Decentralized finance innovates so quickly that new concepts, practices, and financial primitives are upending traditional finance in real-time.
While keeping up with every new DeFi buzzword is nearly impossible, one that’s worth understanding well is composability, sometimes referred to as money legos.
Composability is the interoperability of DeFi protocols resulting in efficient, creative financial services and products for DeFi end-users. That’s a mouthful, so let’s break it down.
Every day, protocols like Aave, Yearn, Synthetix, Curve, and RenVM (amongst others) mesh together to enable, process, and deliver new financial products only possible in DeFi. To understand this point, remember that DeFi protocols are open-source, permissionless, and can be used by anyone.
The open-ended and permissionless nature of DeFi protocols allows you to stack these protocols together just as you would a lego set. By playing with composable money legos (i.e., DeFi protocols like Yearn), you can unlock incredible yield farming returns, deploy flash loans, or take out loans that repay themselves.
The basic point to understand about composability is that DeFi protocols, apps, and platforms can work with each other to your benefit. However, the amount of use you actualize by combining their functions is up to your creativity.
So, how do you play with money legos to make their composability feature work for you? Alchemix, a DeFi loan protocol, is a great example to learn from.
Alchemix allows you to take out instant self-repaying loans. No, that isn’t a typo — Alchemix loans automatically repay themselves over time. The way it works is disarmingly simple:
When all is said and done, Alchemix loans are free, but a lot of money legos action happens in the background to auto-repay your loan.
For beginners, Ethereum is the base layer protocol. Composability favors same-chain protocols because true multi-chain interoperability simply isn’t here yet (but, thanks to Polkadot, it might be soon).
For beginners, Ethereum is the base layer protocol. Composability favors same-chain protocols because true multi-chain interoperability simply isn’t here yet (but, thanks to Polkadot, it might be soon).
Next up on the Alchemix order of operations is Maker DAO. Maker uses Ethereum to mint DAI, an asset-backed stablecoin that always equals one dollar. To use Alchemix, you must deposit DAI, which means you either mint DAI on Maker or convert to DAI from another token.
Once you deposit DAI into your Alchemix Vault, the vault starts farming (loaning) your DAI to other DeFi protocols like Yearn, Curve, and Sushi. By doing this, your vault position starts earning yield, the future earnings of which back your loan today.
The composability of the DeFi protocols in the Alchemix ecosystem turns an otherwise fixed amount of DAI into a powerful financial tool capable of regenerating itself.
A popular saying goes: money doesn’t grow on trees. Money may not grow on trees, but thanks to DeFi money legos, money does grow from money with a level of efficiency unthinkable in traditional banking.
The best DeFi apps, products, services, and protocols also happen to be the most composable.
What makes a DeFi protocol valuable in a composable environment is the utility created between other DeFi money legos. An easy way to understand this is to look at Curve Finance — most protocols use Curve for their services and products, making it a DeFi ecosystem essential.
Ethereum is the current home base of DeFi because it contains the vast majority of total value locked into DeFi apps. However, the rise of blockchain ecosystems not called Ethereum proves that the not-too-distant future of composability entails full interoperability across blockchains.
DeFi’s ability to freely take, integrate, and recycle components from various technologies enables it to find combinations that simply work. Moreover, the interoperability of decentralized finance protocols enables the entire ecosystem to benefit from derivative gains.
As such, the more open and permissionless DeFi becomes, the stronger it is overall, and the more end-users benefit from a genuinely frictionless financial reality.
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