What Is a dApp? Decentralized Apps Guide

In order to understand how a dApp works, let’s walk through how the Uniswap DeFi dApp works. 

Uniswap is a decentralized crypto exchange that allows users to swap digital assets without a central intermediary. Like most dApps, Uniswap is operated by holders of its token, ‘UNI”.

In this example, a user is trying to swap some of their ether (ETH) for Uniswap (UNI). Let’s see what happens on the backend!

1. A user logins into the dApp user interface, which in this case is the Uniswap website, uniswap.org. 

2. The user chooses the crypto they want to both buy and sell (ETH for UNI)

3. The user confirms and sends this transaction.

4. The user connects their self-custody crypto wallet to confirm the transaction. 

5. After confirmation, the dApp messages a smart contract stored on a blockchain to access the ETH/UNI liquidity pool stored on it.

6. The transaction enters a block and is validated by a node.

7. The transaction is broadcast to the entire Ethereum blockchain network for verification.

8. The block that the transactions reside in is added to the blockchain, making it immutable and final.

As we can see, the triggering event here is Uniswap interacting with its smart contract saved on a blockchain. Put simply, dApps are interfaces that allow the public to interact with an organization’s smart contracts.

📕 Read: What Is a DEX? How Decentralized Crypto Exchanges Work

Different Types of dApps

dApps exist for almost every type of business imaginable. Let’s run through a few more popular dApp categories now. 

• Crypto Exchanges

  • Crypto exchanges (DEXs) are the most popular dApps in DeFi. These P2P exchanges operate on blockchains devoid of intermediaries, which makes them transparent and cost-effective.

    Read! Uniswap vs. SushiSwap vs. PancakeSwap: Which DEX Is Best?

• Gaming

  • In 2023, gaming dApps are exploding in popularity. It has been estimated that gaming dApps make up more than half of blockchain usage. This popularity may be due in part to their free-to-play nature; some ‘play-to-earn’ games even reward participants by paying them in crypto and/or non-fungible tokens (NFTs) to play!

• Gambling

  • dApp casinos are run on public blockchains, which makes them inherently transparent. This is in contrast to traditional casinos, which are often opaque when it comes to odds. You can also bet on the outcomes of events such as elections on the Polymarket platform. 

• Social Media

  • Social media dApps are growing in popularity. Unlike traditional social media applications, social media dApps do not sell or store your personal data. Steemit, for example, is a dApp that operates much like Twitter on decentralized technology. 

• Oracles

  • Oracles are used to store and receive information. Many dApps rely upon live data in order to operate (e.g., crypto exchanges). Decentralized oracles, like Chainlink, provide this data on a decentralized platform. 

5 dApps Risks

dApps are not risk-free. Let’s explore the top five risks associated with decentralized apps.

1. Smart Contract risk

dApps are comprised of smart contracts. If a smart contract is written with faulty code, that dApp could be vulnerable to attacks. In order to mitigate these risks, it is wise to: 1) interact only with dApps that are widely used and 2) assure at least two independent audits have been conducted on a dApp before you connect your wallet to it. There is also the risk that a dApp’s software is laggy, which could result in downtime. 

2. Counterparty Risk

Counterparty pertains to the risk of a borrower defaulting on their loan obligations. This risk is present in all types of lending, including DeFi lending dApps. Unlike traditional banks, however, DeFi dApps use overcollateralize ratios. This system makes the default of crypto loans a rare occurrence.

3. Gas Fees

In order to interact with the Ethereum network (which is the most robust blockchain for dApps), you will need to attach a gas fee to your transactions. Gas fees pay validators for adding your transaction to the immutable blockchain. Gas fees can vary widely in value as prices are dictated by supply and demand as well as network congestion. It is therefore best to check the current gas fees before sending a transaction. Though gas fees for simple transactions usually equate to a few dollars, gas fees for smart contracts can cost thousands of dollars. 

4. Seed Phrase Risk

In order to interact with a dApp, you will need a self-custody crypto wallet. Self-custody wallet users are responsible for maintaining a record of their private keys, AKA ‘seed phrase’. If you lose this seed phrase, there is no central intermediary to recover your digital assets. Therefore, it is very important to write down your seed phrase in a secure location. 

5. Impermanent Loss

We mentioned earlier that users of self-custody wallets are able to buy and sell crypto on decentralized exchanges. This liquidity is provided by liquidity pools and automated market makers. Anybody can choose to become a liquidity provider in DeFi (and earn the fees that come with it!) by contributing two cryptocurrencies to a liquidity pool. As users buy and sell from your liquidity pool, the value of the two cryptocurrencies added may fluctuate in value. For example, if you added crypto to the USD Stablecoin/ETH liquidity pool, your proportion of ETH will fall as more users buy ETH from the pool and sell USD. Impermanent loss can also be thought of as opportunity risk; how much would you have made on your crypto (ETH) if it wasn’t in a liquidity pool?