A Complete Guide to DApps: Types, Use Cases, Risks, and Why Traders Love Them

What Is a DApp? The Ultimate Beginner-Friendly Explanation

Decentralized Apps (DApp) unlike traditional applications such as Instagram, Uber and Bank Applications, which run on servers owned by one company, DApps function on decentralized networks, and no one single company or organization has complete control over how these applications operate.

For an analogy, using the restaurant: A traditional application is like a restaurant where the owner of the restaurant determines what food will be served, how much the meals are, and who will and will not be served. A DApp can be viewed as a community potluck, where everyone brings a dish to share, and everyone follows the agreed-upon rules; however, no single person is the head of the potluck.

Three core pieces make a DApp work:

Blockchain: Blockchain is a distributed ledger system built and operated on thousands of computers globally rather than on one single company's server farm.

Smart Contracts: Smart Contracts are automated applications (programs) that execute themselves once their required criteria are satisfied. Think of a vending machine. When you put your money in and hit the button, the merchandise drops down without anyone being present to assist. This is exactly how smart contracts operate except they provide a more sophisticated feature set than merely purchasing candy bars.

Tokens or incentive mechanisms: Tokens or incentive mechanisms are typically cryptocurrency-based tokens that serve as a means of rewarding users, assisting in the execution of transactions and giving holders a voting right in governance roles.

The primary variations between DApps and traditional applications are that DApps provide an open-source environment for all users to see and verify the code; they provide a permissionless setup and do not require any type of permission from any third party for use; and DApps are totally transparent as all transactions take place on the blockchain and are available for anyone to view. DApps essentially take away the need for the traditional application framework.

 

Two examples of DApps working in the marketplace are Uniswap, which allows you to exchange cryptocurrencies directly without a middleman such as Coinbase; and Aave, which allows you to lend money via blockchain technology without the need for a banking facility. Both companies conduct billions of dollars worth of trades on a daily basis without being tied to the traditional corporate structure of most corporations.

For a beginner, the best way to visualize DApps in comparison to traditional applications is to think of WikiPedia vs. the Encyclopedia Britannica. DApps are attempting to accomplish the same goal of putting control back into the hands of consumers by eliminating the central authority of a company and creating DApps as entirely user-driven systems.

How Do DApps Work? A Step-by-Step Breakdown

Here is how a DApp works in terms of what is really happening when you interact with it:

Step 1: You need to authenticate by connecting your cryptocurrency wallet. A wallet acts as an entry pass for the user to access and use the decentralized application. Rather than providing a username and password via email, users simply connect their wallet.

Step 2: The user sends a transaction by making a request to the DApp through the smart contract. As an example, if the user wants to exchange tokens using Uniswap, the user types the token amount they wish to exchange and clicks the swap button. This triggers a transaction that gets sent to the smart contract.

Step 3: The smart contract executes automatically, without the need for any human intervention, based on its underlying code. It automatically validates that the user has enough tokens in their wallet to exchange for the desired amount of tokens based on the calculated price from mathematical equations.

Step 4:  During the time the transaction is being processed, thousands of network nodes are validating the transaction and making sure the transaction meets specific rules. This process occurs within a few seconds to a few minutes, based on how congested the network is at the time.

Step 5: After a successful validation process, the blockchain will update the transaction to be permanent. After the update has occurred, the transaction is now a permanent record and cannot be changed, reversed, or deleted by anyone, including the DApp developer.

Let’s examine a tangible example, namely ETH to USDC trading on Uniswap. To swap ETH for USDC, first, you open the Uniswap app and connect it to your MetaMask wallet. Afterward, you specify how much ETH you want to exchange and confirm that transaction.

The smart contract on Uniswap calculates the exchange rate through the ratio of the liquidity pool, it subtracts a small transaction fee for the liquidity providers, and it then sends USDC to your wallet upon successful processing of your transaction. All processing of this exchange occurs without any manual involvement by Uniswap employees.

However, the transaction will incur transaction fees, or gas fees. All transactions on a blockchain require computational processing power that miners/validators are responsible for supplying in return for rewards, this processing power has a price, called “gas”. During periods of high usage, the price to transact can become very high, often exceeding $50 USD per transaction, particularly on Ethereum.

The most significant difference between DApps’ operations versus traditional apps is that DApps’ rules/code are immutable after they are deployed. When you use an app like Venmo, the Venmo company has the ability to freeze your account, reverse or modify your transaction or change the fee structure without any warning to you. DApps, on the other hand, rely solely on their predetermined code/rules. Therefore, once deployed, the results of the software execution from the smart contract will always run as programmed, with no exceptions, no special treatment and no recourse to report issues or ask customer service for help.

DApps are like automatically dispensing coin machines; after you deposit your money into it and press the button, you have no further influence on what will occur. You have lost the ability to negotiate, request exceptions or any other similar formats of transactions.

Types of DApps: The Essential Categories Every Crypto Trader Should Know

In addition to token trading, DApps are used in a wide variety of industries, each targeting specific problems.

DeFi DApps (Decentralized Finance) are designed to enable transactions using the internet without requiring banks. A decentralized exchange (DEX), such as Uniswap, allows peer-to-peer cryptocurrency trading. Aave and Compound enable earning interest on deposits or borrowing money based on collateral, while dYdX enables leveraged crypto trading. In other words, DeFi allows users to generate interest on their assets without using a traditional banking system, enabling people worldwide to transact with one another.

GameFi DApps (Blockchain Gaming) allow players to have undivided ownership of their in-game assets in the form of non-fungible tokens (NFTs). For instance, Axie Infinity introduced the idea of a gaming business model based on players earning cryptocurrency as a reward for playing games. Some GameFi DApps, such as The Sandbox and Decentraland, provide users with virtual spaces to create economies. In basic terms, GameFi provides players with the opportunity to own assets within a digital environment, allowing them to earn money from selling those assets.

Social DApps Platforms such as Lens Protocol and Farcaster are designed to create an environment in which social media users can exert control over their content and data. As opposed to Facebook owning the information you post on its platform, you can exert control over what you post and when. Social DApps are still in their infancy, but they are already increasing in popularity.

Infrastructure Decentralised Applications (dApps) are a component. Chainlink provides real-world data through smart contracts (commonly referred to as oracles) and Filecoin is an example of a decentralised storage service. The Graph enables developers to easily index and query blockchain data.

Utility DApps encompass the remainder of dApps available, from providing decentralized identity systems to enabling prediction markets (such as Polymarket) via Decentralized Oracle Services (DOS), solving specific needs by leveraging the unique attributes of blockchain technology.

DeFi is the most prevalent sector with over 60% of dApp usage and over $16 billion in value locked (total value of frozen funds). GameFi surged in popularity, millions were invested into gaming and DeFi integration. Social Dapps will provide a critical dimension that has yet to be realised as Web3 evolves.

Each DApp type has its own unique purpose and supports different types of user needs, however they are similar because they operate on a governance model based on code, lack restrictions to geographical boundaries, and promote user ownership of their applications.

Why DApps Matter: Key Advantages for Traders, Investors, and Everyday Users

DApps bring distinct advantages to users compared to traditional apps.

1. No centralization means no single point of failure. If your bank’s server goes down, you cannot get your money. DApps are built on distributed networks, which means that if there is a centralized outage somewhere in the network, your DApp will continue to function. Even if the developers are no longer around, the DApp will continue to function.

2. Transparency creates trust.The blockchain shows everything. You can see every transaction made and every rule applied, and every fee charged on the blockchain. You know how much Uniswap charges per swap (0.3% for the majority of pools), and you can find it without looking through the fine-print of your bank statements.

3. Global access allows anyone to use DApps, regardless of whether they have a bank account, credit history, and/or government-issued ID. The global access offered by the internet allows people in countries that have unstable banking systems or heavy regulation to participate like anyone else with an internet connection.

4. Innovation can happen quickly when permission isn't needed.DApp developers can build upon previous DApps without having to ask for permission. The ability to build on top of existing code (this is called composability) leads to rapid innovation in the DApp community. DeFi refers to this as "money legos".

5. Tokens align users and supporters with DApps. Developers often reward users of their DApps by giving them ownership in the form of tokens. An example is Uniswap’s recent airdrop giving early users $1,200+ of UNI tokens. The token ownership model creates an opportunity for community involvement and growth in a way that has never been offered by a traditional company.

The advantages of using DApps for traders includes having control of their funds when engaging in non-custodial trade activities, the ability to trade 24 hours per day for 7 days a week (no downtime), and typically have lower fees compared to centralized exchanges.

The philosophical advantages include the idea that DApps allow for power to shift from institutions to individuals. Rather than relying on an institution to fulfill its promise of equality and fairness, DApps are based on mathematics; therefore, they are free of bias, emotion, and any variables that could cause the rules of engagement to be changed during trading.

These arguments are supported by actual usage statistics: Today, there are over $50 billion worth of assets in DeFi protocols, which are being utilized by millions of people worldwide, who prefer to use technology for trust, rather than rely on institutions.

The Limitations of DApps: Risks Every User Should Know Before Trading

Dapps sound revolutionary; however, they come with serious downsides that you must be aware of.

Gas prices can be prohibitive. For instance, during periods of heavy congestion on the Ethereum network, a simple token swap might cost between $50 and $100 in gas fees. Thus, small transactions are not economically viable. Layer-2 solutions do help address this issue but add more complexity to the mix.

Smart contracts are written in code that cannot be modified after being deployed (hence, “smart”). A single coding error can result in catastrophic consequences that are irreversible by any means but by the developer who created and deployed said smart contract. As evidenced by the DAO hack in 2016, $60 million in ETH was drained; the Poly Network lost over $600 million in 2021 due to a glitch in its smart contract system. Unlike banks, there is no deposit insurance, customer service, or “undo” button. When a hacker exploits a vulnerability, your funds are gone.

User experience with Dapps is quite cumbersome compared to the likes of Coinbase and Paypal. All of these services make the user experience straightforward and easy to comprehend while utilizing a credit card or bank account to fund your purchases. For Dapps, every transaction requires a fundamental understanding of gas fees, slippage, cooling down, wallet security, and blockchain explorers. Furthermore, if you make one mistake when copying the address of your funds, you risk the permanent loss of said funds.

The Risk of Regulatory Uncertainty: With the continuing development of how regulators manage DApp (and DeFi) protocols, there remains a lot of uncertainty on the regulatory side. The SEC has initiated enforcement actions against multiple DeFi protocols, causing confusion among crypto and DeFi participants surrounding what the future holds. This lack of clarity allows competing projects to suffer from the risk of sudden, random enforcement actions.

The irreversibility of transactions (both good and bad) is a big downside to using DApps and DeFi. If you accidentally send your cash to the wrong wallet, there is no way to get that cash back. If you lose your seed phrase, you lose access to your crypto forever. If you have millions of dollars worth of crypto locked in your wallet and you can't find or remember your seed phrase, you'll never be able to access that crypto again.

Liquidity risk is another disadvantage of using DEXs to trade with smaller tokens. Tokens on DEXs with thin liquidity levels can suffer from significant slippage when you make large trades. Just like with your local bank, a "bank run" can occur with DeFi lending protocols as well.

If you are new to blockchain and DApps, the biggest risk is one of education. A good DApp expects users to have baseline knowledge about how a blockchain works (security keys, how to evaluate smart contract risk, etc.) When you are new to a certain area or subject matter, there is a steep learning curve.

Real-World DApp Use Cases: How People Around the World Use DApps Daily

Millions of people use DApps for real-world needs, it's no longer just speculation.

There are a number of different use cases for DApps. The main uses currently are as follows:

Trading/Investing: In 2024 there will be over $150 billion of trading volume processed on decentralized exchanges (DEX) Avalon is an example of a decentralized exchange that does not require KYC compliance from traders, allowing them to trade spot & derivatives for example. It also allows traders in countries that have capital controls to tap into markets that would be out of reach in a regulatory environment.

Yield Farming/Lending: Users are depositing crypto with protocols such as Aave or Compound to earn interest on their deposits that can be many times that of traditional banks. In addition to simply earning yield, sophisticated traders often employ leverage and utilize multiple protocols simultaneously to take greater advantage of the yield opportunities created by this new technology.

Gaming/Digital Ownership: Thousands of players have made sizable earnings playing games on blockchains. In some cases (e.g., the Philippines, Venezuela), Play to Earn gaming has provided a significant opportunity for players as a real source of income. Players also have full ownership of their digital items created while playing these games, enabling them to sell them freely.

Payments/Remittance: Sending stablecoins via decentralized payment applications is generally far less expensive for cross-border payments when compared to using services such as Western Union. Many countries throughout Africa are now seeing rapid adoption of DeFi and using decentralized applications to send remittances.

Creator Economy: Artists are minting NFTs on their own and selling directly to collectors. Musicians are releasing their music via blockchain based services and receiving a larger proportion of revenue. Authors are tokenizing their writing and building relationships with their readers directly.

Decentralized identity: Some platforms are creating identity systems on a blockchain, giving the user control of their personal data. These platforms are still early in development but have the potential to change how we manage digital identities.

Prediction Markets: Websites like Polymarket enable users to place bets on real-world events, which can lead to a surprising level of accuracy via the use of collective intelligence.

Various regions have different levels of adoption of these products. The top region in terms of GameFi use is Asia. The Americas are the leading market regarding DeFi trading volume. Africa is growing very quickly with stablecoin payments and Mobile DeFi.

These products are being actively used by ordinary people every day and are not limited to just cryptocurrency enthusiasts. Moreover, there is an increased number of use cases as the products are moving beyond speculation towards actual uses.

How to Start Using a DApp Safely: A Beginner-Friendly Step-by-Step Guide

Are you interested in using a DApp (decentralized application)? Here’s a guide to help you use one safely without losing any money.

Step 1: Create a Wallet: The first step in using a DApp is to create a wallet, either by downloading MetaMask (as a browser extension) or Trust Wallet (as a mobile app). Your wallet will be your gateway into using DApps, so create your wallet carefully. When you create your wallet, you will receive a seed phrase, which is a string of 12 to 24 words. It is essential that you write this physical piece of paper down and never record it digitally or take screenshots of it. This seed phrase is considered the “master key” to your funds stored in that wallet.

Step 2: Store Your Seed Phrase Securely: Store your seed phrase somewhere safe, such as in a fireproof safe, and never share this information with anyone for any reason, including the operators of legitimate DApps. If anyone asks for your seed phrase, it is undoubtedly a scam, and there are no exceptions to this rule.

Step 3: Fund Your Wallet with Small Amounts: When you are ready to fund your wallet, buy a small amount of ETH if you plan on using Ethereum-based DApps or the applicable cryptocurrency if you plan on using non-Ethereum based DApps. Start with an amount you are comfortable with (i.e., between $50 to $100) in case you lose it while learning about using DApps.

Step 4: Conduct Research on the DApp: Before using a DApp, check whether it has conducted an audit by a reputable security company. You should also look at the operating time of the DApp; newer DApps typically carry a greater degree of risk than established ones.

Step 5: Connect Your Wallet Cautiously: Anytime you connect your wallet(s) to a DApp, you should ensure that you are visiting the genuine and exact URL of the DApp's website since many scam sites use very similar URLs. When you click the "Connect Wallet" button and approve the connection, this connection will not give the DApp access to any of your funds automatically.

Step 6 - Investigating Gas Fees: Before confirming your transaction always check your gas fees to make sure they don't seem too high; if gas fees are extremely high you may wish to wait until more users are using the network (lowering congestion). MetaMask allows users to change gas settings while sending funds to make transactions faster or cheaper for them.

Step 7 - Initial Swaps/Transactions: Use very small amounts of cryptocurrency for your first trading/sending experience; this will allow you time to become accustomed to how crypto transactions occur.

Step 8 - Contract Address Verification: To add tokens to your wallet make sure you verify the contract address from reliable sources like CoinGecko; scammers like to use similar names as legitimate tokens to trick buyers into buying their tokens.

Step 9 - Caution when using New DApps: Be wary of new/newly launched DApps that promise impossible returns or display a lack of professionalism. If a DApp seems like it has an amazing return on investment or feels wrong, then run far away from it.

Step 10 - Continuing Education: Keep Learning About DApps and Their Security: Join and interact with Discord communities, read documentation provided by multiple sources (especially reputable), and continue to familiarize yourself with the best security practices related to cryptocurrency/dapp

Bonus Tip - Bookmark Official DApp Links: To ensure that you are avoiding phishing DApps, always bookmark the actual URL of any DApp you are interested in using; one wrong click can wipe out all the funds in your Wallet!

Future Trends: Why DApps Will Reshape the Global Financial System

Decentralized applications (DApps) mark a shift in how we interact with the internet; they are here to stay.

As decentralised finance (DeFi) matures, the user experience becomes improved, whilst gas fees drop (due to Layer 2 scaling). As such, Defi will take more market share from traditional finance. Additionally, institutions are beginning to adopt this technology with many large companies introducing blockchain-based financial products.

Tokenizing the real-world assets is gaining momentum, with real estate, stocks, bonds, and commodities being converted into tokens for trading on DApps. The benefits of tokenization include 24/7 trading, fractional ownership, and global access to assets that were previously only available to accredited investors

Web3 identity systems will help solve the privacy issue of users. No longer will users have to give their personal data to all the different websites they visit. Instead, users will be able to prove attributes without the need to divulge their complete personal data. This may eventually replace the hodge-podge of different logins we currently use was well as how we share our data.

Cross-border payments are on the way to becoming a mainstream option for consumers and businesses. By using Stablecoins through DApps, consumers and businesses will have access to lower cost and higher speed than what is currently provided through international payments by the SWIFT system. As regulatory clarity improves, the adoption rate will increase rapidly among consumers and businesses.

Integration of DApps and traditional finance through hybridised models will also grow. For example, banks are already testing the use of blockchain technology for the settlement of their payments.

Improved scalability is solving many of the problems related to operating on a global scale today. The implementation of Layer 2 scaling solutions will offer additional scalability, while new and improved consensus algorithms and blockchain protocols will provide increased transaction speeds, as well as decreased transaction costs, that are competitive with today’s Web 2.0 applications.

The establishment of definitive regulatory structures will offer new levels of legitimacy to the DApp space and help create a better defined pathway for institutional dollar investments and increased protections for end users of DApps. There are likely to be some restrictions placed upon institutional participants under these regulatory structures; however, knowing that they will now have certainty around their ability to participate in this ever-evolving marketplace will encourage governments and large institutions to increase their involvement going forward.

The movement of DApps from their former position as “niche” tools used only within the crypto ecosystem into becoming the foundational infrastructure of the future finance business model is already underway. The only question is whether or not the current financial institutions will move quickly enough to continue to remain competitive with these emerging financial solutions or if they will be completely displaced. 

DeFi has seen its Total Value Locked (TVL) increase to over $50B from near zero just over two and a half years ago, and the number of unique users of DApps has increased from several thousand to several million during that time frame. Though there are large fluctuations in the prices of many cryptocurrencies, the ongoing increase in both the TVL of DeFi and the growth in the number of DApp users demonstrates that there is indeed a substantial market need for DApps.

Ready to Explore the DApp Revolution?

The world of decentralized applications is growing rapidly. There are many legitimate opportunities available right now to benefit from. Whether you are interested in trading more efficiently, discovering alternative investing strategies or understanding where blockchain technology may lead.

Now is the time to get involved and not just read about the future of finance, but rather have the right tools and knowledge available to be able to experience it yourself.

Start trading smarter with TradeWill, where traditional markets meet cutting-edge crypto innovation.