Decentralized Finance - or DeFi - surfaced as a digital financial solution that does not rely on third parties such as central banks or governments. Its popularity skyrocketed in recent years (alongisde crypto and blockchain), but because it’s still in its early stages of development, there have been several DeFi-related issues that the industry is attempting to resolve.
This is where DeFi 2.0 comes into play.
Table of contents
What is DeFi 2.0: definition and expectations 🚀 Increased Operational Liquidity It is not a stablecoin Genuine decentralization Scalability, lower costs and better UX A new security level What is DeFi staking Opportunities
DeFi 2.0 aims to improve the first iteration of DeFi technology. The goal for the next generation of decentralized finance is to improve the current flawed DeFi system. As a result, DeFi 2.0 promises increased scalability, security and liquidity.
On the other hand, DeFi 2.0's purpose is also to comply with and adapt to government requirements, as there are plans to introduce regulatory and compliance laws for DeFi operations in the near future.
The primary distinction between DeFi transactions and traditional transitions is that decentralized finances do not necessitate the use of intermediaries such as banks. Codes are used to specify how potential disputes should be resolved.
These DAOs make use of smart contracts, in which users define the conditions under which they should be executed. It makes use of web3 and blockchain technology to bring to the table loans, insurances, investments, and other transactions.
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Also, the global market cap for DeFi has expanded to over 150 billion dollars by the end of 2021.
Despite this gigantic amount of money, one major problem regarding decentralized contracts is long-term liquidity.
On DeFi 1.0, platforms incentivize liquidity mining, which means their tokens depend on people mining and lending money (or crypto) to a protocol in exchange of tokens as an incentive.
The issue with this is that users can simply cash out. If a large investor cashes out, a huge chunk of the liquidity will be depleted, and the protocol native token will crash.
As a result, when you receive payment for a DeFi loan, your token may be completely undervalued.
Protocol-Controlled Liquidity (PCL) is a DeFi 2.0 solution to this problem. Olympus (OHM), for example, owns 99.5% of its liquidity, thereby safeguarding the value of the reserve-backing. It functions as a guarantee to the person performing the operation.
Olympus accomplishes this through the use of a Decentralized Reserve Currency, which protects the crypto value through a treasury controlled by Olympus. It currently has a balance of over 750 million dollars.
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The Olympus process works by accumulating native tokens such as Ethereum (ETH) or Uniswap (UNI), allowing users to exchange their native tokens for discounted OHM tokens.
This enables Olympus to establish a treasury. In a blockchain environment, it's similar to a bank, however, decentralized.
Breaking a DAO of this type is much more difficult with reserves in both native tokens and bank tokens.
The main difference between the first and second DeFi processes is that instead of users lending their tokens to provide liquidity, decentralized protocols assume this role by accumulating tokens as treasuries. It works as follows:
Stablecoins, which are cryptocurrencies linked to a basket of assets such as the dollar, euro, or even gold and other cryptocurrencies, are commonly used in DeFi operations. However, it is more common to use stablecoins backed by US dollars.
Well, DeFi 2.0, on the other hand, is “against it” because it does not want to keep us tied to inflationary centralized systems and regulatory risks.
Some platforms are innovating by issuing their own floating reserve currency – again, Olympus is an example.
Despite the fact that decentralization is the core value of DeFi projects, the truth is it does not always occur.
DeFi's, under a proper structure, are governed by DAOs and managed by the token holders' community.
Many projects, however, fail to implement these principles, which might have a direct influence on DeFi operations. As a result, the proposal of DeFi 2.0 is to promote projects to be governed more democratically, i.e. in compliance with DAO governance.
It is a fact that DeFi 1.0 protocols are generally expensive, slow, and difficult to use.
This is why DeFi 2.0 intends to provide a better user experience (UX) as well as easier ways to manage smart contracts and provide liquidity.
Another significant point is that with the arrival of Ethereum 2.0, users expect lower gas fees and faster transaction times. After all, the majority of DeFi operations today are Ethereum-based. As a result, protocols built on Ethereum will probably be more scalable. It means that decentralized finance transactions will be faster and less expensive, as well as more accessible.
Contracts based on blockchain are generally secure, but there is one drawback to the first generation of decentralized finance:
The majority of DeFi users do not understand how to manage risk in a safe manner. It means they don't know for sure if they're investing on completely safe smart contracts. There is an urgent need to be more transparent.
Of course, smart contracts are audited on a regular basis, but updates and software changes can result in outdated information. Users may become disoriented if there is a technical issue. The goal of the DeFi 2.0 proposal is to make it easier for users to objectively validate the security of a network as they manage amounts of money.
Another trend that is emerging alongside DeFi 2.0 is DeFi Staking: a method of locking cryptocurrency tokens into smart contracts in order to earn interest on the capital stored. In other words, it is a way to earn interest in the crypto you already own and store.
However, because there is a minimum amount to invest on platforms to stake tokens, some operators pull tokens from multiple people, creating an investment pool in exchange for a fee, making this mechanism more accessible.
Binance, for example, allows users to invest in a DeFi project via their platform without having to manage private keys, acquire resources, or make trades, all of which are time-consuming tasks.
Another successful way to stake assets was created by Lido, a DAO community that builds liquid staking services. There are no minimum amount of tokens required to stake, and the tokens are used throughout the DeFi ecosystem. The idea is to use staked assets to generate additional yield. Users of Lido can stake amounts on Ethereum, Terra/Luna, Solana, Kusuma, or Polygon blockchains.
Based on all of this, there are numerous advantages to enhancing the first generation of decentralized finance. DeFi 2.0 may provide:
Consistent liquidity provision;
Offering more incentives, such as additional yield farm tokens for a loan, for example, lowers the credit provider's risk.
Lender risks can be reduced by hiring insurances that cover smart contracts, which can offer deposit guarantees for a fee.
Using a self-repaying loan, which allows the lender to use the interest earned on the deposited collateral to pay off the loan over time.
The new generation of decentralized finance is developing new ways to gain rewards in a more transparent manner. This is due to DeFi 2.0's incentives for improved user experience, increased liquidity, and more agile blockchains.
Gas fees are expected to fall as smart contract execution systems in blockchains become faster, particularly with the arrival of Ethereum 2.0. Furthermore, DeFi 2.0 should improve scalability, security, and liquidity. There are also new DAO communities operating on DeFi staking, such as Lido, which may lead to an increase in DeFi 2.0 operations.
With these advancements on DeFi 2.0, projects such as Binance Smart Chain, Ethereum 2.0, Solana, and others will be better able to provide these benefits to users.