Summary

DeFi 2.0 is a series of projects to improve the problems of DeFi 1.0. Decentralized Finance (DeFi) aims to provide financial services to the public, but has been plagued by issues such as scalability, security, centralization, liquidity, and information accessibility. DeFi 2.0 hopes to overcome these problems and make the user experience more humane. Once successfully overcome, DeFi 2.0 can reduce the risks of cryptocurrency use, prevent them before they happen, and eliminate the concerns of cryptocurrency users.

There are currently a variety of DeFi 2.0 use cases in the market. Users can use liquidity provider tokens and liquidity mining provider tokens as loan collateral on some platforms. This mechanism can not only release the additional value of the token, but also continue to earn mining pool rewards.

You can take out a self-paying loan while allowing the collateral to continue earning interest for the lender. The interest is sufficient to repay the loan without the borrower paying additional interest. Other use cases include insurance against compromised smart contracts and impermanent loss (IL).

In DeFi 2.0, DAO governance and decentralization have gradually formed a trend. However, actions by governments and regulators will ultimately impact the scale at which projects are run, something to bear in mind when investing as the services provided may have to adapt.

Introduction

Decentralized finance (DeFi) emerged in 2020, and it has been almost two years since then. During this period, we have witnessed the great success of various DeFi projects, such as Uniswap, the decentralization of trading and finance, and new ways to earn interest in the cryptocurrency field. Similar to the development history of Bitcoin (BTC), new fields will always face problems that need to be solved. In order to deal with these problems, the DeFi 2.0 concept has gradually attracted attention and become a new generation of DeFi decentralized applications (DApp).

As of December 2021, we have not yet waited for the full popularity of DeFi 2.0, but its development trend has begun to take shape. Read this article to learn how to view DeFi 2.0 and why it is necessary to address the unresolved issues in the decentralized finance ecosystem.

What is DeFi 2.0?

DeFi 2.0 is an upgrade and reform dedicated to solving the problems existing in the initial wave of decentralized finance (DeFi). Decentralized Finance (DeFi) provides innovative decentralized financial services to all cryptocurrency wallet users, but it is not perfect. Cryptocurrencies have witnessed this journey, with second-generation blockchains such as Ethereum (ETH) being an improvement on Bitcoin. DeFi 2.0 also needs to respond to new compliance regulations planned to be introduced by the government, such as identity authentication and anti-money laundering regulations.

Let's look at an example. Liquidity pools (LP) have achieved great success in the field of decentralized finance (DeFi). Liquidity providers can earn fees by staking token pairs. However, once the token price ratio changes, liquidity providers will face the risk of capital loss, that is, suffer "impermanent loss". DeFi 2.0 protocols can provide insurance against such risks at lower premiums. This solution not only encourages more investment into liquidity pools, but also benefits users, stakers, and the entire decentralized finance (DeFi) field.

What are the limitations of decentralized finance (DeFi)?

Before delving into the use cases of DeFi 2.0, let us first explore the problems that DeFi 2.0 strives to solve. Many of the issues mentioned here are also prevalent in the field of blockchain technology and cryptocurrency:

1.Scalability: Blockchain DeFi protocols on the chain often have network congestion and high gas fees, resulting in slow and expensive service. Even simple tasks can take too long and become less cost-effective.

2. Oracles and third-party information: Financial products that rely on external information have higher quality requirements for oracles, that is, third-party data sources.

3. Centralization: Increasing the degree of decentralization should be a goal of decentralized finance (DeFi). However, many projects still do not have complete DAO principles.

4. Security:Most users neither manage the risks of decentralized finance (DeFi) nor even know what risks there are. They stake millions of dollars in smart contracts without any understanding of whether their funds are safe. Although there are security audits, as long as updates occur, the security audits are almost useless.

5. Liquidity: Markets and liquidity pools spread across various blockchains and platforms spread liquidity everywhere. Providing liquidity means that funds and their total value need to be locked up. In most cases, tokens staked in liquidity pools may not be used elsewhere, resulting in inefficient capital allocation.

Why is DeFi 2.0 important?

Even experienced cryptocurrency users and holders can find decentralized finance (DeFi) difficult to understand and intimidating. However, decentralized finance aims to lower barriers to entry and bring new revenue-generating opportunities to cryptocurrency holders. Users who are unable to obtain loans from traditional banks may be able to make their dreams come true through decentralized finance (DeFi).

Under strict risk control, DeFi 2.0 can make finance accessible to the public, so it is crucial. DeFi 2.0 strives to solve the problems mentioned in the previous chapter, that is, to improve user experience. If it can be successfully resolved and more attractive incentives are provided, all parties will be happy.

DeFi 2.0 use cases

We don’t need to look forward to the emergence of DeFi 2.0 use cases. In fact, there are already projects providing novel DeFi services on numerous networks, including: Ethereum, Binance Smart Chain, Solana, and other blockchains that support smart contracts. Here are some of the most common use cases:

Release the value of staked funds

If you have staked a token pair to a liquidity pool, you will receive liquidity provider tokens. coins in return. With DeFi 1.0, users can stake liquidity provider tokens to liquidity mining, allowing profits to continue to create compound interest. Before the birth of DeFi 2.0, this was the limit of extracting value on the chain. Millions of dollars worth of funds are locked in machine gun pools to provide liquidity to the market, yet there is still potential for further improvements in the efficiency of capital allocation.

DeFi 2.0 takes a step forward by using liquidity provider tokens as collateral in liquidity mining. This enables taking out crypto loans from lending protocols or minting tokens in a process similar to MakerDAO (DAI). The specific mechanisms vary from project to project, but the purpose is to release the value of liquidity provider tokens, so as to generate annual income and seek new profit opportunities.

Smart Contract Insurance

Conducting in-depth due diligence on smart contracts is not easy unless you are an experienced developer. Without this knowledge, project evaluations will be less than comprehensive. As a result, the risk of investing in DeFi projects will be very high. With DeFi 2.0, it is possible to insure specific smart contracts for DeFi.

Suppose you use the Yield Optimizer and stake liquidity provider tokens in its smart contract. Once the smart contract is compromised, all your deposits may be lost. The insurance project provides protection for user deposits and only charges a certain fee from liquidity mining. Note that this is limited to specific smart contracts. If a liquidity pool contract is damaged, funds are usually unrecoverable. However, if the insured liquidity mining contract is damaged, the funds may still be recovered.

Impermanent Loss Insurance

If you invest in a liquidity pool and start liquidity mining, any change in the price ratio of the two locked tokens will cause financial consequences. Loss. This process is called "impermanent loss", and the new DeFi 2.0 protocol is exploring new ways to reduce this risk.

For example, suppose you are adding a certain token to a one-way liquidity pool. You do not need to add a token pair at this time, the protocol will add its native token to the other side of the token pair. In this way, the user and the protocol will receive payment fees for the exchange of the corresponding token pairs at the same time.

The protocol then uses these fees to establish an insurance fund to protect user deposits from unpredictable losses. If this fee is not enough to cover the loss of funds, the protocol will mint new tokens to cover the loss. If the number of tokens exceeds the limit, they can be stored for later use or destroyed to reduce the supply.

Self-paying Loans

Loans usually involve liquidation risk and interest payments. But with DeFi 2.0, there is no need to worry about this situation anymore. For example, let’s say a borrower receives a loan worth $100 from a cryptocurrency lender. The lender offers $100 of cryptocurrency but requires the borrower to put up $50 as collateral. The borrower provides a deposit, and the lender uses the interest earned on the deposit to repay the loan. After the lender earns enough US$100 and an additional premium using the cryptocurrency provided by the borrower, it will return the borrower's deposit in full. There is also no liquidation risk involved. Even if the token collateral depreciates, it will simply take longer to repay the loan.

Who controls DeFi 2.0?

DeFi 2.0 has the above functions and use cases, so who is in control of it all? The decentralization trend of blockchain technology will not stop, and decentralized finance (DeFi) is no exception. MakerDAO (DAI), one of the first batch of DeFi 1.0 projects, set the standard for subsequent development. At present, it is increasingly common for projects to give communities a voice.

Many platform tokens also serve as governance tokens, giving holders voting rights. We have reason to believe that DeFi 2.0 can make the field more decentralized. However, in order to adapt to the development of decentralized finance (DeFi), compliance supervision will also play an increasingly important role.

What are the risks of DeFi 2.0? How to prevent it?

The risks faced by DeFi 2.0 and DeFi 1.0 are roughly the same. The following are several major risks, as well as measures to protect the security of personal funds:

1. Smart contract interactions may have backdoors, weak links, or be attacked by hackers. Auditing also cannot guarantee that a project is safe and sound. Users should research projects as thoroughly as possible and understand that there are always risks associated with investing.

2. Regulation may affect personal investment. Governments and regulators are paying close attention to the decentralized finance (DeFi) ecosystem. Although regulatory regulations guarantee the security and stability of cryptocurrencies, some projects still need to change their service content in accordance with new regulations.

3. Impermanent loss. Even with impermanent loss insurance, there are still huge risks for users who want to get involved in liquidity mining. Risks can never be completely avoided.

4. Difficulty in accessing personal funds. If you need to pledge through the DeFi project's website user interface, it is recommended to use a blockchain browser to locate the smart contract. Otherwise, once the website fails, the pledged funds will not be withdrawn. However, directly interacting with smart contracts requires some technical expertise.

Summary

Although the field of decentralized finance (DeFi) Successful projects abound, but we have yet to see DeFi 2.0 reach its full potential, and for most users, the subject is still complex and difficult to understand. And you really shouldn’t invest in financial products that you don’t fully understand. Creating streamlined processes for new users also has a long way to go. We've seen that there are new ways to earn annual returns while reducing risk. However, we will have to wait and see whether DeFi 2.0 can fully deliver on its promise.

Disclaimer: This article is for educational purposes only. Binance is not affiliated with or endorses these projects. The information provided through the Binance platform does not constitute investment or trading advice or recommendations. Binance is not responsible for any investment decisions you make. Please seek professional advice before taking financial risks.