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What Is DeFi 2.0?

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by John Caroline · 6 min read
What Is DeFi 2.0?
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DeFi 2.0 is simply a short description of the second generation of decentralized finance. This guide explores all that is concerned with DeFi 2.0 and its relevance in the tech space.

Every tech-inclined innovation has always taken the world from its initial phase to a new revolutionized phase as there is always room for new models and revolutionary concepts with these innovations. There is no exception with decentralized finance (DeFi) being a blockchain-based innovation, as the world is already talking about DeFi 2.0, the next generation of DeFi protocols that appeared just a few years after DeFi was birthed.

As decentralized finance begins to approach dawn to a new era of upgraded concepts and rebranded models, let’s dive fully into understanding what DeFi 2.0 is all about.

DeFi 2.0: The Second Generation of DeFi Protocols

As implied by the name, DeFi 2.0 is the second generation of decentralized finance protocol. A proper understanding of decentralized finance in general will make it a lot easier to understand the new version.

DeFi is an ecosystem that shelters all decentralized platforms and projects designed to introduce new blockchain-based financial models and economic primitives while disengaging the traditional financial system.

The issuance of decentralized applications and projects is dependent on proven models of financial-based agreements. These protocols evolve on the ground that they feature permissionless composability and open-source development culture that poses the industry to exclusive benefits.

DeFi has earned high significance in the blockchain space in just a few years of its evolution. The adoption of decentralized finance has been growing at a breakneck pace since 2021 due to the efficiencies it has brought to the financial system. Hence, it is ushering in a new era of decentralized finance generally tagged DeFi 2.0, an upgraded and revolutionized version of the existing DeFi models.

Amid the limitations with DeFi 1.0, the system began to see breakthroughs in the aspect of yield farming, liquidity constraints, and the likes, hence serving as a forerunner that has triggered lots of anticipations towards the second version of DeFi.

Why DeFi 2.0 Matters

The iteration of DeFi 2.0 ushers the world into a new era of revolutionized DeFi protocols that tends to tackle the limitations with the early generation of decentralized finance. The second version of DeFi proposes new innovations and solutions, it only spells progress for the DeFi space while providing consumers with new and exciting mechanisms to drive them towards financial freedom.

The issue of scalability and the unfriendly user interface has been a major challenge to the early DeFi protocols as most DeFi solutions are built on the Ethereum blockchain. The complexities in the model structures make it challenging for users, especially newbies to use decentralized products.

The high gas fee and long waiting periods to execute transactions have been a central challenge in the DeFi space which has caused many to lose interest in using DeFi platforms. However, DeFi 2.0 is set to deploy necessary infrastructures capable of curtailing Ethereum’s scaling issues.

Another notable challenge the DeFi space is facing is that most assets are static and underused, relating to liquidity issues. There is no doubt that DeFi protocols have a low utilization ratio due to poor liquidity solutions.

Although, the Automated Market Maker (AMM) allows exclusive access to operating capital. The model is not efficiently utilized due to AMM’s design, which prevents liquidity from being concentrated. Meanwhile, DeFi 2.0 allows deposited assets to be used to their full potential. Hence, it is making way for a good cash flow to efficiently sustain and support projects.

Other challenges of the current DeFi protocols that its next version seeks to curb include oracles and intermediary information, centralizations, security issues, and lots more.

DeFi 2.0 Examples

Some emerging projects are already building their protocols with the DeFi 2.0 toolkits, hence preparing the industry for the next phase of decentralized finance. Some examples of these projects include:

  • Olympus DAO (OHM), a decentralized reserve currency model with bonds, LP, staking, etc.
  • Avalanche (AVAX) – a swift, low-cost programmable smart contract platform upon which decentralized applications of DeFi 2.0 can be built.
  • Yearn Finance (YFI) is a yield and lending aggregator and insurance provider on the Ethereum blockchain.
  • Curve Finance (CRV) and Convex (CVX), a leading TVL of DeFi protocols. Curve is the DAO, exchange, LP, stablecoin, and more, on which the yield farming platform Convex is built.

Benefits of DeFi 2.0

The second generation of DeFi promises lots of functionalities to make the DeFi space easy to deploy for users. With DeFi 2.0, users can get insurance on specific smart contracts in order to reduce the risks associated with compromising smart contracts. Further, DeFi 2.0 ensures users against the risk of impermanent loss. Finally, the second generation of decentralized finance also curtails the risks associated with lending processes and eliminates interest payable on loans.

Other exclusive benefits to the DeFi sphere include the reduction of the cost associated with executing transactions. Therefore, the industry is provided with low gas fees and swift transaction processes. Besides, DeFi 2.0 promises an efficient liquidity supply. Protocols that need liquidity can efficiently have access to them.

Risks of DeFi 2.0 and Their Prevention

Although DeFi 2.0 promises lots of advantages, the system also tends to be exposed to certain risks.

Firstly, there is investment risk. Investing in any financial instrument is always risky, hence decentralized applications existing on DeFi 2.0 would not be an exemption either. As such, DeFi 2.0 could also expose users to investment risks as smart contracts in the new era could also have some loopholes. Therefore, investors are advised to carry out intense research on any project before venturing into them.

Secondly, there is also a liquidity risk. It is important to note that the risks associated with liquidation can be reduced but not totally minimized. Although DeFi 2.0 protects users against liquidity risks like impermanent losses, intending liquidity miners can still be exposed to losing some funds. Hence, intending liquidity miners are better off if they get themselves competently equipped.

Conclusion

As the general tech space continues to progress, DeFi 2.0 is worth the wait as it is poised to combat the risks associated with DeFi 1.0. Hence, it is making the system of decentralized finance much better and fascinating for people to venture into. As such, the new phase will see DeFi becoming more flexible to use, thus driving the blockchain technology towards the mainstream appeal.

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FAQ

What is DeFi 2.0?

DeFi 2.0 is the second generation of decentralized finance protocols. It is an upgraded and revolutionized version of DeFi 1.0.

Which issues does DeFi 2.0 solve?

It solves the issues of scalability, liquidity constraints, centralization, security, and lots more.

What are the use cases of DeFi 2.0?

Firstly, DeFi 2.0 is used to get insurance on specific smart contracts in order to reduce the risks associated with compromising smart contracts. Secondly, DeFi 2.0 ensures users against the risk of impermanent loss. It also curtails the risks associated with lending processes and eliminates interest payable on loans.

What are the examples of DeFi 2.0 projects?

The most prominent examples of DeFi 2.0 are OlympusDAO (OHM), Avalanche (AVAX), Yearn Finance (YFI), Curve Finance (CRV), and Convex (CVX).

What are the advantages of DeFi 2.0 over DeFi 1.0?

The main advantage is the reduction of the cost associated with executing transactions, which provides the industry with low gas fees and swift transaction processes. Furthermore, DeFi 2.0 provides an efficient liquidity supply. Protocols that need liquidity can efficiently have access to them.

Are there any risks of DeFi 2.0?

DeFi 2.0 is posed to certain similar risks as that of DeFi 1.0 but at a minimized level. Some of these risks include investment risks, liquidation risks, and others.

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