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DeFi 2.0: The second generation of DeFi protocols

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The origin of DeFi in 2018 proved to be a game-changer in the world of finance. It brought democratization to the financial landscape by presenting a more user-focused alternative to centralized financial institutions. Because of its decentralized architecture based on secure distributed ledgers, DeFi is capable of providing a full spectrum of financial services, from routine banking, mortgages and loans, to complex contractual arrangements and asset trading.

DeFi disempowers the centralized financial system by eliminating the need for intermediaries and gatekeepers and empowering common people by enabling them to undertake financial activities on a peer-to-peer basis.

Since DeFi leverages blockchain technology, decentralized financial transactions are more secure and transparent than transactions taking place within the opaque and siloed centralized financial system.

Although DeFi’s contribution toward bringing blockchain technology to the mainstream is significant, it does come with certain limitations that have so far hindered its widespread adoption. But just like everything else in this universe, DeFi has improved and evolved to become DeFi 2.0, a superior version of DeFi that stands to eliminate the challenges associated with DeFi. In this insight, we will understand how DeFi 2.0 overcomes DeFi’s limitations and makes the entire DeFi ecosystem more efficient, secure, and conducive for newer and highly diverse use cases.

DeFi challenges that DeFi 2.0 resolves to overcome (DeFi 1.0 vs DeFi 2.0)

DeFi is a recent innovation, and hence, has not been stress-tested by long or widespread use. Thus, it’s natural for DeFi institutions to meet challenges. Here are certain DeFi challenges that DeFi 2.0 resolves to overcome-

Limited consumer protection

DeFi operates on a peer-to-peer network in a decentralized manner. Thus, there aren’t as many rules and regulations for DeFi users as in centrally regulated financial systems. Although this absence of tight regulations has, in a way, helped DeFi thrive, there are serious challenges associated with this modus operandi. For instance, consumers may have limited recourse in the event of a bad transaction. On the other hand, there is sufficient buffer for users as well as institutions in centralized financial systems. In the US, the Federal Deposit Insurance Corp. (FDIC), for example, reimburses deposit account owners up to $250,000 per institution in the event of a bank failure. Banks must also have a minimum amount of capital as reserves for continued stability. DeFi offers no such protection.

Hackers can pose a serious threat to DeFi

Although a blockchain’s security is almost unbreachable, there are still aspects of DeFi that hackers could exploit to compromise the system. For instance, all use cases of decentralized finance rely on software systems that are susceptible to hacking, and could result in the theft or loss of funds.

Collateralization

Collateral is an item of worth used to obtain a loan. For instance, the collateral for a home loan could be the home you wish to buy. Nearly all DeFi lending transactions require collateral equaling 100 percent of the loan value. This restriction does not just limit who can apply for a DeFi loan but also who is willing to accept one.

Requirement of a private key

To store your cryptocurrency assets, you need a wallet, which can be made secure with a private key. Private keys are unique codes wallet owners need in order to access their funds and prove their wallet ownership. The problem with using wallets in DeFi is that funds become inaccessible if the wallet owner loses his key. Also, a key, once lost, cannot be recovered.

User experience

DeFi platforms’ usability is also a major problem. Decentralized products are difficult to use due to their complicated UX and UI. This is why the majority of DeFi active users are seasoned crypto enthusiasts. Defi 2.0 projects intend to eliminate this problem by making DeFi platforms more fun, interactive and user-friendly.

Ethereum’s dominance

Most DeFi solutions run on Ethereum. It was, after all, the first blockchain protocol to introduce DeFi services. However, due to an ever-growing number of Ethereum users, there are significant transaction delays on the platform; transaction fees are also constantly skyrocketing. Problems like these started creating obstacles in the way of DeFi’s mass adoption. Now, with an evolved version of DeFi in place, other popular blockchains such as Solana, Cardano and Polkadot have also started to enter the DeFi space, helping DeFi enter the mainstream.

Liquidity concerns

Liquidity pools have proven to be hugely profitable in DeFi. They provide liquidity providers the opportunity to earn incentives for staking pairs of tokens. If, however, there is a change in the price ratio of tokens, liquidity providers may lose money. In DeFi 2.0, there is a provision for insurance against this risk, for which a small fee is charged. This doesn’t just encourage investment in liquidity pools but also benefits stakeholders, users as well as the DeFi platform used.

How to invest in DeFi 2.0?

Most of the investment opportunities offered by DeFi 2.0 are the same as DeFi but come with a wider scope. Listed here are a few ways in which DeFi 2.0 investments can be made-

Yield farming

If you are familiar with DeFi, you also probably know what yield farming is. For those unaware, yield farming is using decentralized finance to maximize returns. For instance, some yield farmers keep shifting their cryptos from one loan platform to another for maximized profits. DeFi 2.0 adds additional layers of incentives and utility to yield farming by allowing yield farm LP tokens to be used as collateral for loans.

Lending

Another way to invest in DeFi 2.0 is by offering loans in exchange for an interest amount. Since DeFi 2.0 loans are self-repaying, they offer great peace of mind to both lenders and borrowers.

Liquidity mining

Liquidity mining allows crypto holders to lend their assets to decentralized exchanges for rewards. These rewards are often derived from the trading fee, which traders swapping the tokens have to pay. The fee is charged per swap, and the total reward earned by the lender varies depending on their share in the liquidity pool.

Staking

Staking allows a user to become a validator on a blockchain network that uses proof-of-stake as its consensus mechanism. You simply lock your currency into the blockchain and receive block rewards in return.

DEX trading

Decentralized exchanges (DEXs) facilitate crypto transactions without involving third-party organizations like banks. Many states and countries allow these transactions to occur in a highly regulated environment. However, DEX trading is not subject to such rules and regulations because of its decentralized nature. Besides, DEX trading is cheaper than trading on centralized exchanges, and it facilitates different types of transactions, such as margin trading.

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Major DeFi 2.0 projects

Olympus DAO

Olympus DAO is one of the pioneers in the DeFi 2.0 movement and is popular for its innovative protocol-owned liquidity (POL) model. The platform is a self-governing decentralized autonomous organization (DAO) that uses OHM as its native token. This token, according to Olympus, could become the reserve currency for decentralized finance. OHM tokens are backed by stablecoins such as DAI and FRAX and, hence, can maintain price stability.

Olympus allows token holders to vote on important decisions much like any other DAO. Staking OHM tokens can also help users make money on the platform. Staking allows users to earn sOHM tokens, which can then be used on different DeFi platforms. You can convert your sOHM tokens into OHMs by burning them.

Users can generate LP tokens, issue bonds with them and then buy OHMs at a discounted rate. Selling bonds is another way Olympus DAO members can make money.

Abracadabra.money

Another important DeFi 2.0 project on our list, Abracadabra.money, is essentially a lending platform. If you own interest-bearing tokens like yvUSDC and yvWETH, you can use them as collateral for borrowing or minting Magic Internet Money (MIM), a dollar-pegged stablecoin.

Doing this allows users to turn their interest-bearing tokens into liquid asset. The interest rates on the platform are stable, and the borrowing rates are low. The platform’s governance tokens are called SPELL, which can be used for voting on proposals and also earn a platform fee by staking them.

Convex Finance

Convex Finance is a decentralized finance platform built on stable exchange Curve Finance (CRV). This platform is beneficial for liquidity providers and stakers alike. For Curve Finance’s liquidity providers, Convex offers an opportunity to earn boosted rewards without them having to lock in their CRV tokens. Besides, the platform has no withdrawal fees, and charges very little in performance fees. Similarly, people interested in staking can use Convex to stake their CRV tokens and earn a share of boosted rewards.

Should you invest in DeFi 2.0?

By now, you must have found the answer to “What is DeFi 2.0?” Not just that, you also have a fair idea about how platforms operating within this upgraded DeFi ecosystem benefit users. All DeFi 2.0 innovations are, in fact, directed towards making DeFi a truly decentralized space.

With DeFi 2.0 innovators relentlessly working to fix breaches in DeFi’s original structure to create a more secure, stable and efficient financial system, more and more individuals and businesses are gravitating toward this space to capitalize on its offerings. As a result, the number of DeFi 2.0 platforms is constantly growing. Some projects like Olympus DAO have already earned massive popularity among users and blockchain enthusiasts, and the reasons are obvious. For instance, Olympus DAO’s native token OHM soared to $1415 within four weeks of its introduction. The market capitalization also reached an all-time high of $4.4B. While Olympus is still regarded as the standard-bearer of the DeFi 2.0 movement, other platforms have also helped this new era of open finance strengthen its foothold.

So, an important question that pops up here is: Should you invest in a DeFi 2.0 project? Well, it entirely depends on what aspect of DeFi 2.0 attracts you and whether your financial goals and expectations align with DeFi 2.0’s offerings. And in case you decide to invest in a DeFi project, the next question that surfaces is: Which project should it be? Much like any other crypto investment, your decision to invest in a particular platform should be based on extensive research surrounding that platform, the minds behind it and its working.

Endnote

DeFi has always been viewed as the key player in democratizing finance, and popularizing blockchain technology. DeFi 2.0 is an improved version of the expansive DeFi ecosystem that resolves to fix its flaws and build on its strengths to offer consumers exciting new opportunities to advance on their path to financial freedom.

If you want to build a DeFi 2.0 platform, contact LeewayHertz. We, at LeewayHertz, build highly secure and scalable DeFi 2.0 products that can offer an unparalleled user experience

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Author’s Bio

Akash Takyar
Akash Takyar
CEO LeewayHertz
Akash Takyar is the founder and CEO at LeewayHertz. The experience of building over 100+ platforms for startups and enterprises allows Akash to rapidly architect and design solutions that are scalable and beautiful.
Akash's ability to build enterprise-grade technology solutions has attracted over 30 Fortune 500 companies, including Siemens, 3M, P&G and Hershey’s. Akash is an early adopter of new technology, a passionate technology enthusiast, and an investor in AI and IoT startups.

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