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Chapter 2

What are the building blocks of DeFi?

DeFi is a new form of global finance accessible to all and controlled by no single entity. The key building blocks of DeFi are:
  1. Blockchain Networks provide the computation platform for the execution of smart contracts.
  2. Crypto Tokens perform varied functions such as acting as a store of value, paying for computation on blockchain networks, and providing governance rights. 
  3. DeFi Protocols provide financial services without any centralized intermediary in an autonomous manner through smart contracts.

Blockchain Networks

Blockchain is an immutable and distributed ledger of transactions. It is called a blockchain because it is made of a growing list of records or blocks. Each block contains a set of transactions linked to the previous block through a cryptographic hash.
A cryptographic hash function (CHF) is a mathematical algorithm that maps data of arbitrary size (often called the "message") to a bit array of a fixed size (the "hash value," "hash," or "message digest"). It is a one-way function, that is, a function for which it is practically infeasible to invert or reverse the computation - Wikipedia.
The peer-to-peer network that maintains the blockchain and provides a platform for the execution of smart contracts is called a Blockchain Network.
Bitcoin was the first blockchain network launched in 2009 by a pseudonymous person or group of persons called Satoshi Nakamoto. It was built to introduce a decentralized currency - Bitcoin, which could be transferred without any centralized intermediary.
Both the blockchain network & the digital money on the Bitcoin network is called Bitcoin
Vitalik Buterin published the whitepaper of Ethereum in 2013, defining a general-purpose blockchain network that would enable the development of other decentralized applications in addition to a digital money.
Decentralized Finance is a collective of decentralized applications that focuses on financial services.
The Ethereum blockchain network is called Ethereum, while the digital money on the network is called Ether (ETH).
Today, hundreds if not thousands of blockchain networks exist.

Crypto Tokens

Tokens are digital assets created on blockchain networks. Native Blockchain tokens such as Ether and Bitcoin were the first family of tokens created. They primarily represent a currency and a payment medium for using computational resources on a blockchain network.
In 2015, a technical standard on Ethereum called the ERC-20 was launched. It introduced the construct of a fungible token created on the Ethereum Blockchain Network. Later ERC-721 introduced the Non-Fungible Tokens construct on Ethereum. Another popular standard, ERC-1155 mixes characteristics of both ERC-20 and ERC-721. Other blockchain networks have adopted similar standards. 
A technical standard is an established norm or requirement for a repeatable technical task that is applied to the repeated use of rules, conditions, guidelines, or characteristics for products or related processes and production methods. - Wikipedia


DeFi protocols are programs built on blockchain networks offering financial services such as lending & borrowing, trading, investing, etc., in a decentralized fashion. 
MAKER is one of the oldest DeFi Protocols founded in 2014 and launched in 2017. It allows users to mint a stablecoin by using crypto tokens such as Ether as collateral.
A Stablecoin is a crypto token that maintains its peg with a fiat currency such as US Dollar.
Protocols come in different types, from lending protocols that enable lending and borrowing of crypto tokens to decentralized exchanges that allow users to swap different crypto tokens.

Other Key Infrastructure Pieces

While Blockchain Networks, Crypto Tokens, and Protocols are the key components of Decentralized Finance, other infrastructure pieces play a crucial role in this ecosystem's existence and smooth functioning.
Crypto Wallets act as the gateway for users to interact with everything happening on Blockchain Networks, including DeFi. Oracles act as bridges bringing in data from outside of the blockchain network and passing on data from blockchain networks to the external world. Centralized Financial Institutions such as Circle issue fiat-backed stablecoins that provide a crypto equivalent of a fiat currency in DeFi.