DeFi 2.0 is a movement of projects improving on the problems of DeFi 1.0. DeFi aims to bring finance to the masses but has struggled with scalability, security, centralization, liquidity, and accessibility to information. DeFi 2.0 wants to combat these and make the experience more user-friendly. If successful, DeFi 2.0 can help reduce the risk and complications that discourage crypto users from using it.
We already have a variety of DeFi 2.0 use cases working today. Some platforms allow you to use your LP tokens and yield farm LP tokens as collateral for a loan. This mechanism lets you unlock extra value from them while still earning pool rewards.
You can also take out self-repaying loans where your collateral generates interest for the lender. This interest pays off the loan without the borrower making interest payments. Other use cases include insurance against compromised smart contracts and impermanent loss (IL).
A growing trend in DeFi 2.0 is DAO governance and decentralization. However, governments and regulators may eventually affect how many projects are run. Keep this in mind when investing, as offered services might have to change.
It's been almost two years since DeFi's (Decentralized Finance) rise in 2020. Since then, we've had incredibly successful DeFi projects like UniSwap, a decentralization of trading and finance, and new ways to earn interest in the crypto world. But just like we experienced with Bitcoin (BTC), there are still problems to solve in such a new field. As a response, the term DeFi 2.0 has become popular to describe a new generation of DeFi decentralized applications (DApps).
As of December 2021, we're still waiting for the full flood of DeFi 2.0, but we can already see its beginnings. Understand what to look out for in this article and why DeFi 2.0 is needed to solve outstanding problems in the DeFi ecosystem.
What is DeFi 2.0?
What are the limitations of DeFi?
Before going deeper into DeFi 2.0 use cases, let's explore the problems it's trying to resolve. Many of the issues here are similar to the problems blockchain technology and cryptocurrencies face in general:
Why does DeFi 2.0 matter?
Even for HODLers and experienced crypto users, DeFi can be daunting and challenging to understand. However, it aims to lower barriers to entry and create new earning opportunities for crypto holders. Users who might not get a loan with a traditional bank might do with DeFi.
DeFi 2.0 matters because it can democratize finance without compromising on risk. DeFi 2.0 also attempts to solve the problems noted in the previous section, improving the user's experience. If we can do this and provide better incentives, then everyone can win.
DeFi 2.0 use cases
Unlocking the value of staked funds
Smart contract insurance
Doing enhanced due diligence on smart contracts is difficult unless you're an experienced developer. Without this knowledge, you can only partially evaluate a project. This creates a large amount of risk when investing in DeFi projects. With DeFi 2.0, it's possible to get DeFi insurance on specific smart contracts.
Impermanent loss insurance
If you invest in a liquidity pool and start liquidity mining, any change in the price ratio of the two tokens you locked may lead to financial losses. This process is known as impermanent loss, but new DeFi 2.0 protocols are exploring new methods to mitigate this risk.
For example, imagine adding one token to a single-sided LP where you don’t need to add a pair. The protocol then adds their native token as the other side of the pair. You will then receive fees paid from swaps in the respective pair, and so will the protocol.
Over time, the protocol uses their fees to build up an insurance fund to secure your deposit against the effects of impermanent loss. If there are not enough fees to pay off the losses, the protocol can mint new tokens to cover them. If there is an excess of tokens, they can be stored for later or burned to reduce supply.
Typically, taking out a loan involves liquidation risk and interest payments. But with DeFi 2.0, this doesn't need to be the case. For example, imagine you take a loan worth $100 from a crypto lender. The lender gives you $100 of crypto but requires $50 as collateral. Once you provide your deposit, the lender uses this to earn interest to pay off your loan. After the lender has earned $100 with your crypto plus extra as a premium, your deposit is returned. There’s no risk of liquidation here either. If the collateral token depreciates in value, it just takes longer for the loan to be paid off.
Who's in control of DeFi 2.0?
With all these features and use cases, it's worth asking who controls them? Well, there has always been a decentralization trend with blockchain technology. DeFi is no different. One of DeFi 1.0's first projects, MakerDAO (DAI), set a standard for the movement. Now, it's increasingly common for projects to offer their community a say.
What are the risks of Defi 2.0, and how to prevent them?
DeFi 2.0 shares many of the same risks as DeFi 1.0. Here are some of the main ones and what you can do to keep yourself safe.
While we already have many successful projects in the DeFi space, we're yet to see the full potential of DeFi 2.0. The topic is still complicated to most users, and no one should use financial products they don't fully understand. There is still work to be done in creating a simplified process, especially for new users. We've seen success in new ways to reduce risk and earn APY, but we'll have to wait and see if DeFi 2.0 fully delivers on its promises.
Disclaimer: This article is for educational purposes only. Binance has no relationship to these projects, and there is no endorsement for these projects. The information provided through Binance does not constitute advice or recommendation of investment or trading. Binance does not take responsibility for any of your investment decisions. Please seek professional advice before taking financial risks.