Linda Xie's new work: Composability is Innovation

This article is from Future, authored by Linda Xie, co-founder of Scalar Capital, and compiled by DAOSquare.

Linda Xie, co-founder of cryptocurrency investment firm Scalar Capital, believes that the composability of smart contracts has led to emergent innovations in the crypto world. The article showcases typical cases such as DeFi, no-loss lotteries, publishing (the combination of Mirror and Zora), and flash loans to demonstrate the implementation and advantages of smart contract composability. Composability will place cryptocurrencies at the forefront of revolutions in finance and other industries, fundamentally changing sectors like the internet did, and opening up a new world of infinite possibilities.

Here is the original translation:

While many in the tech community have heard of Bitcoin, cryptocurrencies, and blockchain, smart contracts remain relatively unknown, despite being a significant innovation of Ethereum. Anyone can write a smart contract and deploy it on a public blockchain, enabling various innovations. Hot concepts like NFTs, DeFi, and DAOs—representing new ways to define ownership, provide better financial systems, and facilitate collaboration—are all driven by smart contracts.

Smart contracts empower new types of transactions and have clear advantages over traditional systems. Traditionally, banks take weeks and a lot of paperwork to verify a person's asset status before issuing a loan. With smart contracts, a loan can be automatically issued based on collateral provided by the individual using a piece of code.

However, smart contracts do more than allow various applications to conduct instant and verifiable transactions—they also enable interactions between different applications through programming. In other words, they allow cryptocurrency programs to be composable, like building blocks. This characteristic of composability has garnered significant attention from tech enthusiasts, but it is still not widely understood by the general public; yet, it is one of the most powerful features of cryptocurrencies. Composability allows for the utilization of existing programs within this network and enables adjustments or constructions on top of them, unlocking entirely new use cases that did not exist before.

In other words: composability is innovation.

Why composability is feasible and what new possibilities it brings

In a vast network composed of relatively independent distributed participants, anyone has the ability to leverage others' work to create new applications, but this does not happen spontaneously—it requires collaboration among many people. Developers of Ethereum smart contracts have gradually achieved composability by forming standard protocols that describe how certain types of contracts should operate. For example, the ERC-20 token standard, first proposed by developer Fabian Vogelsteller in November 2015 and formally established in September 2017, describes how Ethereum tokens operate, including basic functions like token transfers and authorizations when consuming tokens, allowing third-party developers to easily support any token that complies with the ERC-20 standard.

This standardization is crucial for composability, just as the internet, email, and other standardized protocols were essential for the development of the web. With these token standards, smart contracts can serve as building blocks that can be combined into larger systems. Like a software library, smart contracts from different protocols and applications can be easily combined like LEGO blocks. In fact, smart contracts in decentralized finance (DeFi)—one of the earliest and most active examples of composability—are often referred to as "money Legos."

How composability plays a crucial role in decentralized finance

Financial positions in DeFi protocols—allowing users to lend, borrow, trade, or interact in other ways without the need for centralized financial institutions—can be represented as ERC-20 tokens that can be redeemed for related funds. For example, if you deposit USDC (tokenized dollars) into the lending protocol Compound, you will receive cUSDC, which represents your certificate of earning interest within Compound. Similarly, when you deposit funds into the decentralized exchange protocol Uniswap to provide liquidity for a specific market, you will receive an ERC-20 token representing your share of the funds in the relevant Uniswap liquidity pool.

Most importantly, these tokens are not "locked" in one protocol—they can now be used in other DeFi protocols. For instance, you can use your Uniswap liquidity provider (LP) tokens as collateral in the lending protocol Aave. Smart contracts enable developers to easily interact across multiple applications based on other protocols; the decentralized finance world encompasses everything from lending to derivatives.

While some DeFi transactions may not be easy for most people to participate in—either due to the complexity of certain applications or the technical knowledge required for protocol interactions—the usability is continuously improving. Projects like Furucombo and DeFi Saver allow users to build and visualize the transaction chains involved in composing different DeFi components, simplifying the workload for developers to combine and interact with different smart contracts. People can easily customize process activities or directly use modules composed by others.

Composability will inevitably bring more choices and better user experiences, as people can act without barriers on existing ideas, and the process is greatly simplified, making it easier to embrace new use cases. As more underlying technologies are simplified, the focus will shift to what people want to do with their money, rather than being constrained by the inefficiencies of the traditional financial world.

So what does composability mean for builders and developers?

Most possibilities can only be unlocked through experimentation, but some new possibilities it brings for builders include:

Developers can create their own projects and communities with minimal financial resources without having to reinvent the wheel, as smart contract platforms like Ethereum can establish systems like a vast, open sandbox. This allows small teams to quickly launch their own projects, which is a significant driving force behind rapid innovation in the crypto world. For example, a new video game developer can easily enhance users' ability to trade items in the game by integrating decentralized exchange protocols instead of building a new marketplace from scratch.

Non-cryptocurrency businesses can improve efficiency and expand more functionalities by introducing open ecosystems like Ethereum, similar to the API economy, which enables various types of companies, including baby stores and small businesses, to access data and capabilities they could not obtain otherwise. In the tech space, a typical case is Reddit's experiment with community points, where tokens are used to reward users for posting high-quality content that can be redeemed for unique items within the community. Reddit plans to launch community points in the form of ERC-20 tokens, allowing them to be used in existing Ethereum wallets and applications. This expands the functionality of community points without Reddit needing to rebuild them from scratch. Even if it is not a cryptocurrency company, it can provide its users with the benefits of cryptocurrency applications, such as allowing Reddit users to use decentralized exchanges on Ethereum to convert their points into other tokens. This will give their points liquidity from the start. Furthermore, once integrated into the Ethereum ecosystem, everyone can incorporate community points into their projects, thereby creating more use cases based on that.

Developers can learn and apply various concepts across industries, including technology, finance, gaming, and art, leading to a deeper understanding of each sector, forming new ways of thinking, and providing new application scenarios for people. For example, by adding DeFi components to games, one can better understand incentive mechanisms and markets; by adding gaming components to DeFi, it can make financial concepts easier and more interesting for the general public. Relatively isolated communities—because they spend time on different platforms or cannot communicate—can also exchange ideas and share thoughts through this method, sparking innovation. Even if everyone is a stranger, smart contracts can facilitate more open and efficient information sharing, making communication more trustworthy.

In addition to the DeFi cases I just shared, there are many interesting composability use cases currently in the crypto world, including:

Earning yields through "no-loss" lotteries

PoolTogether is a project that utilizes decentralized finance protocols to create "no-loss" lotteries. Users can purchase lottery tickets, and all funds collected from ticket sales go into a prize pool, earning yields from decentralized finance protocols like Compound and yEarn Vaults. Everyone can get back their own funds, but one person will win all the accumulated interest earned from the pool. No one loses their principal, making it a "no-loss" lottery. Anyone in the world with an Ethereum address can participate in no-loss lotteries, and anyone can create no-loss lotteries for any token, making participation in such systems easier and safer.

NFTs as collateral

Non-fungible tokens (NFTs) have recently gained significant attention. Unlike interchangeable "fungible" tokens in the ERC-20 token standard, NFTs are unique digital assets whose ownership can be traced on the blockchain. However, even if the tokens themselves are not interchangeable, they still exist within a composable ecosystem. This means that when they are issued on a smart contract platform, anyone can own an NFT or use it to exchange for any other asset existing on the same platform.

When "composing" (inserting, combining) decentralized finance modules, NFT activities are not limited to trading; they can include using NFTs as collateral for loans (like NFTfi), renting out or earning interest on NFTs (like RenFT, Charged Particles), and more.

Imagine you own a valuable piece of real estate in virtual worlds like Decentraland or Cryptovoxels; you could actually borrow USDC against that asset to pay for a down payment on a real-life house. Or say you own an ideal skin in a video game—you could rent that item to other players for temporary use, just like renting a room on Airbnb.

Content publishing

Another typical case of combining two applications due to the composability of smart contracts is the collaboration between Mirror (a decentralized publishing platform) and Zora (a protocol for creating and trading NFTs). Through this combination, Mirror authors can convert their posts into NFTs and embed auction links for the NFTs within their posts. In turn, this allows creators to crowdfund works such as novels, blog posts, or even research papers and other artifacts, where purchasing NFTs will help fund the creators.

Sometimes, NFTs can allow contributors to earn a share of the proceeds when the NFTs are resold. Imagine how interesting it would be if early Kickstarter supporters of Oculus could benefit when Oculus was sold to Facebook due to their belief and support. Recently, John Palmer's $ESSAY became the first community-owned article crowdfunded on Ethereum. This article, published through Mirror, was minted as an NFT on Zora, with supporters forever embedded in the article. People supported the author through crowdfunding donations, achieving a piece of history—the first community-owned article. But in other cases, early contributors (alongside the creators) can also share in this secondary value.

Flash loans

Flash loans are one of the most unique features that cryptocurrencies can achieve—there is nothing in traditional financial systems that can compare to flash loans. Flash loans allow someone to borrow funds and repay the loan within the same transaction; if the loan is not repaid within the same transaction, the transaction fails.

This allows loans to be unsecured, meaning anyone in the world can access these flash loans, regardless of how many assets they have. Flash loans are a deeply integrated application of cryptocurrencies, but in the DeFi space, they are often used for arbitrage.

As cryptocurrencies mature, we can expect these composable smart contracts to gradually apply to the vast world beyond the cryptocurrency community. Ultimately, developers will be able to add a complete decentralized marketplace to video games with just one line of code; or, with another line of code, enable merchants in their e-commerce stores to earn interest on their balances. For institutions, composability places cryptocurrencies at the forefront of revolutions in finance and other industries—this will fundamentally change sectors like the internet did. And for consumers, it will open up a world of new possibilities.

Here, I have only touched the surface of what may happen in the future. The next step is more experimentation. This article has discussed relevant technologies, and in the future, humanity will use its ingenuity to unlock new chapters.

Thanks to Will Warren for reviewing this article.

Related disclosure: Linda Xie is a Managing Director at Scalar Capital Management, LLC, a firm focused on cryptocurrency assets, holding ETH and Ethereum tokens. This article does not constitute investment advice.