DeFi 2.0 – Why You Should Be Excited

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DeFi 2.0 – Why You Should Be Excited

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DeFi 2.0

DeFi 2.0

‍Decentralized Finance 2.0 or DeFi 2.0 for short is the future of financial technology or fintech. With the unprecedented innovations made possible by blockchain, we could be seeing the very last of centralized finance.

Every day, we read more about how blockchain and other emerging technologies will decentralize everything from data to cloud storage and even social media networks, and finance is not left out.

This article will provide a detailed overview of DeFi2.0, its origin as well as previous iterations that have led us to this point in time.

We’ll also discuss why these decentralized finance tools are important and why they matter now more than ever before — including an explanation why this particular era will be pivotal for the future success of DeFi 2.0 moving forward.

What is DeFi?

Decentralized finance, or “DeFi,” is an umbrella term encompassing applications and projects in the public blockchain ecosystem that aim to disrupt the current financial sector. It refers to financial apps created utilizing smart contracts and blockchain technology.

Decentralized finance is a movement toward a decentralized ecosystem for anything related to finance. It includes decentralized exchanges, inter-operable payment networks, financial applications, and more.

The goal of the DeFi movement is to create a more equitable, transparent, and decentralized financial landscape that is sheltered from the risk and uncertainty that accompanies centralized financial institutions. Financial instruments may be easily lent, borrowed, or traded using decentralized apps (dApps).

The Ethereum network is now used to build the majority of DeFi apps, but a number of other open networks are gaining popularity because of their greater speed, scalability, security, and affordability.

Origin of DeFi (DeFi 1.0)

The idea of decentralized systems has been around for decades — the internet itself was born out of a decentralized vision for society. As one might expect, the decentralized finance ecosystem emerged out of the same decentralized philosophy.

For a very long time, people’s confidence in the centralized banking system has been progressively eroding. However, the global financial crisis of 2008 marked the height of this mistrust, enabling individuals to not only doubt the competence of centralized institutions in handling their finances but also to look for alternatives.

DeFi was therefore developed as a decentralized financial system that is accessible to anyone and eliminates the need for reliance on a centralized authority.

It is a network of interoperable protocols and applications that are completely open and transparent, making it immune to censorship, tampering, and outside influence.

The main difference between a decentralized finance network and something like the early internet is that the former is fully peer-to-peer.

There are no centralized servers that act as a middleman between two participants — rather, every participant is an autonomous actor within the system.

This breakthrough was made feasible by the introduction of the public blockchain, which appeared in the years following the release of Satoshi Nakamoto’s well-known whitepaper, around 2008 or 2009.

Blockchain technology played a significant role in the development of decentralized financial systems.

The introduction of Bitcoin, the first peer-to-peer (p2p) digital currency built on top of the blockchain network, was the first significant change that gave the notion of DeFi credibility. Bitcoin makes it feasible to imagine a change in the status quo of finance.

Then Ethereum appeared. With the introduction of smart contracts in 2015, Ethereum made it easier for teams and organizations to develop and deploy the applications that made up the DeFi ecosystem. Thus DeFi 1.0 was birthed.

DeFi1.0 Use Cases

MakerDAO is one of the earliest Ethereum-based autonomous companies and is sometimes referred to as the DeFi foundation. MakerDAO offered a decentralized stablecoin, acting as a safety net against the volatility of cryptocurrencies.

Through these protocols, users were given access to trustworthy trades, frictionless lending and borrowing, and stable fixed currencies. To be eligible for a loan on MakerDAO, borrowers must deposit around 150% of the value of Ether.

Compound Finance launched its platform in September 2018, which enabled borrowers to get loans, and lenders to earn interest on the funds advanced as loans.

Borrowers must deposit digital assets as collateral to fund the loan in order to be approved for one. This procedure is conducted without the involvement of third parties.

Launched in November 2018, Uniswap was one of the first to deploy an automated market maker to ensure that there was enough liquidity between any two token pairs.

Users might instantly trade any Ethereum token using the platform without requiring any authorization from a central authority. Uniswap played the part of a Decentralized Exchange in DeFi (DEx).

AAVE, Curve Finance, Balancer, Bancor, Yam, Synthetix, SushiSwap, and several others are all examples DeFi 1.0 projects. These early DeFi 1.0 initiatives provided a foundation for farming, lending to supply cash, and borrowing with collateral.

Challenges with DeFi1.0

These DeFi 1.0 efforts were quite successful, but it quickly became apparent that they had a number of flaws. How to sustainably draw liquidity is one of the primary issues.

To entice liquidity providers, several DeFi protocols provide their native token (or another “farm token”) as a liquidity mining incentive. This typically works to initially attract finance and helps to “bootstrap” the DeFi initiative because of the alluring incentives.

The issue with the aforementioned is that liquidity providers can easily switch to the next protocol with greater incentives whenever the liquidity mining incentives stop or decrease. Giving out a particular token as a reward also puts pressure on sellers, which lowers its price. The native token’s price may potentially go to zero in severe circumstances. Below are a few examples

Coins fallen to Zero value2

Coins fallen to Zero value2 source

So it was difficult to sustain liquidity. Because providing liquidity forced customers to lock up their assets which resulted in an unfavorable level of capital inefficiency and financial rigidity.

Also, DeFi protocol’s reliance on Ethereum worsened the problem, since the blockchain’s growing popularity resulted in higher transaction costs and longer transaction times.

And the intricacy of the UX and UI made it difficult for newcomers to use decentralized applications.

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DeFi2.0 Comes to the Rescue

When users became aware of DeFi 1.0’s limitations, DeFi 2.0 was quickly introduced to fix some of the issues that were affecting the ecosystem. This inspired many great projects that introduced solutions that were critically desired in DeFi1.0.

Let’s now examine the approaches that have facilitated the growth of DeFi 2.0 initiatives.

DeFi 2.0 Creates More Liquidity

Uniswap is a DeFi 2.0 project familiar to DeFi enthusiasts. Uniswap is a platform built on the Ethereum blockchain and is fully decentralized. The project enables every investor to be a liquidity provider by introducing an automated liquidity protocol.

Many tokens are available here, each with its pool and value. Uniswap intends to collaborate with other firms and funds in the future, which will provide other options for users to earn money.

Another leader in the provision of liquidity for DeFi 2.0 is OlympusDAO, which launched on 1 February 2021. Many of the other DeFi 2.0 protocols are actually forks of OlympusDAO, including KlimaDAO, Wonderland etc.

OlympusDAO eliminated the problem of user always moving away to a project that offers more incentive and thus stifling liquidity with a very simple solution which is to own its own liquidity.

DeFi 2.0 is More Scalable and Supports Interoperability

DeFi users, especially newcomers, have experienced significant difficulty interacting with the Ethereum network. Unfortunately, the high cost of fuel and lengthy wait periods prevented the majority of consumers from using DeFi.

DeFi2.0, on the other hand, offers a variety of alternatives and is thus highly enticing with to the entry of prominent blockchains such as Solana, Cardano, and Polkadot. Additionally, it makes sure that transactions are speedier and less expensive. For instance, Solana can handle up to 50,000 transactions per second.

Blockchain networks have varied architectures, protocols for reaching consensus, ways of defining assets, ways of regulating access, etc. Because the features provided by blockchain networks sometimes operate in isolation, users of DeFi frequently experience substantial pain points related to the challenge of transferring value between blockchains.

These prevent the interaction between blockchain networks without a bridge. As a result, protocols’ ability to increase functionality and scalability is limited. Users must be able to conduct transactions effortlessly across various chains for DeFi to scale.

The foundations for resolving this challenge have been laid by decentralized exchanges (DEXs). The most popular option presently being offered is Uniswap (v3). However, because it only works with the Ethereum network, users may only trade ERC-20 compatible crypto tokens, and there are high gas fees.

Sushiswap, on the other hand, is filling the void left by Uniswap by supporting a number of blockchain ecosystems, including Harmony, Polygon, Fantom, and Avalanche. Users may therefore exchange multiple crypto tokens using the AtomixDEX built-in wallet.

With these foundations, blockchain networks such as Polkadot and Cosmos are delivering additional long-term improvements that can operate on top of a variety of DEXs such as CurveFinance, Sushiswap, and Uniswap.

DeFi2.0 Provides Self-Repaying Loans

Self-repaying loans are a feature of DeFi 2.0 that assist users in resolving the issues of exposure to liquidation and high-interest rates.

A lender that uses a self-repaying loan arrangement might utilize the interest on the submitted collateral to gradually pay off the loan.

The deposited collateral is given back to the borrower once the lender has collected the full loan amount plus any additional amounts paid as a premium.

Self-repaying loans also don’t run the risk of going out of business. The time it takes to repay the loan will be increased in line with the token used as collateral token’s depreciation.

DeFi2.0 Provides Insurance and Prevents Impermanent Loss

Any shift in the price ratio of the two tokens you locked while investing in a liquidity pool might result in temporary losses (impermanent because they could still be recovered). DeFi 2.0 protocols are investigating fresh approaches to reduce this danger.

One of the alternatives proposed is to include the project’s native tokens in single-sided liquidity protocols to counteract any negative effects. This new coin generates money via swap fees for both the token holder and the system.

The protocol’s accrued fees are then used to safeguard deposited cash from temporary loss; this is occasionally supplemented with protocol-minted tokens to supplement the accrued revenue.

DeFi 2.0 Supports Unlocking the value of staked funds

In exchange for staking a token pair in a liquidity pool, you get LP tokens. You may stake the LP tokens with a yield farm to increase your income. This was the end of the value extraction chain prior to DeFi 2.0.

Staking has a bonding time, which is its disadvantage. Users must promise to lock their stake on-chain for a set amount of time—which might be a few days or several years. Such restricted capital is inactive, wasteful, and idle. Better use of this cash is possible.

DeFi 2.0 provides the capability, of allowing the release of staked funds for usage in the DeFi ecosystem. In this procedure, staked assets are converted into tokens via a derivative contract that may later be used with other protocols.

Interoperability is the secret to this model’s success. As said earlier, solutions have been developed that can combine the staking sector with a variety of DeFi ecosystems, opening this treasure box for greater usage.

DeFi2.0 Provides Insurance-backed Smart Contracts

The DeFi ecosystem is still in its infancy and carries a considerable amount of risk. This is especially true for those with little technical skills who might not have the capacity to do adequate research and fairly evaluate initiatives before investing.

This greatly increases the risk associated with investing in DeFi initiatives. You may obtain DeFi insurance for certain smart contracts with DeFi 2.0 for a price, this can offer assurances for a user’s deposits.

What to Expect in the Next Phase of DeFi

Although DeFi2.0 is a vast improvement over DeFi1.0 and has addressed many ecosystem issues, it still has significant challenges.

Recent implementations of DeFi protocols like LUNA, Celsius, Three Arrows Capital, and Lido which either crumbled or started freezing consumer funds also revealed elements of centralization.

Consequently, there are already discussions around DeFi3.0 in the ecosystem, and some projects are already in the works.

This next iteration of the decentralized finance movement is expected to significantly advance the technology by tightening security, facilitating interoperability, and improving stability and sustainability in the ecosystem.

The next generation of DeFi projects has begun using Decentralized Autonomous Organizations (DAOs) to oversee project operations and governance in an effort to completely eliminate centralization. The community is given unlimited power and anyone may vote on the project’s development via a DAO.

Also, multi-chain, multi-farm, and cross-chain possibilities are been addressed while issues bordering on the inclusion of all aspects of finance, such as decentralized hedge funds, options, and derivatives will be considered.

This indicates that with the DeFi technology’s next phase, significant system improvements will have been implemented, promoting more public confidence and wider adoption.

Key Benefits of DeFi 2.0

Key Benefits of DeFi 2.0

Why Should You Care About DeFi2.0?

As a result of the decentralized finance ecosystem, your contacts with and involvement in the financial sector may change for the better forever. DeFi adoption is increasing more quickly, according to the total value locked (TVL) data available.

Additionally, DeFi2.0 projects are bringing in returns in ways that were previously unimaginable. DeFi wants to lower entry barriers and open up new revenue streams for cryptocurrency owners.

Investors in the sector are guaranteed higher returns on investments compared the regular banks. Also, With DeFi, customers who may not qualify for credit from a regular bank can easily do so.

Additionally, DeFi 2.0 makes an effort to address the issues mentioned in the preceding section, enhancing the user experience and thus truly democratizing finance while minimizing risks.

DeFi will undoubtedly govern the virtual world’s economy as we delve farther into the worlds of AR, VR, and the Metaverse.

Conclusion

Decentralized finance is one of the most influential and successful innovations birthed by the blockchain invention. It holds great promise for eliminating entry barriers to the financial markets and enabling frictionless value exchange to develop highly liquid and interoperable financial services without centralized middlemen.

When tracking the rise of DeFi, it is evident that participation in this new, open financial sector is increasing at a breakneck speed.

DeFi has become a mainstay as DeFi 2.0 improves the technology while the next phase promises global financial inclusion. Therefore, it is important to keep researching ways to bring about decentralized finance safely, quickly, and for the benefit of all.

 

Sources:

1. https://crypto.com/research/defi1_vs_defi2

2. https://consensys.net/blog/cryptoeconomic-research/defi-2-0-an-alternative-solution-to-liquidity-mining/

3. https://www.financialexpress.com/digital-currency/what-is-the-goal-behind-defi-2-0/2625889/

4. https://academy.binance.com/en/articles/what-is-defi-2-0-and-why-does-it-matter

5. https://cointelegraph.com/defi-101/defi2-0-a-beginners-guide-to-the-second-generation-of-defi-protocols

6. https://www.leewayhertz.com/defi-2/

 

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