What is a dAPP?
A dAPP, or decentralized application, is a program built on a blockchain. The application allows for real-world use cases and functionality of crypto coins.
- Developers code a dAPP’s program using smart contracts.
- We use our digital wallets and a website interface to utilize the program.
Benefits of a dAPP
Since dAPPs are decentralized and run on smart contracts, they are entirely autonomous. So unlike centralized applications like Facebook or Twitter, no single authority runs a dAPP or has the power to shut it down. Moreover, dAPPs give people complete control over their money and finances. As we will see below, financial dAPPs are rapidly replacing traditional banking practices.
Blockchains and dAPPs
Every blockchain has its own set of dAPPs. The Ethereum blockchain has hundreds dAPPs, while the newer Solana blockchain has less than a hundred. Some dAPPs are duplicated on multiple blockchains to take advantage of a specific blockchain’s protocols, such as speed and cost per transaction.
For example, since the Ethereum blockchain is slow and costly, a dAPP would make more sense running on the Avalanche blockchain where transactions are processed much quicker, for a fraction of the cost. As a result, developers will often hard-fork their code onto different blockchains.
Hard-fork is a fancy way of saying “copy-and-paste” onto another blockchain. SushiSwap is a dAPP for swapping coins, and it has been hard-forked to run on all EVM blockchains, including Ethereum, Fantom, and Avalanche.
Blockchains not built on the EVM, such as Solana or Terra, can’t simply hard-fork EVM dAPPs due to differences in the programming language. Thus developers have to tediously re-build EVM dAPPs for non-EVM blockchains. Fortunately, Solana and Terra have attracted many hard-working developers to build new dAPPs.
Connecting to SushiSwap
Before we go any further, it will be helpful to use a dAPP to get a general idea of how they work. Let’s try the SushiSwap dAPP – a coin exchange platform.
- Using the google chrome browser, go to Sushi.com
- Connect your MetaMask to the site. (V)
- Switch to the Avalanche chain from your MetaMask.
- From Coinbase, send any small amount of Avalanche (AVAX) to your MetaMask (V)
- In the swap interface, select AVAX for the first token and DAI (a stable coin) for the second token.
- Enter in an amount of AVAX to swap to DAI, hit swap, and confirm the transaction. Sushiswap will convert our AVAX into the DAI stable coin. If you don’t see the DAI coins deposited in your MetaMask, make sure to manually add the DAI coin to the wallet.
In simple terms, SushiSwap is one of many decentralized exchanges (DEX). A DEX is a finance-based dAPP that allows users to swap from one coin to another without using a centralized exchange (CEX) such as Coinbase.
Advantages of a DEX
The four main reasons we would use a DEX over a CEX is:
- It’s quick, anonymous, and cheap.
- It gives individuals complete control of their money instead of being in the hands of a CEX.
- Will never halt trading or shut down.
- It can be used to take profits by swapping to a stable coin, such as USDC, as we did above.
- Rewards you for being a liquidity provided (LP). We will cover this below.
To expand a little on number two, CEXs profit by collecting a small fee from traders. While a DEX also collects a fee, it distributes the fee equally amongst users. We discuss the specifics and mechanics of a DEX here.
Types of Protocols (dAPPs)
Generally speaking, a protocol is a set of guidelines. DAPPs run on protocols set by developers. Like a democracy where citizens vote on laws, users of a dAPP vote to approve or deny a change made to the dAPP’s protocols.
Earlier, we said that dAPPs are based on real-world utility. Finance-based dAPPs, for example, aim to replace banks. DAPPs for finance are commonly referred to as DEFI or decentralized finance. AAVE, a popular DEFI dAPP, allows anyone to borrow or lend money in a matter of seconds.
For the most part, we can replicate a centralized platform as a dAPP. Here are some sectors in which dAPPs are being built and what they aim to replace:
- Finance dAPPs (DEFI) – to replace traditional banking
- Exchange dAPPs – to replace stock and currency brokers, like Coinbase
- Gaming dAPPs – to replace the conventional model of in-game payments
- Social media dAPPs – to replace social media companies, like Twitter.
- Gambling dAPPs – to replace casinos
- Music dAPPs – to replace music streaming companies like Spotify
- Video dAPPs – to replace video streaming companies like YouTube
Currently, there is a massive surge in the popularity of dAPPs in the DEFI sector. Investors are dumping billions onto these platforms, given the promise of making insane APYs. For example, loaning money out on AAVE yields up to 20% interest. There have been APYs as high as 2,000,000% on some dAPPs.
As hinted above, DEFI is the new big wave of Web 3.0. DEFI is how teenagers with as little as $1000 turn six-figure profits in a couple of weeks.
Most DEFI dAPPs can generate between 20-40 percent of annual interest — holding the edge over traditional banks by far. In 2022, keeping excess capital in banks or bonds is silly. It is time to slowly start moving your money onto dAPPs to reap the massive rewards and benefits.
Fact: DEFI is a world of opportunity with astounding ROI.
It is important to note that DEFI is relatively small and new. While the amount of capital on DEFI dAPPs sums up to billions, the space is volatile. Large rewards are often distributed to early adopters to offset potential losses. However, the overall trend does seem to be profitability in the long term. As DEFI grows with more users and capital, potential risks will decrease, but so will rewards.
Let’s go back to SushiSwap and cover another method of passive income we hinted at earlier: liquidity providing.
Providing Liquidity (LP) on a DEX
One of the core features of DEFI is a DEX or decentralized exchange. A DEX is like a centralized exchange (CEX), such as Coinbase or Binance. However, since no central authority runs a DEX, its users must provide liquidity. Liquidity refers to the number of available coins the DEX has to swap between two coins successfully. The DEX automatically and proportionally distributes a reward for helping run the platform.
LP on Sushiswap
We provide liquidity by depositing our coins into pools. Let’s go back to the example where we swapped AVAX for DAI. The swap utilized the coins provided in the AVAX/DAI pool by putting in AVAX while taking out DAI. The AVAX/DAI pool’s coins came from liquidity providers (LP), who will collect the .3% fee you paid on the swap.
Providing liquidity to a pool (or token pair) allows a DEX to swap between two coins. You can provide liquidity, by simply providing an equal amount of coins to the pool of your choice.
Using the example above, go to the “pool” tab and click “add” liquidity. To provide liquidity to the AVAX/DAI pool, select the two tokens and enter the amount you want to contribute. Approve the transaction, and you have successfully become an LP! Every day, you will receive a portion of the pool’s fees.
Let’s calculate how much you would make. Suppose you put in $10k total (5k in AVAX and 5k in DAI). If the total pool size is $100,000, your coins account for 10% of the liquidity. Therefore, you will get paid 10 percent of all fees the pools generate every day. If the AVAX/DAI pool generates 10k per day on average, you will make 1k per day.
Learning more about LP
There is much more to know about being a liquidity provider and we highly recommend reading the next section where we go more in-depth on the advantages and risks.
Watch this tutorial if you want to provide liquidity on any DEX. We will show you how to provide liquidity on Trader Joe (a DEX on the Avalanche blockchain) for the AVAX/USDC pair.
The next chapter will cover the most popular DEFI dAPP on every blockchain