What are DApps and how do they work?
Decentralized apps, or dApps, are software powered by cryptocurrency. By paying with crypto-coins, users can receive various software-enabled services, such as digital wallets or games. So if you think of cryptocurrency as a token that pays for machines to run, then dApps act like a video arcade, where clients can deposit money to use the service.
Here’s how dApps work—pronounced Dee-Apps or maybe just daps, depending on who you ask—and why they’re key to moving forward with the promises of the so-called Web3.
What are dApps and how do they work?
Decentralized apps and traditional apps are similar in many ways, offering a service, such as running a social network, making a stock trade, or handling some other rote task. The main difference between these two types of apps is that dApps use blockchain technology, which is a database that records every transaction that usually runs on a decentralized computer network.
To use a dApp, a user pays a certain amount of cryptocurrency to activate a smart contract, a type of contract that automatically executes when certain conditions are met. For example, a smart contract can perform a stock trade, like the arcade running a game after you deposit a token.
The blockchain database allows each action to be performed and recorded on a distributed ledger, decentralizing the entire process and removing centralized oversight of the process. However, dApps are often open source, meaning that any person can see the code behind the app and even make their own contributions to it.
“Whether a user creates an account, buys a digital good, makes a trade or transfers assets, they only need to trust the open source smart contract and the underlying decentralized network,” said Eric Chen, CEO and co-founder of Injective Labs , a company that creates and develops decentralized financial markets.
“All activity is also logged and secured on-chain, so everything is fully visible and uneditable, creating full transparency and accountability for the end user,” says Chen.
This transparency “allows users to verify that the dApp is running as intended and that there is no fraud or cheating,” says Aaron Rafferty, CEO of BattlePacs, a voter engagement platform that uses blockchain and non-fungible tokens (NFTs) to fuel political debate.
What are some popular dApps and why would someone use them?
The broad appeal of dApps is that they provide users with increased privacy and greater security than traditional apps, providing valuable benefits to users. Decentralized apps can perform a variety of different functions, but they are often focused on a few different areas:
- Decentralized exchanges: Decentralized exchanges allow clients to trade cryptocurrencies or NFTs between each other, peer-to-peer. Without a single point of failure, Rafferty says, the exchange becomes more robust and “less likely to be hacked or shut down.” Relying on a “trustless” network, users are not forced to provide personal information, although they may be legally required to in some areas.
- Yield Platforms: A yield platform is part of what is called DeFi, for decentralized finance. A yield platform allows the cryptocurrency owner to earn interest as part of a loan or from providing liquidity on an exchange, among other income-generating ideas.
- Wallets: A crypto wallet works much like an analog wallet, allowing a crypto owner to hold, spend, and receive cryptocurrencies. Among other things, they can be used to sign transactions and manage private crypto accounts.
- Game: Games are a popular form of dApp, which allow players to earn and spend virtual currencies.
And dApps can host other popular services such as messaging apps, social media and video streaming platforms from a decentralized blockchain platform. DApps provide a use case for cryptocurrency, given its limited use in the real world.
“These dApps often offer a higher level of privacy and security than their centralized counterparts,” says Rafferty, noting the immutable nature of blockchain-based dApps.
“Once something is put on the blockchain, it cannot be taken off or changed without network consensus,” he says. “This allows developers to create more secure and reliable applications, which in turn gives users a better experience.”
The open source nature of dApps can also help build resilience among the entire network.
“For example, decentralized exchanges can form an ecosystem with strongly linked incentives to add features and product offerings for users at an exponential rate, which a centralized exchange cannot do,” says Chen.
What are the disadvantages of dApps?
While dApps can create (or recreate) many popular services or platforms on the traditional internet, they are not without significant problems for users.
- Bad coding: One of the biggest concerns with dApps is the coding itself, especially around smart contracts. The smart contract or dApp is only as good as the underlying code. If you pay for a particular service, you may not get what you pay for. Furthermore, smart contracts are immutable after they’re in place, experts say, meaning you could be out of luck and money.
- Potentially expensive: Using dApps can be expensive, depending on exactly what you do and when. For example, if you use a wallet to send cryptocurrency, it may end up costing a significant amount to do so. And that cost can change depending on exactly when you want to use the service.
- Enables potentially illegal activity: One of the major use cases for cryptocurrency is to enable payment for illegal goods and services or to facilitate money laundering. “It’s important to research a dApp before using it and to be careful when sending or receiving payments,” says Rafferty.
- No guarantees of profitable trades: A dApp may enable the trading of virtual assets or cryptocurrencies, but that alone will not make them a profitable trade. As a user, you must decide whether it makes sense to use the dApp to, for example, trade or lend cryptocurrency. The dApp only facilitates the transaction.
- Security issues: A poorly coded smart contract can also expose users to financial loss if the contract involves a financial transaction of any kind. Hackers have increasingly targeted smart contracts because of the potential payoff if they succeed.
“DApps are still in their early stages of development and as such may be subject to technical risks,” says Rafferty.
The bottom line
The appeal of dApps can be significant if you’re looking for specific features that leverage blockchain technology’s strongest features, including privacy and immutability. But dApps still pose significant risks to users who want to conduct financial transactions, although even those risks may be reasonable for users who want to avoid oversight of certain types of transactions.