Dec 16, 2021
What Is DeFi 2.0 and Why Does it Matter?
In the case of DeFi, we talked about DeFi 2.0, with a wave of ambitious new protocols that have ushered in the next phase in DeFi’s evolution.
But what is DeFi 2.0 and what is its goal? Is it really a paradigm shift or just a hastily put-together marketing term? Let’s find out together!
What is DeFi 2.0?
The vision of DeFi 2.0 is to provide decentralized alternatives to traditional financial instruments and markets such as Compound, Aave MakerDAO, and Uniswap. Projects are able to use the features of blockchain technology and smart contracts to bring innovative financial services and make them easily available to a wide range of users.
The challenge presented by that vision lies in ensuring that even without intermediaries like banks, there can be enough liquidity to keep markets functioning properly. That is why DeFi protocols often rely on liquidity mining pools that provide the necessary assets for automated trading.
Another problem is that DeFi protocols need to borrow liquidity from third-party vendors. This happens through liquidity mining rewards programs, where liquidity providers receive tokens for lending assets. This has proven to be an effective way to get quick liquidity but the problem is that liquidity providers are only motivated by token rewards and can leave a protocol as soon as those rewards that is exhausted.
This is one of the problems that DeFi 2.0 protocols seek to solve — because they want to put protocols in charge of their own liquidity. But it goes further.
While the first generation of DeFi apps was user-oriented, the new kids on the block display a clear B2B focus. DeFi 2.0 products take advantage of the fact that the first generation of DeFi products have managed to kick-start the industry by establishing an early user base and creating the key DeFi primitives that products can now be used to build the next wave of DeFi applications. And the goal of this new wave of DeFi products is to make sure the sector is sustainable.
Sustainable Liquidity
Creating a mechanism for sustainable liquidity is at the heart of some of the pioneers of the DeFi 2.0 movement. OlympusDAO is one of the pioneers, a protocol that aims to create a decentralized reserve currency.
The protocol sells its native OHM tokens at a discount through what it calls a federation mechanism. This mechanism will pay the discount to the buyer in five days. Users can purchase OHM with crypto assets such as DAI and ETH, but can also pay with liquidity provider (LP) tokens representing trading pairs including OHM, for example. such as OHM-DAI and OHM-WETH. This is what allows OlympusDAO to own its own liquidity.
Another mechanism that OlympusDao uses is OHM staking, which reduces selling pressure on the token.
Empowering DAOs
Building protocol-controlled value mechanisms is one way in which DeFi 2.0 is set to benefit DAOs. Still, the movement’s pioneers expect that won’t be the only way. Reaffirming the movement’s B2B focus, Scoopie Truples from Alchemix predicts that the new wave of DeFi products will create many useful tools that will help DAOs compete with corporations.
Allowing DAOs to effectively compete with traditional businesses will be a decisive step towards enhancing DeFi’s connectivity to the broader economy.
Risks of DeFi 2.0
Risk is no exception in the innovation and DeFi and crypto space. This is true in the case of DeFi 2.0.
The general sentiment in the space is that the potential risks pale in comparison to the benefits that can be unleashed through the successful implementation of DeFi 2.0 concepts. At the same time, this does not mean that risk factors should only be ignored. There are ways to mitigate those risks, such as by educating users, using rigorous smart contract testing processes, and ensuring that bugs don’t affect the broader ecosystem.
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