DeFi 2.0 Explained: Second Generation of DeFi

Decentralized finance, or Defi, is one of the most successful and influential waves of blockchain-based innovation. Defi is a broad range of decentralized applications that can disintermediate traditional financial services to unlock new economic primitives. It is powered by blockchains that have built-in smart contracts capabilities and secure Oracle networks like Chainlink.

The Defi protocols are constantly evolving and improving upon existing models of financial-based agreements. This is due to their inherent advantages of open-source development and permissionless composability. Defi 2.0 is a new type of innovation that has been emerging at breakneck speed. This is due to a surge in liquidity-focused, decentralized finance projects in the last few months. Is Defi 2.0 even a thing?

DeFi 2.0, a term that has emerged in the blockchain technology industry, refers to a subset of Defi protocols built upon previous Defi breakthroughs such as yield farming and lending. Liquidity constraints are a common problem for many on-chain systems that use native tokens. This is a key focus of Major Defi 2.0 projects implementations.

This article discusses the financial innovations and the utility of the Defi 2.0 ecosystem.

Early DeFi developments

Uniswap and Aave, Bancor and MakerDAO, Compound, as well as other Defi pioneers, have built a strong foundation for the burgeoning Defi industry. They also added many valuable and useful "money LEGOs" (such as the MakerDAO and MakerDAO) to the ecosystem. Uniswap (the first decentralized automated market maker) and Bancor were the first to let users swap tokens without having to give up custody. Aave and Compound allowed for decentralized lending and borrowing. This enabled on-chain yields for deposits and permissive access to operating capital.

MakerDAO offered a decentralized stablecoin that ecosystem members could use to make transactions. This was a buffer against volatility in cryptocurrencies. These protocols provided users with access to reliable exchanges, frictionless borrowing/lending, and stable pegged currencies. These are three of the key financial primitives that are commonly found in traditional financial markets.

The infrastructure that supports these well-known Defi-based services, however, is very different from those of centralized companies in terms of transparency and control. These decentralized services are the foundation of Defi's innovation.

DeFi 2.0's goal

The new Defi 2.0 apps are not geared towards users as the previous generation was. Instead, they have a business-to-business (B2B), focus. Defi 2.0 protocols take advantage of the fact that the first generation Defi products were able to bootstrap the industry by establishing a user base and creating the essential Defi primitives that can be used by future manufacturers to build the next generation of Defi apps. This new generation of Defi protocols has the goal of ensuring the sector's sustainability.

The sector's dependence on token incentives and third-party providers to secure liquidity is what prevents it from becoming sustainable. Defi's almost non-existent correlation between traditional financial markets and traditional finance is also a major problem. These are the fundamental problems that Defi 2.0 and all subsequent projects aim to solve.

Many of the Defi 2.0 movement's pioneers focus on long-term liquidity. OlympusDAO is a protocol that aims to create a decentralized reserve currency. OlympusDao announced Olympus Pro as a tool that allows other Defi protocols to use the bonding mechanism to gain liquidity. This is a clear demonstration of Defi 2.0's B2B focus.

Defi 2.0 will help decentralized automated organizations (DAOs) in another way by creating a protocol-controlled value mechanism. Defi 2.0's new products will provide valuable tools that allow DAOs to compete against companies. This will reinforce the movement's B2B focus.

DeFi 2.0 innovation, second generation DeFi protocols

Still unsure why Defi 2.0 is so beloved? Keep reading.

Defi 2.0 research started when DeFi's limitations were understood by users and projects. This led them to seek out the best solutions. Each solution has led to minor market movements that are precisely what the market needs.

Let's take a look at some of the solutions that Defi 2.0 has used to expand its projects.

Scalability - Layer one, Layer two

For Defi users, especially novices, it has been difficult to interact with the Ethereum network. Due to high gas prices, long wait times, and lengthy wait times, Defi has not been available to most consumers. Defi offers a variety of options, which makes it very appealing. Defi, on the other hand, offers many opportunities that make it appealing.

BSC, Polygon, and Solana received the cash. These are three blockchains that can provide the best service to users. Solutions to the scaling problem could trigger the next market wave.

Liquidity: Yields

To solve the liquidity problem or attract additional capital and users to the Defi market, the simplest solution is to help them earn yields. AMM protocols provide a partial solution to liquidity problems. They allow any person who has sufficient funds to provide liquidity to a token pair.

Teams might be able to obtain enough liquidity from other teams, rather than providing liquidity for themselves. End-users were not motivated to provide liquidity to support a new coin. This was because they would be exposed to temporary loss and receive minimal revenue through swaps. They had to have a compelling financial reason to take this risk. The result was a chicken and egg problem.

Swaps can cause slippage, which discourages users from participating in the Defi protocol's ecosystem if there's not enough liquidity. Without consumers participating in token transactions, there isn't enough fee volume to encourage third-party actors and pool their tokens to provide liquidity. Another important Defi breakthrough was made. Yield farming is the practice of using liquidity provider tokens to bootstrap liquidity for new Defi protocols. How is yield farming going to revolutionize Defi?

This solution addresses the chicken-and-egg dilemma by providing strong economic reasons for third-party liquidity providers to provide a token's higher returns. Because of deeper liquidity, they might be able to generate higher cumulative fees and earn more yield by staking more of the native token.

The advent of yield farming enabled new Defi protocols to be able to bootstrap substantial amounts of liquidity to launch, sustain and minimize slippage for users who want to enter their ecosystem. Defi protocol numbers have increased exponentially, as a result of yield farming, which has shown how Defi project creators and users can both access liquidity at a lower cost.

Defi projects should engage in yield farming initiatives and bootstrap liquidity because it is essential and healthy. To avoid long-term negative consequences, however, project teams need to be careful about their token supply and long-term yield farming strategies.

Centralization: DAOs

Defi users come to Defi not only to make money but also to be independent and self-sufficient. However, one group still controls large numbers of Defi protocols, which causes a loss of faith among Defi users.

Defi projects are known for their propensity toward prioritizing the decentralized aspects. In recent years, the DAO, which allows anyone to vote on the evolution of the project's progress, has seen a surge in popularity.

Capital efficiency. The next interest

Defi is expanding at an incredible rate. The industry's TVL (Total Value Locked) has been steadily increasing. However, Defi is the biggest challenge in that assets are not being used and remain static. Consider the following scenario to understand why.

Lending. Currently, Defi protocols have low utilization rates, which means that there are more lenders than borrowers.

AMM: AMM is DeFi's "Liquidity Pool", and draws a lot of TVL. However, most of the TVL is not used. AMM's design prevents liquidity concentration. Aggregator - Users who input assets to aggregator protocols to obtain Agtokens can't spend them anywhere else.

Many projects such as Olympus DAO and Abracadabra have started to design appropriate initiatives. These are becoming the catalyst for the next wave in the Capital Efficiency branch. Defi 2.0 will be able to do the following for projects that focus on capital efficiency:

Optimize TVL - Allow assets that have been deposited to be used to their maximum potential

A sustainable cash flow is possible: Olympus DAO's system of exchanging LP tokens for bonds has shown that it reduces the likelihood of dump and farm situations while providing long-term liquidity. A good cash flow will allow projects to grow more sustainably and attract more investors to invest in Defi 2.0.

Defi continues to evolve

Whether you view Defi 2.0 news as a new generation in decentralized finance, or simply a fancy name for it, one thing is certain: It's yet another sign of the Defi industry's continued progress.

Importantly, the Defi 2.0 movement's initiatives show that we have already completed the most crucial stage of this evolution: the bootstrapping stage. Now that this is over, Defi 2.0 projects have all the tools they need for advancing decentralized finance.

Developers are becoming more creative when it comes to designing protocols (the idea of money lego), that maximize profit, capital efficiency, and decentralization. While some trade-offs are still to be discovered, they exist. It seems that everyone is just excited for the moment. Defi phase 1 taught us many things. There were many successes as well as mistakes. There are lessons to be learned from the not-so-distant past. This field is maturing in terms of technology and adoption. People are also forgetting the decentralized ethos of the old world, which includes regulation, government, and traditional finance.