What is a Smart Contract? (Simplified)

A smart contract is a self executing computer generated contract, the terms of which are stored in the blockchain. When terms of the contract are met, a transaction fulfils automatically. This eliminates the need for a third party, like a bank, because the ‘rules’ are already pre-determined. Every transaction resulting from a smart contract is recorded in an unchangeable database; a blockchain.

The Advantages

The advantages of using a smart contract is that you can pre-programme outcomes for diffferent scenarios. Let’s say you were raising money and the price target was £1000. If the price target is met, rule 1 would be triggered and the money would be given directly to charity. If the price target isn’t met, rule 2 would be triggered and the money raised would be redistributed back to the donors. This process saves both time and money. It also prevents any misuse of funds as they are locked in the smart contract until the terms are fulfilled.

What is a Smart Contract Platform? (Simplified)

A smart contract platform simply hosts applications on which smart contracts are supported. Let’s take a simple comparison. Ethereum is a smart contract platform and it hosts decentralised applications. This is rather like how an iphone hosts apps like instagram and facebook, except the big difference is that the data s not controlled by a centralised company and the Ethereum platform supports smart contracts.

The First Smart Contract Platform: Ethereum

Ethereum was in fact the first smart contract platform, holding the majority of the market share at a modest $560 billion market cap. However, Ethereum was not designed to scale the way that it has. The network has become overstrained, making the cost to interact with it very high.

High Fees in Practice

Like below, this can be as simple as exchanging one coin for another on an exchange (Uniswap in this case). Even if you want to swap $20 worth, there is still a sizeable fee. Here it amounts to $93.25!

The Emergence of Layer 1 Solutions

In response to this issue, we’ve seen a surge in interest in Ethereum alternatives (also known as layer 1’s). These platforms can provide faster and cheaper transactions regardless of high volume.

For example, we’ve seen platforms like Solana take on extraordinary growth this year, now amounting to an impressive £74 billion market cap. To provide a bit of context, Solana was at a mere $1.52 on January 1 2021! That’s over 100x in 9 months.

Other layer 1’s like Avalanche, Fantom, Terra have also seen impressive growth this year. These platforms give users the speed and low cost that Ethereum cannot offer at the moment.

High Potential for Layer 1’s

With this in mind, it is safe to say there is a lot of upside potential for these layer 1’s. . As such, we’ve compiled a collection of metrics that will help you research and identify the top layer 1 protocols.

Researching & Evaluating the Platforms

There are several metrics you can use to evaluate whether a blockchain has high potential. (list non-exhaustive).

1. Blockchain Fundamentals
2. Development Activity
3. Backers
4. Total Value Locked
5. News & Trends

1. Platform (Blockchain) Fundamentals

One of the first things to evaluate is how good the infrastructure of the platform is. One of the key differentiators for the new layer 1’s is the use of proof of stake consensus vs proof of work, which has a large impact for speed, energy efficiency and scalability. Yet’s see how Ethereum and Solana measure up against eachother.

See All Ethereum Stats

See All Solana Stats

Ethereum

Although Ethereum has had first mover advantage, it has become almost unusable at a low level. At a maximum capacity of 25 transactions per second and average fees of $100, it is has become unappealing to use.

Also, waiting nervously for minutes whilst a transaction goes through is not an optimal experience to say the least. It is interesting that despite these flaws, Ethereum is still the dominant player in the space.

Solana

Solana ranks higher on every metric, and by a considerable degree. The proof of stake consensus really does make a monumental difference to performance. This better infrastructure has certainly contributed to Solana’s success throughout this year.

2. Development Activity

Another metric to consider is development activity. To keep it simple, wherever the majority of the developers allocate their time is likely to be the dominant platform.  A good metric to get an idea of growth is to look at the developer activity on github for each platform.

Source – Crypto Miso

Interestingly, Solana ranks 2nd and Ethereum 36th in terms of activity for the previous 6 months. It is worth noting that Github commits only give an idea of overall sentiment, as a commit refers to a change/update of the code and can be any size – from a copy change to a new feature.

The Quality of the Applications

Inline with the developer activity, the quality of the products and the speed of development is fundamental to the success of the platform. Diving into the different protocols and apps will give you a good indication of whether the ecosystem as a whole has impressive projects.

The most valuable projects are likely to be those that provide a better alternative product to an already existing industry.

To see a list of applications built on the different platforms, coingecko has lists of projects under each platform. DeFi Llama also has top projects by platform, ranked by Tvl. Access all these links per platform/blockchain below

Blockchain

3. Backers – follow the money

If in doubt, follow the money. This strategy is certainly a good one and can actually refine your research for you. Funds are often very transparent as to what their investments are, and even though they are likely to get the pre-market allocations to platforms and projects, investing early will certainly give you a better chance of a higher return.

At InCrypto Hub, we’ve already accumulated link to the top funds portfolios and their websites to help you with the research.

Source – InCrypto Hub

A good tactic is also to follow certain individuals on twitter, the hub of crypto activity. Following team members of large funds, such as Multicoin Capital, can provide some valuable insights.

4. TVL

The Total Value locked in the platforms’ ecosystem is also a great indicator of growing popularity, although somewhat artificial. TVL signifies the amount of capital that is being staked in a protocol and gives a good indication as to the overall health of the smart contract platform.

Sometimes a surge in TVL will precede a price increase, and so this can be a good metric to catch trends early.

At an impressive $172 billion Total value locked, Ethereum sits comfortably as the smart contract platform leader.

Source – DeFi Llama

Solana currently sits at $13.53 billion locked, which is more than a 4x increase since August!

Source – DeFi Llama

5. News & Identifying Trends

On a certain level the cryptocurrency market runs on news, speculation and trends. Identifying whether the platform will fit into the newest trends / provide some infrastructure for upcoming trends will significantly contribute to its success. Identifying a narrative with a core fundamental thesis helps to identify these trends before they happen.

For example, with the rising fees on Ethereum, it is likely that low level NFT buyers will look to platforms with lower fees so they can participate. These could be Ethereum based, like Immutable X (zk rollup), or marketplaces like Magic Eden or Solanart on Solana.

Another Example: The play to earn narrative is strong at the moment, especially with the rise of Axie Infinity. The smart contract platform that becomes the ‘go to’ development platform for games is likely to do extraordinarily well.

Summary & Final Thoughts

In summary, alternative smart contract platforms to Ethereum could well see substantial growth as mainstream adoption continues. We’ve already seen a huge surge in interest over the past year and this is likely to continue.

However, it is certainly worth considering the impact that zk rollups may have in aiding Ethereum to scale. Unlike layer 1 platforms, zk rollups actually become less expensive as users increase. This could certainly have an interesting effect on the market, potentially catalysing a shift back to Ethereum.

If you’re interested in finding out more about the cryptocurrency universe, we provide a range of services to individuals, companies and funds to help them navigate the world of crypto.

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In the meantime, check out our site below, containing all the best crypto resources and tools.

InCrypto Hub

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Technological risk

Technical and operational failures are one of the biggest threats to Defi at the moment. This is due to the current limitations of the blockchain and not being infallible.  As Defi has grown so have the number of cyber attacks, bugs and network congestions which can cause an investor to lose their funds.

Hackers stole $120 million from Defi protocols in 2020 through 15 separate attacks. Only 50% of the stolen funds were later recovered.

Asset risk

The blockchain cannot eliminate the risks which are inherent to investing.  There is extreme volatility in the Crypto markets opening the investor up to holding assets which can decline in value rapidly and cause liquidity risks.

In extreme circumstance this can lead to panic selling and something known as a “bank run” which can send prices plummeting, sometimes to zero.   The market is heavily weighted with retail investors, which increases the volatility.

Compliance/legal risk

Defi is still in its early stages and many of the services that are offered are by unincorporated bodies that appear to operate outside of regulatory obligations. As most of the services that Defi essentially offer are digitized and automated software programs, there is no longer the need for the intermediary, such as the bank, which in turn can lead to several risks and result in an uncertain regulatory environment.

No direct guidance from regulatory bodies can lead to a host of problems whether it be anti-money laundering or consumer protection. Regulators in the U.S and elsewhere are increasingly talking about ways to rein in these risks by pushing for greater regulatory clarity.

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Staking is a phrase you will hear frequently in the Crypto industry and it can be a complex idea or simple one depending on how deep you want to dig. Crypto Staking is similar to depositing money in a bank and in return you earn a percentage-rate reward over time for locking up your assets. Before delving into the practicalities of staking, we first need to understand the mechanism that underpins the staking process; Proof of Stake.

What is Proof of Stake?

Proof of stake is new consensus mechanism that emerged with the idea of increasing blockchain speed and efficiency and allowing for blocks to be mined without relying on specialised mining hardware, such as ASIC computers but instead network participants. Participants can pledge their coins to the cryptocurrency protocol for a chance to add the new block onto the blockchain in exchange for staking rewards.

Participants that stake larger amounts have a higher chance of being chosen as the next block validator. This model is far more energy efficient than proof of work, as it doesn’t have to rely on miners to validate the blocks.

The Practicalities of Staking

On a very practical level, Staking involves transferring funds from a cryptocurrency wallet to a blockchain validator node in order to support the security and operations of a blockchain network. The reason your assets receive rewards whilst being staked is that the blockchain validator puts your assets to work using a proof of stake (PoS) model.

This process is used to ensure that all transactions are verified and added to the blockchain. It is important to note that staking is only available with those cryptocurrencies that use the PoS model.

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Decentralised Finance, or more commonly known as DeFi, is an umbrella term for peer-to-peer financial services hosted on the blockchain that are geared towards disrupting the conventional financial system.

DeFi allows users to earn interest, borrow, lend, buy insurance, trade derivatives and trade assets without relying on any third party like banks or brokerages to facilitate the transaction. It also does away with the lengthy KYC process required to transact with any of these organisations.

More importantly, users have full control over their assets, differing dramatically from the centralised financial organisations we all currently utilise.

The Benefits

One of the main benefits of DeFi is the easy access to financial products, particularly for those individuals who do not have access to the current financial system. According to the world Bank Data from 2017, approximately 1.7 billion adults globally are estimated to be “unbanked”.

Summary

In summary the aim of DeFi is to create a financial ecosystem that is open source, permissionless, transparent and operates without any central authority. Once fully adopted, DeFi has the potential to totally disrupt the current financial system as we know it.   

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Passive income is income generated from investments where the investor does not have to actively work in order to make the investment grow. In the Crypto space there are a number of areas where passive income can be earned of which the most popular are currently Mining, Staking, Lending, Yield Farming and Liquidity Providing.

Mining

What is Mining

Mining cryptocurrency is the original form of earning passive income in the cryptocurrency space using the original consensus algorithm, Proof-of-Work. Miners will compete against each other to solve complex mathematical problems and verify transactions on the blockchain. The fastest miner to solve the puzzle will win the right to produce the next block on the blockchain and in turn be rewarded with crypto coins or tokens.

Bitcoin: The Early Days

In the early days of Bitcoin this was relatively easy and an everyday computer could be used. As the competition increased, miners were forced to use more energy and more power to retain the same success. Today cryptocurrency mining has become mainly a corporate business where there are large mining farms using hundreds of ASICS (Application-Specific Integrated Circuits) and large amounts of electricity.       

Staking

What is Staking?

You can stake your crypto by transferring specific coins from a cryptocurrency wallet to a blockchain validator node in order for them to support the security and operations of a blockchain network. The reason your assets receive rewards whilst being staked is that the blockchain validator puts your assets to work using a proof of stake (PoS) model. This process is used to ensure that all transactions are verified and added to the blockchain.

The Pos Model

It is important to note that staking is only available with those cryptocurrencies that use the PoS model. PoS is a more energy efficient alternative to the proof of work model used by Bitcoin and Ethereum1.0 currently use.

There are cases where you have to add or delegate funds to a staking pool but on the whole exchanges will do this for you. Some examples of coins that can be staked are Polygon (MATIC), Terra (LUNA), Polkadot (DOT) and Binance (BNB)

Lending

What is Lending

Lending has become very popular way of earning passive income in the crypto industry as it returns a far higher interest rate than a bank would pay for a cash deposit. The basic values of lending crypto are the same as traditional cash loans in that you can lend your assets for a chance to earn interest and in the case of crypto you are lending your digital assets.  There are four main ways to lend in the crypto arena which are as follows:

• Peer to Peer Lending (P2P) allows you to lock up your assets for a period of time in return for collecting interest payments at a later date.  The system allows the users to set the terms on the amount they want to loan and whether the interest rate should be fixed or set by you based on the current market rate.
• Centralised Lending  (CeFi) allows you to deposit your assets with a third party provider where the interests and lock up periods are fixed and in return the user earns interest (typically paid in the deposited assets). Popular CeFi lenders include BlockFi and Nexo.

• Decentralised Lending are autonomous lending protocols where there is no third party involved.  It allows users to execute lending services directly on the blockchain via smart contracts-powered lending pools to earn interest. Popular Defi Lenders include Compound (COMP) and Aave (AAVE).

• Margin Lending is where the user can lend their crypto asset to traders to trade and get repaid the loans with interest.

Liquidity Provider & Yield Farming

What are Liquidity Pools

Another popular way to earn passive income in the Defi markets is by depositing your crypto assets into decentralised liquidity pools. Liquidity pools provide the liquidity required by decentralised exchanges that allow trading to take place. By doing this you become a “Liquidity Provider”. In return for providing liquidity to these trading pools, the user will be awarded both trading fees and LP tokens (Liquidity Provider tokens). 

LP Tokens

As a Liquidity provider (LP) you will hold LP tokens which gives the LP the option to stake their LP tokens in something known as a “yield farm” which will generate additional yields in the form of cryptocurrency. This essentially means that while your pooled assets are earning a share of all the trading fees your LP tokens are also earning rewards.

Popular Decentralised exchanges with liquidity pools include Uniswap (UNI) and Pancakeswap (CAKE)

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