DeFi Protocol Development Guide

Learn to build decentralized finance protocols with security best practices.

Introduction

Decentralized Finance (DeFi) aims to recreate traditional financial systems (lending, borrowing, trading) without intermediaries. Building a DeFi protocol requires a deep understanding of smart contract security and economic incentives.

In this guide, we will design a simple Lending Protocol where users can deposit collateral and borrow assets.

Core Concepts

• Collateralization Ratio: The value of collateral must exceed the value of the loan.
• Liquidation: If the collateral value drops, it is sold to repay the loan.
• Interest Rates: Dynamic rates based on supply and demand.

The Smart Contract Architecture

We'll use Solidity and OpenZeppelin libraries.

// SPDX-License-Identifier: MIT
pragma solidity ^0.8.0;

import "@openzeppelin/contracts/token/ERC20/IERC20.sol";
import "@openzeppelin/contracts/security/ReentrancyGuard.sol";

contract LendingPool is ReentrancyGuard {
    mapping(address => uint256) public deposits;
    mapping(address => uint256) public borrowings;
    
    IERC20 public token;

    constructor(address _token) {
        token = IERC20(_token);
    }

    function deposit(uint256 amount) external nonReentrant {
        require(amount > 0, "Amount must be > 0");
        token.transferFrom(msg.sender, address(this), amount);
        deposits[msg.sender] += amount;
    }

    function borrow(uint256 amount) external nonReentrant {
        require(amount > 0, "Amount must be > 0");
        require(deposits[msg.sender] >= amount * 2, "Insufficient collateral"); // 200% collateralization
        
        token.transfer(msg.sender, amount);
        borrowings[msg.sender] += amount;
    }
    
    function repay(uint256 amount) external nonReentrant {
        require(amount > 0, "Amount must be > 0");
        require(borrowings[msg.sender] >= amount, "Overpayment");
        
        token.transferFrom(msg.sender, address(this), amount);
        borrowings[msg.sender] -= amount;
    }
}

Security Considerations

1. Reentrancy: Always use nonReentrant modifiers.
2. Oracle Manipulation: Use decentralized oracles like Chainlink for price feeds, never rely on spot prices from a single DEX.
3. Integer Overflow: Solidity 0.8+ handles this automatically, but be aware.

Testing

Testing is critical in DeFi. Use Hardhat or Foundry to write comprehensive tests, including fuzzing.

it("Should not allow borrowing without collateral", async function () {
  await expect(lendingPool.borrow(100)).to.be.revertedWith("Insufficient collateral");
});

Conclusion

This is a simplified example. Real-world protocols like Aave or Compound involve complex interest rate models, governance tokens, and flash loans. Security audits are mandatory before mainnet deployment.