentralized governance approach, where token holders vote to decide on major decisions of the project, such as protocol upgrades, parameter adjustments, fund allocation, etc. This makes project decision-making more democratic and avoids the abuse of power by centralized institutions.
Incentive mechanism: In order to encourage users to participate in governance, DeFi projects will give voters certain token rewards through token incentives. This not only increases user participation, but also enhances community cohesion and project sustainability.
