What Is Defi 2.0 And Why Does It Matter?
In the crypto world, people keep asking “what is Defi 2.0” and this question keeps one in the dark because they intend to milk the DeFi market.
Decentralized finance, or DeFi for short, is a class of blockchain-based solutions that aim to address the issues with traditional finance, namely centralization and the lack of personal autonomy and ownership over one’s finances.
By the end of this article, you will have an in-depth knowledge of decentralized finance, and how your resolve to know “what is DeFi 2.0” can make you rich.
Defi 1.0 was not enough
Before addressing “what is DeFi 2.0”, it would be good to see some of the more prevalent issues that DeFi 1.0 had.
And they are:
Locking up money and its entire value is necessary to provide liquidity to a pool. And this was the basis of DeFi 1.0.
This financial rigidity often leads to inefficiency in the capital, even though it is spread across various blockchains and markets.
The lack of long-term, practical incentives for liquidity providers outside of distributing LP tokens is a problem for many DeFi 1.0 protocols.
Currently, one issue with liquidity providers is that they frequently withdraw both their allocated resources and rewards once they become eligible or when a more competitive protocol with a higher APY becomes available.
A protocol’s native tokens are frequently diluted in supply as a result of this recurring and capitulated market sale.
Data congestion can frequently be an issue for DeFi 1.0 platforms during periods of high network activity.
Transaction speeds are slowed by these bottlenecks, which also raise the cost of network fees like gas (in the case of Ethereum).
Even from reputable DeFi 1.0 security companies like Certik, routine software upgrades and changes can frequently result in outdated and redundant information, despite the fact that there are periodic audits of smart contracts.
Given the highly technical nature of these systems, the majority of DeFi 1.0 users still don’t know how to safely manage risk or independently verify a network’s security as they stake (lock-up) significant amounts of money.
Many DeFi 1.0 platforms give up decentralization to enable greater levels of scalability and security, which is consistent with the problems highlighted by the blockchain trilemma.
Financial services that rely on off-chain or external information require third-party data sources (oracles) with higher quality than what is currently offered in web3.
What is Defi 2.0
Now that you have seen the shortcomings of DeFi 1.0, you will now get the answer to “what is DeFi 2.0”.
DeFi 2.0 is an initiative that seeks to improve upon and address the issues with the first DeFi wave.
DeFi was groundbreaking in that it offered decentralized financial services to anyone with a cryptocurrency wallet, but it still has flaws.
This process has already occurred in the cryptocurrency industry, with Ethereum (ETH) and other second-generation blockchains outperforming Bitcoin.
In addition, DeFi 2.0 will have to respond to new compliance rules like KYC and AML that governments intend to implement.
Since DeFi enables liquidity providers to be compensated for staking token pairs, liquidity pools (LPs) have proven to be incredibly successful.
However, liquidity providers run the risk of suffering an impermanent loss of funds if the tokens’ price ratio changes.
For a modest cost, a DeFi 2.0 protocol might offer protection from this. Users, stakeholders, and the DeFi industry as a whole gain from this solution, which increases the incentive to invest in LPs.
Why does DeFi 2.0 matter?
What is DeFi 2.0 and why does it matter? It will interest you to see that DeFi protocols are now valued at over $250 billion, and the combined market value of all DeFi tokens is now getting close to $150 billion.
For DeFi, there is an estimated $1 quadrillion global derivatives market. Considering this, we can conclude that DeFi still has ways to go before it can resemble traditional finance in any significant way.
Nevertheless, the DeFi 1.0 we currently have offers an impressive array of financial services. For instance, the MakerDAO makes it possible to use cryptocurrency as security against stable coins and other less volatile assets.
You can create artificial tokenized assets that resemble an existing investment using derivatives platforms like Synthetix. This allows for the creation of indexes like the crypto index.
However, DeFi needs to go further than merely decentralization in order to appeal to a larger audience.
DeFi platforms don’t hold any specific party accountable for security lapses, so there is little chance of finding the culprit or recovering the stolen funds.
Decentralized finance 2.0 is an effort to fix some of the flaws in earlier contracts that have cost holders millions of dollars.
What are the use cases of DeFi 2.0
To really get the answer to “what is DeFi 2.0”, you also need to know the use cases of 2.0.
Now, we will look at the various use cases of DeFi 2.0. And they are:
Cross-chain bridges designed to combat low liquidity will be possible with DeFi 2.0. Liquidity pools and layers of smart contracts can be used to connect various blockchains. In addition to native resources, users have access to additional resources. Trading between pools on different chains can help a chain with its asset’s lack of liquidity.
Unlocking the value of staked funds
When you stake a token pair in a liquidity pool, you will be given liquidity provider tokens as payment, but with decentralized finance 1.0, you can stake the liquidity provider tokens with a yield farm to increase your profits.
Decentralized finance 2.0 advances this method by using the yield farm liquidity provider tokens as security. It follows a similar process to MakerDAO(DAI), where tokens are either created from scratch or taken from a lending protocol.
The main concept is that while generating APY, the value of the tokens used as liquidity providers should be unlocked for new opportunities.
Smart contract insurance
If you’re not an experienced developer, conducting enhanced due diligence on smart contracts can be challenging. Without this knowledge, you can only partially evaluate a project.
Due to this, investing in DeFi projects carries a significant amount of risk. Obtaining DeFi insurance for particular smart contracts is now possible with DeFi 2.0.
Consider a scenario where you’re using a yield optimizer and have staked LP tokens in the smart contract of the tool. All of your deposits could be forfeited if the smart contract is compromised.
For a fee, an insurance project can provide you with a guarantee on the deposit you made with the yield farm. Keep in mind that this will only apply to a specific smart contract.
If the liquidity pool contract is violated, you typically won’t receive a payout. However, you’ll probably receive a payout if the yield farm contract is compromised but still covered by insurance.
Impermanent loss insurance
Any alteration in the price ratio of the two tokens you locked could result in financial losses if you invest in a liquidity pool and begin liquidity mining.
Impermanent loss is a term used to describe this process, but new DeFi 2.0 protocols are looking into alternative ways to reduce the risk.
Consider adding one token to a single-sided LP as an example, since adding a pair is not necessary. The native token of the protocol is then added as the second token in the pair.
After that, both the protocol and you will receive payments made by swaps in the relevant pair.
The protocol uses the money from their fees to gradually create an insurance fund that will protect your deposit from the effects of temporary loss.
The protocol can create new tokens to make up the difference if there are not enough fees to cover the losses. Tokens that are extra can either be saved for later use or burned to reduce supply.
A loan usually entails interest payments and the risk of liquidation. But with DeFi 2.0, this doesn’t need to be the case.
Consider borrowing $1000 from a cryptocurrency lender as an illustration. You are given $100 in cryptocurrency by the lender, but $500 is needed as security.
After receiving your deposit, the lender invests it to generate interest that will be applied to your loan. Your deposit will be returned once the lender has made $1000 using your cryptocurrency plus an additional sum as a premium.
Additionally, there is no danger of liquidation here. Simply put, the loan will take longer to pay off if the value of the collateral token declines.
How to invest in DeFi 2.0
Having answered “what is DeFi 2.0”, this article will show you how to milk it, in this section.
Although there are many ways to invest in DeFi 2.0, it helps to think of them as falling into one of two categories: purchasing tokens or using DeFi 2.0 platforms.
Trading or hodling a DeFi protocol’s native token on a DeFi platform is one of the simplest ways to invest in DeFi 2.0. If the project continues to develop, the value of your investment should increase as well (as long as it’s not a stable coin, which is created to have a stable price).
Regarding purchasing tokens, not much needs to be said. All you have to do is choose the appropriate project and buy its native token.
A list of a few projects to get you started is provided at the end of this guide.
Using DeFi 2.0 platforms
Although DeFi 2.0 complicates the use cases for DeFi, it (ideally) streamlines the front-end procedure. This implies that it’s easier than ever to use your money to accomplish more things.
Consider using DeFi protocols that offer the features you need if you want to generate returns that you can trust. Decentralized applications (dApps) are the usual term used to describe the platforms.
The ways to make money from using DeFi 2.0 platforms are:
The term “yield farming” now refers to all DeFi activities that produce a return (yield) on a particular class of digital asset collateral, which is typically expressed in annual percentage yields (APY).
Reinvesting profits is generally regarded as an essential component of “farming” in each yield farming activity, though it is not required. Each investor should consider their objectives and level of risk tolerance.
In one farm opportunity, users can offer loans in exchange for interest payments. Self-repaying loans provide more security for both lenders and borrowers.
Liquidity mining or liquidity provision (LP)
Another way to yield farm involves users giving their cryptocurrencies to liquidity pools so that other users can trade against them in exchange for commissions. In the event of a market downturn, temporary loss insurance can reduce losses.
Users can join a proof-of-stake blockchain as validators and earn block rewards by locking the validator token or currency of that chain in another opportunity to yield farm.
Users can purchase (and sell) tokens that distribute ownership of DAO governance to token holders.
Depending on the organization’s objectives, participating in the DAO has different advantages.
Decentralized exchanges give users a way to trade cryptocurrencies without a centralized authority overseeing each transaction.
They frequently charge lower fees than centralized exchanges and provide options like margin trading. Every nation and state has different laws concerning trading though.
Although decentralized gaming is a separate industry, it intersects with DeFi 2.0 whenever money is involved.
As this market matures, keep an eye out for opportunities for play-to-earn and ownership models based on DeFi 2.0.
Below is a list of some of the most popular DeFi projects today:
- Synapse ($SYN)
Automated market maker (AMM) and trustless cross-chain bridge.
- Avalanche ($AVAX)
DeFi 2.0 dApps can be created on a fast, affordable platform for programmable smart contracts on layer-1
- Solana ($SOL)
Solana is a leading rival of Avalanche and Ethereum as a layer-1 smart contract platform.
- Yearn Finance ($YFI)
On the Ethereum blockchain, there are companies that aggregate yield and lending and offer insurance. But this project is not available to US citizens.
- MakerDAO ($MKR, $DAI)
The DAO, which controls $DAI, the native stable coin pegged 1:1 to the US dollar, is governed by holders of $MKR tokens.
- Algorand ($ALGO)
Layer-1 and layer-2 smart contract protocols are focused on scale and blockchain interoperability.
What are the risks of Defi 2.0, and how to prevent them?
Compared to DeFi 1.0, DeFi 2.0 carries many of the same dangers. The most important ones are listed below, along with what you can do to protect yourself.
Smart contracts that you interact with might have vulnerabilities, backdoors, or be hacked. An audit cannot guarantee the safety of a project.
Hence, you need to carry out as much research as you can on the venture, and remember that risk is a part of investing.
2. Government regulations
Regulation may have an impact on your investments. The DeFi ecosystem is attracting the attention of governments and regulators around the world.
While laws and regulations can increase the security and stability of the cryptocurrency market, some projects may need to modify their services as new regulations are established.
3. Transient loss.
Anyone interested in participating in liquidity mining should be aware that there is still a significant risk, even with IL insurance. It is impossible to completely eliminate risk.
4. Inability to access your money
You might find it difficult to get to your money. If you stake through the website interface of a DeFi project, finding the smart contract on a blockchain explorer might be a good idea.
In the event that the website goes down, you won’t be able to withdraw. However, you will need some technical know-how to interact with the smart contract directly.
Frequently asked questions (FAQs)
Why DeFi will change the world?
Many of the issues with the current financial system can be fixed by DeFi, including granting access to the financial system to those who are not banked.
In the upcoming years, DeFi can offer enhanced transparency and more reliable security while displacing many of the antiquated procedures.
How will DeFi affect banks?
DeFi has vulnerabilities that could threaten monetary stability if it were to spread widely. Due to high leverage, liquidity mismatches, inherent interconnectedness, and a lack of shock absorbers like banks, these can be severe.
Now that your question “what is DeFi 2.0” has been answered, you should research more on the projects and milk the market.