Decentralized finance (DeFi) is fundamentally driven by composability. It enables developers to create new, innovative financial products and services by building on top of existing protocols and smart contracts. Composability enables the different DeFi protocols to work together in a way that creates a more efficient and complex system of financial operations. This allows protocols to work like legos whereby one protocol’s output can be fed into another’s input, giving rise to much richer use cases and providing the potential to extend the scope of decentralized finance beyond isolated applications.
Why does Composability Matter?
The core idea of DeFi is open and permissionless innovation. By composing protocols, developers can build on the work of others, combining protocols to create new functionality that is not possible—or at least not practical—to build on their own. It creates a positive feedback loop: The more protocols that are developed and made interoperable, the more valuable the whole ecosystem becomes, which is good for increased liquidity, greater capital efficiency, and a more vibrant market of financial products. Composability is important not only within the same blockchain ecosystem but also across different blockchains. Cross-chain interoperability enables assets and data to flow freely across ecosystems, creating new markets and opportunities. It is far more valuable to have a protocol that can easily interface with other protocols because it can leverage the liquidity, user base, and utility of the entire DeFi ecosystem.
Powerful Solutions
Composability is powerful, and it’s not limited to a single blockchain. Axelar and Wormhole, cross-chain solutions, are essential to moving DeFi off of isolated chains and into the connected, multi-chain ecosystem it should be. Axelar’s interoperability layer enables decentralized applications (dApps) to send assets, data, and messages across multiple chains such as Ethereum, Cosmos, Solana, Avalanche and more. Axelar unlocks these dApps to work seamlessly across chains, creating a global, cross-chain DeFi ecosystem that expands the opportunity for liquidity, user base, and use cases.
Wormhole also enables token transfers between Solana, Ethereum, Terra, and other blockchains by providing a decentralized bridge allowing for secure, trustless token transfers across chains. This is essential for DeFi protocols to aggregate liquidity from multiple sources or to create cross-chain products, such as liquidity pools, lending markets, or decentralized synthetic assets. Axelar and Wormhole are the next frontier of DeFi’s composability, making multi-chain interactions simple, efficient, and secure.
Does Layered Interactions Matter?
The layered interactions that composability enables to push the boundaries of DeFi by expanding the range of possible financial services and the efficiency with which they can be created and executed. These interactions matter for several key reasons:
Capital Efficiency
DeFi protocols are able to focus on their core competencies such as AMMs, lending, or derivatives and outsource other functionalities to specialized protocols thanks to composability. This leads to more capital-efficient products – liquidity from different platforms can be pooled and optimized for the best returns. For instance, a lending protocol can use liquidity from an AMM (such as Uniswap or Curve) to provide better borrowing rates or collateralization options.
Liquidity Aggregation
Liquidity aggregation is greatly improved by cross-chain composability. Now an Ethereum-based liquidity provider can interact with lending protocols on Solana and leverage Solana’s lower transaction costs and faster speeds. The result is a more liquid and efficient market, where assets can flow between ecosystems to allow capital to be deployed where it is most efficient.
Innovative Financial Products
Composability, in its modular form, makes it possible to create new financial products that combine the features of several protocols. Composability creates synthetic assets, decentralized derivatives, and tokenized options. By stacking and combining protocols, developers can build on top of new financial structures, such as liquidity-backed synthetic assets, without having to build all the components themselves. For example, a lending protocol can be combined with a decentralized oracle to form a synthetic commodity exposure product that allows users to bet on or hedge price movements of real-world assets.
So what can we learn from all these?
Composability is the backbone of DeFi’s explosive growth and the reason why it can continue to push the limits of decentralized finance. With the inclusion of protocols such as Kamino and Orca, Meteora and Raydium, and the emergence of cross-chain solutions like Axelar and Wormhole, DeFi protocols can reach entirely new levels of functionality. These layer interactions enable more capital efficiency, liquidity aggregation, and the creation of innovative financial products. As the composable DeFi ecosystem matures, it will unlock more sophisticated and complex financial structures, bringing DeFi to newer and broader financial landscapes.