defi-2.0

DeFi 2.0: Enter The New Generation Of The DeFi Protocol

It has almost been two years since Decentralized Finance or DeFi has entered into the world of cryptocurrency and there has been a striking rise in 2020. Following the rise, we have seen incredibly successful DeFi projects such as Uniswap. The project is a good example of the conjunction of decentralized trading and finance. It offers a new way to earn interest from cryptocurrencies. However, like the Bitcoin (BTC) cryptocurrency, there exists some problems in the new sphere that need to be solved. As a result, the term DeFi 2.0 has become much popular for describing a brand new generation of DApps or DeFi decentralized applications.

As of the time of writing, we can see the new beginning of DeFi 2.0. But we are awaiting the complete influence of DeFi 2.0 in the crypto space. In this article, we will address everything about the new generation of the DeFi protocol and how it is focussed to eradicate the existing limitations of the DeFi 1.0.

What Is DeFi 2.0?

DeFi 2.0 can be termed as a new revolution aiming to upgrade and fix the issues with the original DeFi wave. The original DeFi had been to some extent successful in offering decentralized financial services to the individuals with the cryptocurrency wallet, yet it still possesses some weaknesses. The crypto space has already seen this process with the second generation of the blockchains such as the Ethereum (ETH) that is improving on the Bitcoin. Similarly, the DeFi 2.0 is also expected to react to the new compliance regulations that the government has been planning to introduce like the Anti-Money Laundering (AML) and Know Your Customer (KYC).

An example of this can be stated as the Liquidity Pools (LPs). The LPs have successfully proved itself in DeFi as it permits the liquidity providers to earn fees for their staked coin pairs. However, in the case of the price ratio alterations of the staked coins occur, the liquidity providers will risk losing their money via  a process known as the impermanent loss. A DeFi 2.0 protocol has been expected to provide insurance against this for a relatively small fee. This solution offers a greater incentive to invest in the LPs and benefit the stakers, users and in general the DeFi space.

Before we move on to the the new financial paradigms and the usefulness of the DeFi 2.0 ecosystem, the article explores some of the existing breakthroughs that had set the stage for the DeFi evolution, DeFi 2.0 movement and also discusses the liquidity limitations that the new generation of DeFi is expected to tackle.

The Early DeFi Developments

Aave, Bancor, Compound, MakerDAO and Uniswap have been some of the early pioneers of DeFi that have constructed a rock solid foundation for the development of the DeFi economy. This has also added simultaneously several critical and composable money LEGOs to the ecosystem.

The primitive decentralized automated market makers or AMMs like Bancor and Uniswap had been the very first to permit the users to swap their tokens without the need to give up any custody. Compound and Aave on the other hand had facilitated the decentralized borrowing and lending permitting for the on-chain yield for deposits in addition to the permissionless access to the operating capital.

MakerDAO has also offered a decentralized stablecoin for the ecosystem members for retaining and use in the transactions. This provides a buffer against the cryptocurrency volatility. The users had gained access to several dependable exchanges, stable pegged currencies via these protocols and frictionless borrowing or lending. These are the three key financial primitives that are commonly available in the traditional financial markets.

Nevertheless, in terms of user control and transparency the infrastructure that underpins these reputed DeFi based services, has been vastly different from the centralized companies. The DeFi innovations have been built on the various technological implementations that underpins these decentralized services.

What Have Been The Limitations Of The DeFi 1.0?

The DeFi 2.0 is the successor of the DeFi 1.0 that aims to fix the flaws of the existing DeFi model. It also leverages the strengths to offer the consumers with the new and exciting options on the way to financial freedom. The numerous limitations of the DeFi 1.0 are discussed below:

  • Scalability: The DeFi protocols on the blockchains bearing high traffic and gas fees often offer expensive and slow services. This means that the simplest of the tasks can take up a long time and then become cost-inefficient.
  • Oracles & Third-party information: The financial products based on the external details require higher quality oracles or the third-party sources of data.
  • Centralization: DeFi must reach out for an increasing amount of decentralization. However, many of the projects still lack the DAO principles in place.
  • Security: Most users do not understand or manage the risks that are present in DeFi. They usually stake millions of dollars in the smart contracts that they are not sure of if they are safe even. Although security audits are in place, they tend to become pretty less valuable as the updates take place.
  • Liquidity: The liquidity pools and the markets are spread across various platforms and blockchains splitting the liquidity. Offering liquidity also locks up the funds and their total value. In maximum cases, the tokens are staked in the liquidity pools that cannot be used anywhere else and creates capital inefficiency.
  • Cash Flow: Especially in the crypto sphere, people tend to have a short attention span. You can obviously tell that the people are moving far from the DApps for pursuing bigger financial prospects. The yields have become less appealing unlike it used to have earlier, especially for the blue chips of the DeFi. This has also resulted in the far, and dump scenario that further led to the unhealthy cash flow for practices including several other issues that contributes to the inefficient usage of the assets.

What Is The Goal Of DeFi 2.0?

Dissimilar to the earlier generation of the DeFi applications that were more focussed towards the users. On the contrary, the newcomers possess a specific business to business or B2B focus. The new generation of the DeFi protocols capitalize on the fact that the DeFi 1.0 products have successfully bootstrapped the industry through establishing a basic user base and developing the important DeFi primitives. These primitives can now employ the future manufacturers for constructing the next wave of DeFi apps. The purpose of the latest generation of DeFi protocols is safeguarding the long term viability of the sector.

The fundamental issue of the DeFi that is preventing the sector from growing sustainable are:

  • The dependence on the third party providers and token incentives of the sector for securing the liquidity.
  • The non-existent correlation of DeFi with traditional finance and the global economy.

Thus, the entire purpose of the introduction of DeFi 2.0 and beyond is to carefully address the issues. A couple of the DeFi 2.0 movement pioneers are focussed on developing the methods for long-term liquidity. In this regard, a platform needs special mention, OlympusDAO. It is a protocol that is intended to build a decentralized reserve currency. The platform has also announced Olympus Pro that is a tool permitting the other DeFi protocols for using the bonding mechanism and gaining their liquidity. This however, demonstrates the B2B focus of DeFi 2.0.

The DeFi 2.0 is expected to help the decentralized automated organizations of the DAOs via building the protocol controlled value mechanisms.

How Does The DeFi 2.0 Matters?

DeFi can be specifically daunting and challenging to understand even for the experienced cryptocurrency users and HODlers. Nevertheless, it focused on lowering the barriers to entry thereby creating new opportunities for the crypto holders to earn. The users who might not receive a loan via the traditional bank, might get an opportunity with the DeFi.

The DeFi 2.0 matters a lot as it can democratize finance without having to compromise on the risk. It also attempts to solve the problems that DeFi 1.0 had improving the users’ experience. It will be a win-win situation for all if we can do this and offer better incentives.

DeFi 2.0 Vs DeFi 1.0: Why Is The Former Better?

The following differences can be seen between the DeFi 2.0 and DeFi 1.0:

Parameters

DeFi 2.0

DeFi 1.0

User To User Connection

Strong connection between the users

No connection between the users

Ecosystem

DAOs, liquidity incentives to create a warm, sustainable and interconnected decentralized financial architecture and capital efficiency

Includes decentralized central trading applications, DEXs, lending and stablecoin applications, liquidity machine gun pool applications, synthetic assets and insurance type projects

Governance Pattern

Governance & policy rights are delegated to the members

Disorganized community and inappropriate governance pattern

Incentive Schemes

Users are rewarded 100%; attractive incentive scheme for users

Unattractive limited incentive scheme for users

Scope For Innovation

Unlimited scope for technological and financial innovation

One way technology development and innovation

Currently, most of the DeFi projects are focussed on issuing tokens for printing money and this kind of the DeFi projects that has not yet proposed the new solutions in the distribution of the governance tokens and the community governance alongside its launch of the mining architecture, is pretty frequently unsustainable.

The currency transactions are required for creating a DeFi 2.0 decentralized financial system that is both automatically distributed and sustainable. The decentralized finance in the new generation of DeFi is much more likely to connect the community members who supply the liquidity. The liquidity incentives are also being pushed for connecting the relationships in all of the future transactions for creating a sustainable, warm and interconnected decentralized financial architecture.

The version 2 of DeFi protocol is committed towards breaking the cold transaction mode of the earlier version of the DeFi. This expects that the users could be able to make close connections horizontally while making strong vertical ties as that advocates for the close relationships between the users.

The community members of the DeFi 2.0 are going to enjoy both ecological governance and decision making authority as compared to DeFi 1.0. All the members are stakeholders while the communities ensure that each member can put forward their choices.

DeFi 2.0: The Use Cases

You might be glad to know that you do not have to wait for the DeFi 2.0 use cases as there are already certain projects that are running offering the new DeFi services across several networks. These projects include Binance Smart Chain, Ethereum, Solana and several other smart contract efficient blockchains. In this segment, we will look at some of the most common ones.

Impermanent Loss Insurance

Suppose you invest in a liquidity pool and start liquidity mining. If there are any alterations in the price ratio of the individual tokens that you have locked, then you might incur financial losses. This phenomenon is termed as “Impermanent Loss”. However, there are just a few of the new DeFi 2.0 protocols that are exploring the new ways to mitigate this risk.

For instance, imagine that you have added one token to a single sided LP where you are not required to add a pair. The protocol then adds its native token as the opposite side of the pair. Then you will receive fees paid from the swaps in the respective pair and the same will happen with the protocol.

Over the course of time, the protocol utilizes their fees for building up an insurance fund for securing your deposit against the impact of the impermanent loss. If there is a crunch in the fees and the losses cannot be repaid, the protocol might go ahead and mint new tokens for covering them. On the contrary, if there remains an excess in the tokens, they can either be stored for utilization in future or are burned for reducing the supply.

Self-Repaying Loans

Usually, extracting a loan involves interest payments and liquidation risk. With the inclusion of DeFi 2.0, this will not be the case. For instance, assume that you have taken a loan of $100 from any cryptocurrency lender. The lender offers you $100 of crypto in return of $50 collateral. As soon as you provide your deposit, the lender utilizes this collateral to earn an interest for paying off your loan.

As the lender earns $100 with your cryptocurrency and additional coins as a premium, the lender will return your deposit. In this case, there remains no risk of liquidation. If the collateral token loses some of its value, it will take a little longer for the loan to be repaid. 

Smart Contract Insurance

Conducting enhanced due diligence on smart contracts is quite challenging unless you are an experienced developer. You can solely partially evaluate a project if you do not hold much knowledge. This creates a whopping amount of risk when investing in the DeFi projects. With the new generation of the DeFi protocol, it is possible to receive DeFi insurance on the specific smart contracts.

Assume that you are utilizing a yield optimizer and you have staked LP tokens in the smart contract. If the smart contract gets compromised, you might lose all your deposits. In this place, an insurance project holds the capabilities to offer you a guarantee on your deposits for a fee with the yield farm.

You need to keep in mind that this would only be for a particular smart contract. Usually, you will not get a payout in case the liquidity pool contract gets compromised. Nevertheless, if the yield farm contract gets compromised but the insurance covers you, you are likely to receive a payout. 

Unlocking The Staked Funds Value

If you have ever staked a pair of tokens in a liquidity pool, you must have received LP tokens in return. In case of the DeFi 1.0, You are able to stake the LP tokens with the help of a yield farm for compounding your profits. Before the onset of DeFi 2.0, this was concerned as far as the chain goes to extract the value. Millions of dollars are stored in the vaults offering liquidity. However, there is potential for further improving the capital efficiency.

The new version of DeFi takes this step to the next level and utilizes these yield farm LP tokens as the collateral. Thai utilization could be to mint tokens in a similar process to MakerDAO (DAI) or for a cryptocurrency loan from a lending protocol. The exact mechanism alters from project to project but the idea remains the same, that is your LP tokens must have their value unlocked for the new opportunities while it is still generating the APY.

Who Controls The DeFi 2.0?

At this point you might wonder who is controlling the DeFi 2.0. To answer this, it can be said that a decentralization trend has always coexisted with blockchain technology. DeFi, however, is no different. MakerDAO was one of the first projects of DeFi 1.0 that set a standard for the revolution. Currently, it is increasingly common for the projects to offer their community a scope of voice.

Several platform tokens as well work as the governance tokens offering their holders voting rights. You can Definitely expect that the DeFi 2.0 is going to infuse the crypto space with more decentralization. Whatsoever, the role of compliance and regulation has started to become more important as they catch up with decentralized finance.

DeFi 2.0 Risks & Preventive Measures

Both DeFi 1.0 and DeFi 2.0 share many of the similar risks. Here are the key risks and what you can do about it for keeping yourself safe. 

Smart Contracts With Vulnerabilities

The smart contracts that you are interacting with might possess some sort of vulnerabilities such as back doors or might be weak enough to be hacked. An audit cannot guarantee the safety of a project either. You need to conduct as much research as possible on the project and consider the fact that investing always involves certain risks.

Regulation Might Affect Your Investments

The regulators and the governments worldwide are getting inclined toward the DeFi ecosystem. While the law and regulation can bring stability and security to the cryptocurrency, some of the projects might have to alter their services as new rules are created and implemented. 

Impermanent Loss

Even if you possess the IL insurance, you are still exposed to large risks if you want to get involved with the liquidity mining. The risk can never be completely minimized. 

Accessing Your Funds Might Be Difficult

If you are staking your token pairs via the website user interface of a DeFi project, it will be a good move to locate the smart contract on the blockchain explorer. Else, you will not be able to withdraw if the website goes down. Despite this, you would require some technical expertise for interacting directly with the smart contract.

List of DeFi 2.0 Coins

Below is a glimpse of the DeFi 2.0 tokens:

  • 8ight Finance
  • Alchemix
  • Cerberus
  • Gyro
  • Klima DAO
  • Life DAO
  • Nidhi DAO
  • Olympus
  • Spell Token
  • Tempo DAO
  • Tokemak
  • Wonderland

Top DeFi 2.0 Projects

As already seen, the term DeFi 2.0 explained is still on its way to find its narrative via multiple blockchains and excessive APRs. Specifically, the version 2 of DeFi is almost synonymous with a couple of projects of which two are Wonderland and Olympus. Currently, they are trending much more.

The users are now in awe considering the massive returns and the APRs of these protocols that are constantly attracting all kinds of capital. This is not solely limited to the cryptocurrency community. This means that if you invest $1,000 in OHM at this moment and then staked it for a year, you will have $80,000 at the end of the year.

In this segment we will cover the top new generation DeFi projects that seem to have a great future prospect. 

OlympusDAO

It is one of the first protocols of DeFi that came about with the introduction of the new wave of the DeFi version. Also, it possesses some lofty ambitions. The project seeks to be a trustless, decentralized crypto reserve bank backed by a humongous number of cryptocurrency assets.

You need to take into consideration that the DeFi 2.0 alters the relationship with the capital holders. It does not rent the liquidity but the protocols aim to own their very own liquidity. The users having their capital sell their assets to the OlympusDAO treasury for receiving the discounted OHM tokens via a process known as “Bonding”. The assets in the treasury offers revenue for the protocol and thereby increases the risk-free value for every token. Then the users are incentivized to lock away the tokens that they get through this process of staking. This takes away the pressure of selling the tokens.

Now comes the creation and value of the $OHM token that is aiming to be both a unit of exchange and a store of value. Via the OlympusDAO, the $OHM token gets issued and managed depending on its monetary policy. As a result, OHM neither wants to completely be a speculative store of value such as Bitcoin (BTC) nor does it wishes to be pegged to a certain amount as that of a stable coin like USDC or USDT. It sits somewhere in between.

Here are some interesting facts about the OHM token:

(i) Since OHM possesses a free floating value that is its price fluctuates based on the free market and it is not pegged to the US Dollar, it escapes the Federal Reserve or the US government curated monetary policies.

(ii) The OHM is backed by the assets and the liquidity in the treasury. All the assets that you sell to Olympus are stored in its treasury that produces revenue for the protocol and thereby increases the risk-free value of each of the OHM tokens.

(iii) As already mentioned before, staking the OHM coins is incentivized owing to its massive APY. At the time of writing it is almost a whopping 7000%+ APY.

Wonderland.Money

With the success of OlympusDAO, a couple of copies also termed as the forks from the project’s code have appeared. These are attempting to chase the same success that OlympusDAO has gained. Amongst all the forks, the most popular one is Wonderland.Money. A couple of things influence its popularity:

(i) Though Wonderland is a fork, it had been built as another part of the growing and already renowned MIM (magic Internet Money) ecosystem on the Avalanche using the Abracadabra protocol that permits for the different synergies than OlympusDAO.

(ii) Avalanche is considered as another layer 1 blockchain offering low fees and a high throughput. As a result, the users that have given up on the Ethereum gas fees are much more likely to put money into Wonderland.

As already explained, since Wonderland is a fork, largely the protocol remains the same. Below is a quick comparison between OlympuDAO and Wonderland.

Parameters

OlympusDAO

Wonderland

Blockchain

Ethereum (ETH)

Avalanche (AVAX)

Token

$OHM

$TIME

Token Issuing Service

Bonding

Minting

Current APY (At The Time Of Writing)

7,000%

80,000%

What Is Upcoming In DeFi 2.0?

While the OlympusDAO and its forks are leading the situation for DeFi 2.0, some of the latest and innovative protocols and assets are continuously being built keeping the same values in mind.  One of such a new project is Brinc Finance or Brinc.fi. The token of this project is $BRC.

So what exactly is $BRC? Well, it is a digital asset that can solely be bought by depositing the funds into a reserve such as the public Ethereum wallet address. Cent percent of the $BRC tokens in circulation are backed by these reserve funds. This indicates that every $BRC token is backed by the funds that had been used to buy them as opposed to the majority of the cryptocurrencies that do not possess any form of backing or reserve.

The burning, minting and the control of all the $BRC tokens are entirely done by the smart contracts so that the supply of the $BRC token always remains decentralized and completely free from any sort of manipulations or arbitrary actions of the team that is behind the project.

None of the individuals such as the team, the founders or the community gets a single token without depositing funds to the reserves. This is what makes Brinc a lot more different from all the earlier cryptocurrency projects. Additionally, Brinc is offering the real intrinsic value:

  • Each of the tokens is backed by the DAI reserves that are held on-chain.
  • The protocol generates the fees on the purchase and sell of the BRC token supply.
  • The DAI reserves can be reinvested into the third party DeFi protocols for generating income and the value that increases the treasury base.

The DeFi Evolution Is Still In Progress

You might think DeFi 2.0 is a new generational change in decentralized finance or it might just be a fancy name. But one thing is for sure. It is just another sign that the DeFi space is continuing to progress. Most importantly, the various types of the initiatives that comprises the DeFi 2.0 movement displays that we have already crossed the phase of what is perhaps the most critical stage of that evolution usually termed as the “Bootstrapping phase”. As that went out of the way, the DeFi 2.0 projects now possess the tools that they needed to keep pushing forward decentralized finance.

When it comes to the designing of the protocols (concept of the Money Lego) maximizing profit, the developers are becoming more observant. The designing protocols are also maximizing the decentralization, capital efficiency and related. Some of the tradeoffs are yet to be seen. However, they still exist. For this time, it seems that everyone is merely excited.

Considering the more philosophical sense, the first phase of DeFi has taught us a lot of things. While going through this phase, we have had experienced both the blunders and the accomplishments. We have learned a lot of lessons from the not so distant past. Additionally, we can see that the phase is maturing in terms of technology, adoption and the decentralized ethos that people rarely remember as they combine with the old world that is government, regulation and traditional finance.

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