The value of DeFi: Understanding DeFi Evolution From 1.0 to 3.0
In 2021, the volume of funds in the DeFi sector grew by 1,210% — from $18.71 billion to $245.22 billion. 2021 was the year of unprecedented growth for DeFi. But what were the conditions that preceded this surge?
The fundamental elements of DeFi
DeFi is an independent financial ecosystem open to all users. In it, participants interact with each other directly, without intermediaries such as banks, credit organizations, and others. This makes transactions faster and cheaper.
DeFi protocols are considered to be among the most reliable and secure as they operate on the basis of blockchain and smart contract technologies.
Blockchain is a distributed database in which information about completed transactions is stored as a continuous chain of blocks. Information within this system cannot be altered or faked.
A smart contract is a computer algorithm that fulfills the terms of an agreement between two or more parties to a transaction.
Most of DeFi protocols are based on the Ethereum blockchain, although user interest in other platforms such as Polkadot or EOS is also growing.
Smart contracts execute the terms of the transaction in the blockchain and perform the financial turnover within a given site. This process is fully automated and gives the parties to a contract the guarantee that the information written in the code is protected, encrypted, and cannot be used by third parties for their own purposes.
Due to its reliability and practicality, DeFi quickly became popular and is now in high demand. In November 2021, the size of the decentralized finance market reached $274 billion.
Features of different generations of DeFi
DeFi 1.0
DeFi 1.0 is an early decentralized financial infrastructure. It includes:
- Decentralized Applications for Centralized Trading and DEX (Uniswap, SushiSwap)
- Loan applications (Aave, Compound)
- Stablecoin Applications (MakerDao)
- Liquidity pool applications
- Synthetic assets (Synthetix, UMA)
- Insurance type projects (Cover, Nexus Mutual)
MakerDAO was one of the first autonomous organizations based on Ethereum and can be seen as the backbone of DeFi. The project released a stablecoin called DIA, backed by digital assets that are managed through MakerDAO smart contracts, unlike USDC and USDT, which are backed by dollars in a bank. MakerDAO has created a path to an open and permissionless financial system. Borrowers contribute around 150% of the value of Ether to get a DIA loan on MakerDAO.
In September 2018, Compound Finance launched a platform that allowed borrowers to take out loans and lenders to earn interest on the money they set aside for loans. To qualify for a loan, borrowers must deposit digital assets as collateral to cover the loan. This is done without the participation of third parties.
In November 2018, Uniswap was successfully launched. The platform has pioneered an automated market maker (AMM) to ensure sufficient liquidity between any pair of tokens. On the platform, users can freely exchange any token for Ethereum with any central control or permission. In DeFi, the Uniswap platform acts as a decentralized exchange (DEx).
Similar to Uniswap, Curve Finance DEx focuses on stablecoin exchanges. It also uses AMMs like Uniswap to issue tokens from its liquidity pool to DeFi markets like Yearn and Compound Finance.
Many other platforms include Balancer, Bancor, Yam, Synthetix, Sushi Swap, AAVE, and many others. The key here is that DeFi 1.0 provided a baseline for income farming, liquidity lending, and secured borrowing.
DeFi 2.0
DeFi 2.0 was created to address the limitations that were present in the early stages of DeFi:
1. Since most DeFi projects are built on the Ethereum blockchain, they enjoy high traffic but are often slow and cost-inefficient. Hence, scalability solutions were expected.
2. Zero insurance risk is another trend in DeFi 1.0. In the event of a system compromise or hacks that could result in the loss of assets, many liquidity providers were often exposed to risks due to the lack of an insurance scheme.
3. The risk of intermittent loss was a major concern in the DeFi 1.0 era. This happens when the value of the asset you provided in the liquidity pool changes.
4. It is difficult for beginners to navigate between the UX and UI of many of the DeFi projects. Therefore, projects were only available to crypto experts.
5. To a large extent, many DeFi projects are still centralized as they do not operate as a DAO in their ecosystem. Either the development team or the investors still manage the projects themselves, which makes them less reliable. The principle operation of a decentralized autonomous organization allows any member of the DAO to take part in decisions with regard to the future of the project.
In addition to addressing the issues listed above for users, other DeFi projects are now looking to address these issues for older projects in order to make the industry more stable for more users.
In this way, DeFi 2.0 has increased the efficiency of capital use by providing insurance for smart contracts and insurance against non-permanent losses. To address liquidation risk, DeFi 2.0 has also adopted self-sustaining loans. Another standout feature of DeFi 2.0 is the presence of a protocol-owned or protocol-controlled liquidity pool (PCV). This liquidity is used to invest in other projects and distribute the profits among the holders. Projects such as Solana, Avalanche, and Polygon have also contributed to improving scalability in the DeFi space.
DeFi 3.0
While DeFi 2.0 was able to fix some of the issues outlined above, it also introduced new challenges. As many people move from CeFi to DeFi, there is a lot more liquidity flowing into the industry. This has resulted in attracting the attention of attackers who often exploit gaps in smart contracts.
Another reason for the emergence of a new generation of DeFi is the inclusion of all forms of financing, including decentralized hedge funds, options, and derivatives.
Simply put, DeFi 3.0 is another layer on top of DeFi 2.0. It also has its own treasury, but all you need to do in this case is to have the token in your wallet. The price of the token will either increase, or new tokens will be distributed among the holders’ wallets. It simply reflects the activity of the protocol. Examples include Multi-Chain Capital, Multi-Farm Capital, and Cross Chain Capital.
Multi-Chain Capital (MCC)
With MCC, users can buy Ethereum, farm for other cryptocurrencies, and share profits among holders. MCC specifically farms for Polygon, Fantom, and Avalanche token holders. Whenever someone buys MCC tokens, 5% of the value of the purchased token is distributed among the holders. While 5% of each sale goes to the MCC treasury and $MCC buyback.
Multi Farm Capital
Allows you to shop on Ethereum, farms for you on multiple chains, and returns the profits to the holders. Like the MCC, the MFC token represents a share of the profits from the investment in the farm. What makes MFCunique different is that they strive to give the community as much choice as possible.
Cross Chain Capital (CCC)
Cross Chain Capital runs on the Avalanche blockchain, offering rewards to holders. First, through a passive income of 10% for each purchase of CCC, and second, through long-term sustainable buyback protocols and liquidity to keep the value of the project token high.
In a Nutshell
DeFi 3.0 has an outstanding long-term trajectory because the mechanism used for buybacks and profit-sharing is a great way to offset the problems of DeFi 2.0.
Financial crises have demonstrated how unstable traditional financial systems are. Those who understand this have already turned their eyes towards new technologies, in particular cryptocurrencies and DeFi platforms.
The Standard is a DeFi protocol combining the yield farming of cryptocurrencies as well as physical assets such as gold. It enables users to generate a stable virtual currency called “Standard Euro.” This is achieved by locking up tangible and intangible assets as collateral in decentralized smart contracts, called Smart Vaults. Doing so allows people to spend their locked-up funds without selling their assets.
