Decentralized finance (DeFi) applications make it possible to borrow, lend, trade, and earn interest on cryptocurrency without involving a bank or brokerage. And by eliminating those third parties, DeFi promises to make the financial system more efficient. For example, you could earn a 3.2% annual percentage yield (APY) by lending Tether -- a stablecoin designed to track the U.S. dollar -- to the Compound protocol right now. But the average bank currently pays an APY of just 0.06% on money kept in a savings account.
Not surprisingly, DeFi has captured the attention of many. In the past year, the dollar value invested in DeFi across all blockchains rose 1,400% to $257 billion. As that trend continues, Solana (SOL -1.87%) and Avalanche (AVAX -1.44%) are well-positioned to benefit, thanks to the blazing transaction speeds made possible by their innovative consensus mechanisms.
Here's what you should know.
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Consensus mechanisms
Cryptocurrency is powered by blockchain technology and secured by cryptography. That sounds complicated, but blockchain is just a type of database. It's a decentralized system that records transaction data, and that information is stored across every node (computer) on the network. Many of those nodes are miners, which take responsibility for verifying transactions and securing the network.
Generally speaking, that involves one of two consensus mechanisms: proof of work (PoW) or proof of stake (PoS). Cryptocurrencies like Bitcoin and Ethereum use PoW. That means miners group transaction data into blocks, then run that data through a cryptographic hash function, which spits out a 64-character alphanumeric response known as a hash. Notably, the same data will always produce the same hash, and changing even a single digit of the input data would completely alter the output hash.
In PoW systems, miners add a nonce (number only used once) to the data in each block. The goal is to generate a hash that meets the predetermined difficulty pattern -- in other words, a 64-character output that starts with a lot of zeros. But the odds of generating a hash with the appropriate number of zeros are incredibly remote. In fact, Bitcoin miners try hundreds of millions of nonces per second until a valid output is generated, which takes roughly 10 minutes.
At that point, the valid hash is added to the block as a signature, and the finalized block is added to the blockchain. Let's call that finished block of transactions "Block B." Here's the important part: The hash from Block B is added to the next block -- let's call it "Block C" -- which creates a secure chain. Remember that changing even a single digit from Block B would completely alter the 64-character output. So if you attempted to fraudulently edit transactions in Block B, its output hash would change, meaning it would no longer match the hash added to Block C. Under those circumstances, the blockchain would reject the change and revert back to its original state. That's how cryptography is used to secure the public ledger of transactions on the network.
Systems secured by PoS consensus work in a similar way, except rather than spending computing power, miners (now called validators) must stake a predetermined amount of cryptocurrency. That guarantees their honesty because any attempt at fraud will result in the loss of their stake. Once that prerequisite is met, validators are chosen at random to add new blocks to the blockchain, thereby securing the network as described above.
Solana and Avalanche are different
In both PoW and PoS, once the valid hash signature is applied to a block, all nodes in the network must confirm its validity. That takes time, creating bottlenecks that result in slow transaction speeds and high transaction fees. Put simply, the cryptographic consensus mechanisms used to secure most blockchains aren't easily scalable.
To solve that problem, Avalanche uses a type of PoS built on snow protocols. Whereas other mechanisms require every node to confirm transactions with all other nodes, Avalanche nodes repeatedly and randomly sample a small subset of nodes until everyone within that sample group is in agreement. That allows the network to reach a consensus more quickly. In fact, Avalanche can currently handle 4,500 transactions per second (TPS), and it reaches finality in less than two seconds (i.e., the point at which blocks are irreversibly added to the blockchain). For context, Ethereum handles roughly 14 TPS, and it takes six minutes to reach finality.
Similarly, Solana blends proof of history with PoS to achieve consensus. In this system, incoming transaction data is timestamped as it's hashed, creating a verifiable timeline of events. That means each node can validate each transaction independently, rather than waiting for consensus from every other node. To that end, Solana can handle 50,000 TPS today, and it reaches finality in less than a minute.
That makes Solana the world's fastest blockchain in terms of throughput and Avalanche the world's fastest blockchain in terms of time to finality. In both cases, those value propositions have generated significant interest among developers and investors. In fact, Avalanche and Solana rank as the fourth and fifth most popular DeFi ecosystems, with $12.3 billion and $12.2 billion invested on each platform, respectively.
Going forward, as DeFi continues to gain traction, more developers and investors will likely find their way to these ecosystems. And because validators collect transaction fees in the form of the native cryptocurrency, increased use of the Solana and Avalanche blockchains means demand for the coins should rise, driving their prices higher.
