A decentralized application, often referred to as a “DApp,” is a type of software application that runs on a decentralized network, typically a blockchain, rather than being hosted on a centralized server. Think of it as a new way of creating apps, where no single entity controls the data or the backend operations.
How is a DApp Different from a Regular App?
To understand a DApp, let’s first look at how a regular app works. Most of the apps you use every day—like social media, banking or gaming—are centralized. This means they are controlled by a specific company that owns the servers where all the data is stored. If these servers go down, or if the company decides to change how the app works (or even shut it down), users have little to no control over what happens.
A DApp, on the other hand, is built on blockchain technology, which is a network of computers (nodes) that work together to ensure that data is stored across many locations, making it decentralized. Instead of a single company controlling everything, DApps’ operations and data are distributed across this network. This new approach has the potential to give users more control, transparency and security than ever before.
DApps are crucial in the web3 world because they embody the principles of decentralization, transparency and user empowerment. Unlike traditional apps, DApps can:
Be censorship-resistant: No single authority can block or censor a DApp, making it more resilient to external pressures.
Provide greater security: Since data is distributed across a blockchain, it’s easier to fortify the application against attacks that could compromise the system.
Ensure transparency: All transactions and operations are recorded on the blockchain, where they are publicly viewable and able to be verified by anyone.
Centralized vs. Decentralized Applications: Key Differences
Let’s break down the differences between centralized and decentralized apps to make this clearer:
Feature
Centralized App
Decentralized App (DApp)
Control
Controlled by a single entity (e.g., a company)
No single point of control; governed by code or community
Data Storage
Data stored on centralized servers owned by the company
Data stored across a decentralized network of nodes
Security
Vulnerable to hacks if the central server is compromised
More secure as data is spread across the blockchain
Censorship
Can be censored or altered by the controlling entity
Resistant to censorship; governed by smart contracts
Transparency
Operations and data are typically hidden from public view
Fully transparent; all operations are on the blockchain
Downtime
Can experience downtime if servers fail
Minimal downtime as it relies on a distributed network
Examples of DApps
Uniswap: A decentralized exchange that allows users to trade cryptocurrencies without relying on a central authority or paying fees to intermediaries.
Aave: A decentralized finance (DeFi) platform where users can lend and borrow cryptocurrencies without needing a bank or financial institution.
Rep.run: A decentralized social media platform built on GalaChain, designed to restore data ownership and control to users.
GalaChain was first built by a centralized company (Gala Games) in order to power its growing ecosystem of web3 entertainment through the core brands of Gala Games, Gala Music and Gala Film. But in a unique approach to web3 ecosystem building, GalaChain’s long-term plan was always to move its network toward full decentralization as it continued to grow.
GalaChain is a primary blockchain (layer 1) built to host not only its own platforms, but an entire universe of decentralized applications that can exist within unique channels (layer 2) that are part of the chain. Each of these channels and all their DApps are powered by GalaChain, but also contribute to the network’s increased scalability, supporting the tokenomics of $GALA and enhancing consumer use of the blockchain.
Imagine a long train that travels at astounding speeds, never stopping. Each train car is independently managed by its creator, containing whatever cargo (data) is required for its goals. No matter how many cars are added to the train, it continues carrying all cargo with ease. In fact, as more cars are added, the train can even gain stability and speed. The train is called GalaChain and the train cars are its channels.
2024 marks the year that GalaChain shifted from a proprietary blockchain for an entertainment company to an open blockchain upon which new developers can build as they please. With easy-to-access tools and creator resources, GalaChain is a perfect place for traditional tech innovators to “get their feet wet” with web3 tech.
Decentralized applications represent a significant shift in how we think about software, offering new possibilities for user control, transparency and security. As the web3 world continues to grow, DApps are set to play a crucial role in this decentralized digital future.
DeFi, short for Decentralized Finance, refers to a financial system that operates on blockchain technology, enabling peer-to-peer transactions without intermediaries like banks or traditional financial institutions. In simple terms, it is a new, decentralized way to conduct financial transactions using smart contracts, cryptocurrencies, and blockchain networks instead of relying on centralized control.
Think of it this way: if traditional finance (TradFi) is like a bank where you need a middleman to approve, process, and validate your transactions, DeFi is like a vending machine that automatically handles everything when certain conditions are met, without needing human approval or oversight. DeFi allows for borrowing, lending, trading, saving, and investing — but it removes the need for trusted third parties.
DeFi is an evolution of financial technology (FinTech), which traditionally aimed to make finance more accessible and efficient using digital platforms. While FinTech largely innovates within the bounds of existing regulatory frameworks and institutions, DeFi steps outside of these centralized models entirely, using blockchain to create an alternative financial ecosystem.
The FinTech boom in the early 2000s brought about digital wallets, online banking, and mobile payment systems, making financial transactions easier and more accessible. However, these still relied on banks, payment processors, and regulators. DeFi took this a step further by completely removing the need for these intermediaries. With the rise of cryptocurrencies like Bitcoin and Ethereum, DeFi was born, offering decentralized applications (dApps) that mimic and improve upon traditional financial services.
Why is DeFi Important in the Web3 World?
DeFi plays a central role in the Web3 movement by democratizing finance. It gives users more control over their assets and offers access to financial services to anyone with an internet connection, regardless of their geographic location or social status.
In Web3, where decentralization and user sovereignty are core principles, DeFi aligns perfectly with these goals. Instead of having centralized institutions control money and finance, DeFi allows users to interact directly with financial markets and services through decentralized networks. This aligns with the broader Web3 ethos of decentralizing control, enhancing transparency, and increasing user autonomy.
DeFi vs. Traditional Finance (TradFi)
In traditional finance (TradFi), users must place a significant amount of trust in financial institutions. Banks, for example, hold customer funds, process payments, and issue loans, and customers must trust these institutions to operate fairly and securely. These systems are centralized, meaning a single authority, like a bank or government, controls them. For generations, this has been the norm, and while secure in many ways, it also brings risks such as institutional failures, corruption, and exclusion from services for unbanked populations.
DeFi, on the other hand, is built on trustless systems. Instead of trusting banks or payment processors, users trust the blockchain and smart contracts. These are automated programs that execute transactions only when specific conditions are met, and because they are run on a decentralized network, they cannot be tampered with by any single entity. This removes many of the vulnerabilities seen in TradFi, such as bank failures or unauthorized account freezes.
Example: A DeFi Lending Protocol
Let’s say you want to take out a loan in a traditional bank. You go through a lengthy process involving paperwork, credit checks, and the bank’s approval. In a DeFi protocol, you could simply put up some cryptocurrency as collateral, and the smart contract would automatically issue a loan to you in a different cryptocurrency, without needing a middleman or a credit check. The terms of repayment, interest, and other conditions would be encoded in the contract, which executes them automatically.
The Role of Trust in Centralized vs. Decentralized Finance
In centralized finance (CeFi), trust is a fundamental requirement. Users must trust that banks and financial institutions will safeguard their money, conduct transactions fairly, and manage risks appropriately. These institutions often operate under government regulations, providing a sense of security, but they are still subject to human error, mismanagement, or even malfeasance.
In decentralized finance, trust is minimized through the transparency and security of blockchain technology. Because all transactions and smart contract codes are visible on the blockchain, users can independently verify the system’s integrity. This transparency significantly reduces the need for trust in a central authority. Blockchain’s cryptographic security further ensures that transactions cannot be altered or forged.
The Risks of DeFi
While DeFi removes many of the risks associated with centralized intermediaries, it’s not without its own challenges. The early nature of DeFi technology means it still carries risks that users should be aware of:
Smart Contract Vulnerabilities: Smart contracts are only as good as their code. Bugs or exploits can lead to significant losses, as seen in several high-profile DeFi hacks.
Lack of Regulation: DeFi operates largely outside of traditional regulatory frameworks. While this offers freedom and flexibility, it also leaves users without legal recourse in the event of theft or fraud.
Scams and Bad Actors: The openness of DeFi allows anyone to create a decentralized application, which unfortunately includes scammers. Users must exercise caution and thoroughly research projects before investing or using their services.
Despite these risks, DeFi represents a transformative shift in how financial services can operate. It opens up a new world of possibilities for individuals who were previously excluded from the financial system, while also giving users more control over their own assets.
The Future of DeFi
As DeFi matures, many of the current risks will likely be mitigated through technological advances and better security practices. We can expect to see greater collaboration between DeFi and traditional financial systems, with the possibility of hybrid models that blend the best of both worlds.
DeFi is not just an innovation in finance; it’s a movement that seeks to fundamentally reshape the financial landscape. By leveraging blockchain technology, DeFi removes the need for centralized institutions, offering a more open, transparent, and secure financial system. While it still has growing pains, the potential for decentralized finance to revolutionize the way we interact with money is undeniable.
Scalability is the ability of a system, network or process to handle a growing amount of work or its potential to be enlarged to accommodate that growth. For traditional businesses, scalability refers to how well a company can increase production or services to meet demand without sacrificing performance or losing control over operations.
Think of it like expanding a coffee shop: As demand grows, you might open new locations or hire more staff to meet the needs of more customers.
In the web3 world, scalability refers to how well a decentralized network can grow to support more users, applications and transactions without compromising on speed, security or efficiency. Unlike traditional networks, decentralized networks like those built on blockchain technology operate across numerous independent nodes rather than a centralized server. This difference introduces unique challenges and opportunities for scalability.
In the web3 era, scalability isn’t just a nice-to-have feature—it’s a necessity. As decentralized networks grow, so does the demand for faster transactions, better user experiences and increased security. If a blockchain cannot scale effectively, it risks becoming slow, expensive or unreliable. This can deter users, developers and businesses from adopting the technology.
For example, early blockchain networks like Bitcoin and Ethereum struggled with scalability due to the growing number of transactions they had to process. Each transaction had to be verified by multiple nodes, causing network congestion, delays and high fees. This scalability problem led to the development of newer blockchains designed to handle more transactions per second (TPS) while maintaining decentralization and security.
In web3, scalability challenges are compounded by the decentralized nature of the networks. Since no single entity controls the system, solutions must be implemented across a wide range of participants, which adds complexity. The faster these networks can scale, the more seamless and effective decentralized applications (dApps), games and platforms can become.
Let’s compare scalability in the traditional business world with decentralized networks. In a successful traditional business, scaling might require hiring more staff, improving internal processes or automating certain tasks. For example, a rapidly growing startup might hire hundreds of new employees within a year to keep up with its success. As it scales, it will also face growing pains, such as managing a larger team, more complex operations and the need for more structured procedures.
In decentralized networks, this process can look very different. A decentralized project can achieve massive scale quickly with fewer resources because it’s not limited by centralized control. The network grows by adding more nodes and users who contribute to its security and processing power. However, this rapid growth presents its own challenges, such as maintaining consensus across a larger number of nodes, preventing congestion and ensuring the network’s security.
Blockchain projects must solve scalability issues sooner than later because, unlike most traditional centralized businesses, decentralized networks can easily grow at an exponential pace. The more participants and transactions on the network, the higher the demand for computing power, storage and bandwidth.
The Future of Scalability in Web3
In the blockchain space, it’s common to hear about the “blockchain trilemma,” which refers to the challenges of balancing decentralization, security, and scalability. Typically, improving one of these elements has come at the cost of another. For example, a highly decentralized network may struggle with scalability because each transaction requires verification from many nodes.
However, blockchain technology is rapidly evolving, and new solutions are emerging that aim to address this issue. Layer 2 solutions, sharding, and new consensus algorithms like Proof of Stake (PoS) are designed to enhance scalability without compromising security or decentralization.
GalaChain and Scalability in Web3 Entertainment
A great example of an innovative approach to scalability in web3 is GalaChain, the custom-built blockchain by Gala. GalaChain was designed to support high transaction volumes and complex interactions, particularly for the entertainment industry, which includes gaming, music and film. The gaming industry in particular places enormous demands on blockchain scalability because of the sheer volume of interactions required by millions of users engaging in actions like in-game purchases and character customizations. Gamers have notoriously high standards for their tech.
By focusing on scalability from the start, GalaChain ensures that its network can handle the growing demands of the entertainment industry. GalaChain is built to accommodate future growth, which means the more people who use it, the better it becomes at handling large-scale operations. This “bigger it gets, the bigger it can get” concept reflects the idea that scalability is not just about managing current demand but preparing for exponential growth.
Why Scalability is Critical for the Future of Blockchain
The web3 era moves incredibly fast, and one of the biggest risks for blockchain developers is falling behind on scalability. During development phases, the technology can leap forward, leaving slower-moving projects struggling to catch up. This is why it’s essential for blockchain platforms to not only solve current scalability issues but to anticipate future demands.
For example, as blockchain adoption spreads across industries like finance, healthcare and supply chains, the number of transactions and interactions on these networks will skyrocket. Developers need to build systems that can handle this explosion in activity. Without proper scalability, blockchain projects risk becoming obsolete or too costly for widespread use.
In the web3 world, scalability is everything. It’s the key to unlocking mass adoption and enabling decentralized applications to compete with traditional technologies. As decentralized networks like GalaChain continue to grow, scalability ensures that they can meet the demands of tomorrow, not just today. Whether it’s handling millions of game transactions or enabling the next generation of decentralized finance (DeFi) applications, scalability will determine which platforms thrive in the future of web3.
Check out this developer deep dive into GalaChain from LF Decentralized Trust:
The term “Web3” often pops up in discussions about the future of the internet, but what does it actually mean? To understand Web3, let’s first look at how the internet has evolved through its different stages: Web1, Web2, and now, Web3.
Web1: The Read-Only Internet
Web1 was the earliest version of the internet, spanning from the 1990s to the early 2000s. It was a time when the internet was made up of static web pages. These pages were often referred to as “read-only” because they functioned like digital brochures—informational but not interactive. You could only view content, much like flipping through a newspaper or browsing an encyclopedia. Web1 was the era of the personal home page and simple, non-dynamic websites.
Think of it as going to the library and looking at books on shelves: you could gather information, but you couldn’t check anything out or add new books to the collection. Unless you were among the programming elite, you were not likely to have created web pages in those days.
Web2: The Social and Interactive Internet
Then came Web2, the era we’re most familiar with today. Starting in the mid-2000s, Web2 introduced a new level of interactivity and participation. With the rise of social media platforms like Facebook, Twitter, and YouTube, the internet transformed into a space for sharing, commenting, and creating user-generated content.
Web2 is the “social web.” It enabled platforms and applications to gather data and provide personalized experiences. For example, you could “like” posts, share photos, comment on articles, and stream videos. Web2 also ushered in a shift where users became the product—companies collected vast amounts of data to offer targeted advertisements and generate revenue.
Throughout the Web2 era, large social media companies were becoming empires by collecting self-reported data from users of their platforms. Now they are essentially advertising platforms who distribute traffic to smaller-scale marketers and creators willing to pay for it. If you’re looking to get a product in front of the right audience, social media marketing is often the best solution. These platforms know how to effectively target various audiences, based on the information gathered over two decades of consumer use.
A good analogy for Web2 is a public square where everyone can set up booths, interact with one another and contribute to the conversation. However, the square is controlled by a few large companies that set the rules, decide who can participate, and take a cut from every transaction.
Web3: The Ownership and Decentralized Internet
Web3, sometimes referred to as the “decentralized web” or the “ownership internet,” is the next evolutionary stage. While Web1 was about reading information and Web2 was about interacting and creating content, Web3 aims to give users ownership of their content, digital assets and online identity through the use of decentralized technologies like blockchain.
Blockchain serves as the backbone of Web3, allowing for transparent, secure and decentralized record-keeping. This technology enables the creation of digital assets such as cryptocurrencies (e.g., Bitcoin, Ethereum), non-fungible tokens (NFTs) and decentralized applications (dApps). In essence, Web3 uses cryptography and decentralized systems to distribute power and control away from centralized entities, like tech giants, and back to the users.
Web3 is building a new internet world where you no longer just post a photo or upload a video, only for the hosting platforms to monetize your content. Instead, you have new options to own that content directly, decide how it’s used and even get compensated for it without the need for a middleman.
Why is Web3 Important?
True Ownership of Digital Assets
In Web2, your digital presence and content are owned and controlled by the platforms you use. If Instagram or YouTube decides to delete your account, all your content could vanish. With Web3, you own your digital identity and assets. These assets—whether they’re cryptocurrency in your wallet or digital artwork as NFTs—are stored in a decentralized manner, making it much more difficult for a single entity to take them away.
Decentralization
Web3’s decentralized nature means there is no single point of control or failure. Instead of relying on centralized servers and companies, Web3 applications operate on a network of nodes (computers) maintained by users, making them more resilient to censorship and data breaches.
Blockchain nodes are essentially points of data intersection on a decentralized network, or joints. They are user-operated checkpoints where transactions and smart contracts are validated to ensure the integrity of the blockchain, no matter how large.
With decentralization also comes unprecedented scalability. Prior to Web3, networks were limited in their growth by things like real estate, energy consumption and warehouse space for servers. In Web3, decentralized networks have the ability to grow much larger, distributing their operations all over the world.
Transparency and Trust
Blockchain technology makes every transaction transparent and verifiable. This transparency helps build trust in digital interactions and transactions, whether it’s tracking the authenticity of digital art or verifying a peer-to-peer financial transaction.
In many ways, the transparency of Web3 reduces the need for trust. While online banking is streamlined and convenient, it requires the user to trust that their money is safe. Web2 systems typically require users to exercise trust, while the transparency and security of Web3 systems reduce the amount of trust required.
Incentives and Participation
In Web3, users can be rewarded directly for their participation. For example, some decentralized social media platforms reward users with tokens for creating content, commenting or participating in discussions. This is a stark contrast to Web2, where the platforms, not the users, profit from the content and activity.
This aspect of Web3 is what inspired Gala’s founders to first create a world of Web3 gaming that allowed players to own and trade their in-game items. Instead of committing to pay a large portion to the social media platforms in control of Web2 marketing, Gala is on a mission to return that control and freedom to its users. It is through this incentivization first approach that Gala Games was able to award over $1 Billion in value to player-owners in its gaming ecosystem in just the first 2 years of operation.
Today, Gala’s core brands of Games, Music and Film (along with the numerous in-development third-party GalaChain projects) present a variety of ways to collect digital assets and get rewards for participation in the ecosystem.
Web3 applications are often designed to be interoperable and composable, meaning that different applications and platforms can work together seamlessly. This fosters innovation and enables developers to build on top of existing projects without needing permission or integration deals.
Gala invites external developers and innovators to build on its layer-1 blockchain, GalaChain, using the GalaChain SDK and the Gala Creators toolkit.
Real-World Use Cases of Web3
Decentralized Finance (DeFi): Financial services built on blockchain that operate without a central authority, enabling peer-to-peer lending, borrowing, and trading.
NFT Marketplaces: Platforms like OpenSea and Rarible allow artists to mint, sell, and auction digital art as NFTs, providing new revenue streams for creators.
Gaming and Virtual Worlds: Games like Common Ground World and virtual worlds like Decentraland let players truly own in-game items, characters and virtual real estate, which they can sell or trade with others on peer-to-peer marketplaces.
Decentralized Social Networks: Platforms like Mastodon and Lens Protocol provide social networking experiences without the control or data surveillance typical of Web2 social media platforms. GalaChain even has its own gamified social media network: Rep.run.
Challenges and Future Outlook
Web3 is still in its early stages and faces several challenges:
User Experience: The technology is complex, and using Web3 applications often requires a steep learning curve, particularly around setting up digital wallets and managing private keys.
Scalability: Current blockchain networks, like Ethereum, struggle with high transaction fees and slow processing times during peak usage.
Regulatory Uncertainty: Governments and regulatory bodies are still figuring out how to approach decentralized technologies, which creates uncertainty for developers and users.
Despite these hurdles, Web3 holds immense potential to reshape the digital landscape. As technology matures and more people become aware of its benefits, we could see a new era of the internet where users have true ownership, privacy, and control over their online experiences.
Web3 represents a paradigm shift in how we interact with the internet. It’s not just about making existing systems more efficient but about fundamentally rethinking how we create, interact with, and own content and assets online. While the journey toward widespread adoption is still ongoing, the principles and technologies behind Web3 lay the groundwork for a more decentralized, transparent, and user-empowered internet.
Yield farming is a popular concept in decentralized finance (DeFi) that allows users to get rewards by lending or staking cryptocurrency on a blockchain-based platform. The idea is straightforward: you deposit your digital assets into a decentralized application (DApp) or liquidity pool, and in return, the platform rewards you with additional tokens. It’s similar to the way interest can be earned on the money held in a savings account.
Yield farming helps decentralized platforms by providing liquidity, which is essential for these platforms to function smoothly. The less liquid a digital asset is, the more difficult it becomes to buy or sell that asset, resulting in the potential for extreme price volatility. In exchange for contributing to an asset’s liquidity, users receive rewards, which vary depending on the platform and the type of assets staked.
How Does Yield Farming Work?
Let’s compare yield farming to a community garden. Imagine you’re growing plants in a shared garden where everyone contributes seeds (digital assets). As the plants grow, the garden yields fruits (rewards), which are shared among all contributors based on how much they’ve contributed.
Yield farming works in a similar way: Users provide liquidity to decentralized platforms, and the platform distributes rewards proportionate to each user’s contribution.
Here’s how it typically works step by step for the user:
Provide Liquidity: You deposit your cryptocurrency into a liquidity pool on a DeFi platform. These liquidity pools are essential for decentralized exchanges (DEXs) and other financial services to operate without a traditional intermediary.
Collect Rewards: In return for providing liquidity, you earn rewards, often in the form of the platform’s native token or other assets. The more liquidity you provide, the more rewards you can earn. These rewards are typically accumulated over time from the transactional fees charged to those who trade on the platform.
Stake or Claim: Some platforms allow users to stake their reward tokens in additional liquidity pools to compound their rewards, while others simply let you claim the rewards directly.
What is a Liquidity Pool?
A liquidity pool is a collection of funds locked into a smart contract. These funds are used to facilitate trading on decentralized exchanges or to support lending and borrowing activities on DeFi platforms. By contributing to a liquidity pool, you help ensure there is enough liquidity for users to trade or borrow assets, making the entire platform more efficient.
A basic liquidity pool involves an exchange pairing between 2 different tokens. When initially providing liquidity, the provider would stake equal value parts of each token, ensuring that they have added liquidity to that pairing equal to the value they have contributed.
Why is Yield Farming Important in DeFi?
Yield farming plays a crucial role in the decentralized finance ecosystem. It ensures that there is enough liquidity for decentralized exchanges and lending platforms to function smoothly without needing centralized control. Large privately owned exchanges provide the liquidity themselves, keeping enough value to back the trade activity for all their exchange pairings.
The decentralized approach empowers users by enabling them to get rewarded while contribute to the ecosystem, without relying on traditional financial intermediaries, such as banks.
Here are some key reasons why yield farming is important:
Liquidity Provision: Without yield farmers, DeFi platforms would struggle to have enough liquidity for trades, loans and other financial operations. Yield farmers ensure there’s always enough liquidity in the system.
Reward Incentives: Yield farming provides an attractive way for users to get rewards by simply holding and staking their digital assets, often far more than traditional savings accounts.
Decentralized Control and Anonymity: By participating in yield farming, users help maintain a decentralized system, keeping control in the hands of the community rather than centralized entities.
Risks of Yield Farming
While yield farming can offer high rewards, it also comes with certain risks. Here are some of the main concerns to be aware of:
Impermanent Loss: When you provide liquidity to a pool, you might experience impermanent loss. This happens when the price of the assets you’ve deposited changes compared to when you added them. If the price moves significantly, your potential rewards could be reduced. There is no guarantee that the value of the liquidity you have provided will hold steady.
Smart Contract Vulnerabilities: Yield farming relies on smart contracts, which are pieces of code that automatically execute transactions. If there’s a bug or vulnerability in the smart contract, it could result in loss of funds.
Platform Risk: Not all DeFi platforms are created equal. Some may have weaker security measures or be more prone to hacks and exploits. It’s important to research the platform you’re using before depositing assets.
Popular Platforms for Yield Farming
There are several popular DeFi platforms where users can participate in yield farming. Here are a few:
Uniswap: One of the largest decentralized exchanges where users can provide liquidity to earn rewards.
Aave: A DeFi lending platform where users can deposit assets into liquidity pools and earn rewards through lending.
Compound: Another popular lending platform where users can earn rewards by lending out their assets.
Each of these platforms operates slightly differently, but they all provide opportunities for users to stake or lend their assets and earn rewards.
Yield Farming in Action: An Example
Let’s break down a simple example of yield farming in action:
You decide to stake some of your digital assets (for instance, Ethereum) on a platform like Uniswap.
You deposit these assets into a liquidity pool for a specific trading pair, such as ETH/USDC (Ethereum and USD Coin).
As people trade between ETH and USDC on the platform, they pay small fees, which are distributed proportionally to all the liquidity providers in the pool.
In addition to these fees, you may also earn rewards in the form of the platform’s native tokens.
Over time, the rewards accumulate, and you can choose to reinvest them or withdraw them.
Yield farming is often a valid option for long term holders of well established cryptocurrencies who would like to generate passive rewards from their holdings. However, it is always important to do extensive research before making the decision to provide liquidity or get into yield farming. Not all dApps and platforms are created equally.
This article is meant for educational purposes only and should not be considered financial advice.
Liquidity is a concept that pops up often in the world of finance, and it’s just as important in the Web3 space, especially with the rise of decentralized finance (DeFi). In simple terms, liquidity refers to how easily you can buy or sell an asset like a cryptocurrency, without drastically changing its price.
To put it in everyday language, imagine you’re at a market selling apples. If there are plenty of buyers ready to purchase your apples at the current price, then your apples are more “liquid.” You can sell them quickly, and you don’t have to drop the price to attract a buyer. However, if there are only a few buyers, you might have to lower the price or wait a while to sell your apples. In that case, your apples are less liquid.
Sellers and buyers are both necessary for any market to work effectively; the concentration of each of them influences the market in many different ways.
In Web3, liquidity applies to digital assets like cryptocurrencies and tokens. High liquidity means people can trade their tokens quickly, while low liquidity means it’s harder to find someone to trade with, and you may need to wait longer or accept a worse deal.
Why is Liquidity Important in Web3?
Liquidity plays a big role in how smoothly decentralized markets and applications function. Here’s why liquidity is crucial in the Web3 world:
Efficient Trading: High liquidity means you can easily trade your tokens without slippage (the difference between the expected price of a trade and the actual price). If liquidity is low, prices can swing drastically after each trade, creating an inconsistent and unpredictable market.
Fair Prices: In liquid markets, prices tend to be more stable and reflective of real value. With low liquidity, even small trades can cause big price movements, making it harder to predict what you’ll pay or receive for a token. This is why with tens of thousands of altcoins in existence, the vast majority of them have proven so volatile from one day to the next.
User Experience: Web3 applications like decentralized exchanges (DEXs) need liquidity to offer fast and reliable services. If liquidity is low, users may experience delays or unfavorable prices when trading tokens, which can discourage participation in that exchange. For a decentralized exchange like Uniswap to compete with a centralized (privately owned) exchange like Coinbase, liquidity is used to create equally convenient trading activities for users.
How Does Liquidity Work in Web3?
In Web3, liquidity typically comes from two main sources:
Liquidity Providers (LPs): In decentralized finance (DeFi), liquidity often comes from regular users who deposit their crypto into a liquidity pool. These users are called liquidity providers. By contributing their tokens to the pool, they help create liquidity, which allows others to trade. In return, liquidity providers earn rewards like a share of the trading fees. Typically, a liquidity provider contributes to a liquidity pool by providing an equal-value amount of both tokens involved in that exchange pairing.
Liquidity Pools: A liquidity pool is a smart contract that holds funds to facilitate trading between different cryptocurrencies on a decentralized exchange. For example, if someone wants to trade Ether (ETH) for a stablecoin like USDC, the liquidity pool allows them to do so without needing a direct buyer or seller. The more funds in the pool, the easier and quicker trades can be made.
Think of liquidity pools like communal pots of money that people can use to trade tokens with each other. The bigger the pot (more liquidity), the easier it is for everyone to trade, and with larger amounts at a time.
Examples of Liquidity in Web3
Uniswap and Liquidity Pools: One of the most popular platforms in DeFi, Uniswap, allows users to swap between different tokens by tapping into liquidity pools. Users provide liquidity by depositing pairs of tokens (like ETH and USDC) into the pool. In return, they receive a percentage of the fees generated when other users make trades.
Stablecoins as Liquid Assets: Stablecoins like USDC or DAI are often considered highly liquid because they are widely used and can be easily exchanged for other tokens. Their prices are stable, which makes them ideal for providing liquidity in many DeFi applications.
NFT Liquidity: Liquidity doesn’t just apply to cryptocurrencies—it also applies to NFTs (non-fungible tokens). Some platforms are experimenting with ways to create more liquidity for NFTs by letting users fractionalize them, meaning they split the NFT into smaller pieces that can be traded more easily.
Liquidity Mining and Yield Farming
In the Web3 world, liquidity mining or yield farming is a way that people are incentivized to provide liquidity to a decentralized platform. Essentially, liquidity providers earn rewards, usually in the form of extra tokens, for depositing their assets into a liquidity pool.
For example, if you deposit your crypto into a liquidity pool on Uniswap, you may receive Uniswap’s governance token ($UNI) as a reward. This is a reward incentive, a way to encourage more liquidity, keeping decentralized exchanges running smoothly.
Why Liquidity Matters for Web3 Projects
For Web3 projects to thrive, they need liquidity. Without it, users would struggle to trade tokens or interact with decentralized applications (dApps). Here are a few key reasons why liquidity is critical:
Smooth Functioning of DEXs (Decentralized Exchanges): DEXs rely heavily on liquidity pools. Without enough liquidity, users can’t easily swap tokens, which disrupts the whole system.
Trust and Adoption: High liquidity signals trust in a project. If a project has deep liquidity, more users are likely to join, trade, and use the platform. On the other hand, low liquidity can deter users because they may worry about the stability and usability of the platform.
Price Stability: More liquidity means token prices are more stable and less likely to be affected by large trades. This creates a healthier market and attracts both casual and serious investors.
Common Liquidity Terms in Web3
Liquidity Provider (LP): A user who contributes tokens to a liquidity pool to facilitate trading on a decentralized exchange.
Liquidity Pool: A smart contract that holds tokens to enable decentralized trading between two or more cryptocurrencies.
Slippage: The difference between the expected price of a trade and the actual price. High slippage happens in low-liquidity environments.
Liquidity Mining/Yield Farming: The process of earning rewards for providing liquidity to a platform or decentralized exchange.
Impermanent Loss: A potential risk for liquidity providers. This occurs when the price of the deposited tokens changes compared to when they were deposited, leading to lower value when they’re withdrawn.
The Lifeblood of Web3
Liquidity is crucial to making decentralized platforms work efficiently. Whether it’s enabling quick and cheap token swaps, stabilizing prices or collecting rewards through liquidity mining, liquidity plays a huge role in Web3 ecosystems.
For those new to the Web3 world, understanding liquidity can help you make better decisions when participating in DeFi platforms, trading tokens or even providing liquidity yourself for passive rewards.
