DeFi 2.0 is an emerging trend in decentralized finance that promises to revolutionize the industry. It is a major advancement from the traditional DeFi protocols, bringing in new concepts that could revolutionize the way we use, manage, and interact with financial services. DeFi 2.0 provides an open and permissionless financial system, allowing individuals and organizations to interact with the blockchain without relying on centralized third-party intermediaries. The goal of DeFi 2.0 is to create a more efficient, secure, and transparent financial system. In this article, we will explore everything you need to know about the new direction of DeFi 2.0.
- DeFi 2.0 is the second generation of decentralized finance, whose projects aim to solve the problems of the “first version”. This includes more efficient use of capital, liquidity stabilization mechanisms and long-term incentives for users.
- The criteria for belonging to DeFi 2.0 are not strictly defined. This category includes at least a few dozen projects. Among them are Olympus DAO, Abracadabra Money, Alchemix, Tokemak and others.
- Often, DeFi 2.0 protocols build their services on top of existing DeFi infrastructure, including decentralized exchanges with automated market maker technology (AMM-DEX) and crypto asset-backed lending protocols.
What problems does DeFi 2.0 solve?
Today, decentralized finance remains one of the main directions of the crypto industry. At the same time, as DeFi has developed, the structural weaknesses of this area have become apparent – low scalability and high commissions, instability of liquidity and income, problems with the security of smart contracts and centralization. DeFi 2.0 projects aim to use new principles and approaches to address these issues.
Most DeFi protocols attract investors by offering them incentives in the form of project native tokens. The “liquidity mining” mechanism works well in the short term, but the accelerated issuance of the token, which pays rewards to liquidity providers, puts pressure on its price. Sooner or later, the yield is reduced, which creates the risk of a massive “exodus” of capital and its migration to another protocol.
DeFi 2.0 tries to solve this problem by creating a protocol reserve fund, or treasury, which is used to earn money in popular DeFi applications. In addition, with the help of treasuries, DeFi 2.0 projects provide “liquidity as a service” (Liquidity as a Service, LaaS) to other DeFi services. The end result should be the creation of a permanent income, which allows you to refuse from too high profitability through the issuance of a governance token.
Investors providing liquidity to DeFi protocol pools in the form of crypto asset pairs are constantly exposed to the risk of Impermanent Loss (IL). They arise due to changes in the relative rates of two assets in the pool, which significantly reduces the expected return on investment and worsens the attractiveness of such investments.
Although some popular AMM-DEXs offer their own solutions to reduce the impact of IL (for example, Balancer pools use an arbitrary ratio of asset shares), only DeFi 2.0 services have tried to radically solve this problem using one-way pools.
Many DeFi services were created by anonymous teams that made all the decisions on the development of the project. This opens up a wide scope for fraud, and also increases the likelihood of intentional or accidental management errors that harm the well-being of the project and the safety of private investments.
The answer to these challenges was the spread of DAOs — decentralized autonomous organizations, whose members, through on-chain voting, decide most of the tactical and strategic issues related to the development of the project.
If for DeFi 1.0 the transition to the DAO was rather slow and not mandatory, then for DeFi 2.0 it was initially the industry standard. As a rule, the transfer of control into the hands of the community is evidence of the maturity of the project, when the team has implemented all the intended functionality and has achieved success in attracting users and liquidity.
The history of the emergence and prominent representatives of DeFi 2.0
Most representatives of the 2nd generation of decentralized finance began work during 2021. At the same time, the term DeFi 2.0 itself came into use. Let’s take a look at some of the most prominent representatives of second-generation DeFi protocols.
Olympus DAO (OHM)
Launched in spring 2021 on the Ethereum network. Aimed at creating a decentralized reserve currency backed by its own reserve fund (treasury).
The main way to fill the Olympus DAO treasury is to sell the OHM governance token through the bonding mechanism. Users can buy short-term bonds (bonds) using a number of crypto assets (DAI, ETH, etc.), receiving OHM tokens at a small discount within five days.
Selling pressure was reduced by staking OHM tokens. Moreover, at the start of the project, the profitability of staking exceeded 200,000% per annum (taking into account automatic re-staking every 8 hours).
In order to increase the stability of the protocol, the team has gradually reduced the profitability of OHM staking. At the same time, LaaS was launched—an Olympus Pro product that allows other DeFi protocols to use the pegging mechanism to obtain their own liquidity. In this way, a source of income for the protocol was created at the expense of the Treasury, independent of the influx of new investors.
At its peak in November 2021, Olympus DAO’s TVL was over $860M and the OHM token was over $4.3B. This success spawned a wave of copycats who used the Olympus DAO source code to run copies.
As of June 2022 services OHMfork And DeFi Llama have over 130 Olympus DAO forks across all popular blockchains. Most of them differ from OlympusDAO only in the name and native token staking returns, but they are managed by anonymous developers, which increases the risk of losing funds. Dozens of such projects have already ended in exit scams.
Abracadabra Money (SPELL)
Started in May 2021, initially only on the Ethereum mainnet, and today operates on popular EVM-compatible networks, including Arbitrum, Fantom, Avalanche, and BNB Smart Chain. The protocol allows you to convert crypto assets (including yEearn Finance, Curve and SushiSwap treasury tokens) into Magic Internet Money (MIM) algorithmic stablecoin. MIM is traded on many decentralized and centralized exchanges, so investors can easily exchange it for other stablecoins. As an incentive for liquidity providers, the project accrues SPELL management tokens, gradually reducing the reward. To stabilize liquidity, Abracadabra uses Olympus Pro, buying back bonds at a discount to form Treasury reserves. SPELL is used in DAO voting. In addition, SPELL holders who are locked into staking receive a share of Abracadabra’s fees and charges.
It is a decentralized lending platform, launched in February 2021 on the Ethereum blockchain. It allows users to take out “self-repaying” loans secured by crypto assets by issuing highly liquid synthetic tokens. Debt positions are automatically repaid with income generated through integration with the yEarn Finance yield aggregator and Aave and Compound lending protocols.
The first version of the Alchemix protocol allowed the minting of the alUSD synthetic stablecoin when making a deposit in the DAI stablecoin. Later, USDT, USDC, ETH and other assets were added as collateral for loans. For all assets, the Loan-to-Value (LTV) parameter is 50%. That is you can borrow up to half of the deposited security.
The management of the platform is gradually transferred to Alchemix DAO, which is funded by 10% of the protocol’s revenues. Holders of ALCX governance tokens can vote to fund projects that expand the use of alUSD.
Launched in August 2021 on the Ethereum blockchain, this project focused on solving long-term liquidity and “non-permanent losses” issues. It accepts deposits like a lending protocol but distributes each crypto asset into a separate pool called a “reactor”.
Holders of the TOKE governance token vote on how to use the liquidity from each reactor. To participate in voting is stimulated by TOKE payments. Third-party DeFi services can borrow the liquidity accumulated in the protocol, paying fees as it is used. These fees go to the Treasury (Tokemak Treasury).
According to plans, over time, their volume should reach a level at which the protocol will no longer need to attract liquidity from outside.
Risks and disadvantages of DeFi 2.0
While DeFi 2.0 has its benefits, it still shares many of the risks inherent in decentralized finance, including human error, bugs and vulnerabilities in smart contracts, and the possibility of asset price manipulation due to incorrect price oracles.
Smart contracts that have not been properly audited have already caused serious financial losses in DeFi 2.0. For example, in June 2021, shortly after the launch of support for the synthetic asset alETH, pegged to the price of ETH, there was an incident in the Alchemix protocol. Due to an error in the logic of the smart contract, several users received a total of 4,300 ETH ($6.5 million at the time) illegally.
In addition, for projects that support algorithmic stablecoins (such as MIM and alUSD), there is a risk of losing their fiat currency peg due to manipulation or market conditions.
The specific risks of DeFi 2.0 include the fact that most of these projects use the classic liquidity mining mechanism at the beginning of their work, hoping to eventually move to a stable model with their own treasury. However, Treasury revenue growth is largely dependent on the overall market situation in the DeFi industry. Therefore, during a period of slow market activity, self-sufficient liquidity for DeFi 2.0 protocols may be an unattainable goal.
Prospects for the development of DeFi 2.0
During 2021, while the capitalization and the number of users of the crypto market were growing, DeFi 2.0 projects have shown their ability to attract users and their capital through a number of innovative solutions. However, the bearish trend in the stock and cryptocurrency markets, which began in 2022 due to events in the global economy and politics, brought down TVL and the capitalization of all projects in this segment without exception.
The coming “crypto winter” will be a test of strength for the entire DeFi industry. It is difficult to say which of the existing DeFi 2.0 projects will be able to survive in the new conditions and which will leave the scene. In any case, interesting approaches to attracting liquidity and users that have already performed well will continue to be used, regardless of market conditions.
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DeFi 2.0 is the next step in the evolution of decentralized finance, offering users a more secure, efficient, and reliable experience. With its increased adoption, users will benefit from increased transparency and lower fees, as well as access to more innovative financial products and services. DeFi 2.0 is poised to revolutionize the way users interact with the financial system and create a new class of financial products and services for the world.
What is DeFi 2.0?
DeFi 2.0 is the concept of taking decentralized finance (DeFi) to the next level. It is an evolution of the current DeFi landscape, with the goal of making it more efficient, secure, accessible, and easier to use.
DeFi 2.0 is focused on improving scalability and interoperability while maintaining decentralization and security. This includes introducing new technologies such as blockchain sharding, layer 2 solutions, and interoperability protocols. These protocols are designed to make it easier to move assets between different blockchain networks, as well as to make it easier to use DeFi applications.
DeFi 2.0 is still a concept and is not yet fully realized. However, there are many projects in the space that are aiming to implement these features, and the industry is evolving quickly.