DeFi 2.0: What is it and why does it matter?

The original decentralized finance (DeFi) sector has been around for years, but it only became big in 2020. After it got under the spotlight, a number of highly successful projects emerged. However, just like with early cryptocurrencies, the early DeFi sector developed with a number of problems. Now, the crypto industry is looking to take the next step in its evolution. To do so, it is working on a new generation of DeFi, known as DeFi 2.0.

This guide will explain what DeFi 2.0 is and how it differs from the original DeFi. We will also talk about its own goals and limitations and how to spot worthwhile DeFi 2.0 projects.

What is DeFi 2.0?

DeFi 2.0 is a new movement that intends to fix the problems of the original DeFi sector. Back when DeFi first emerged in 2020, it was considered a revolutionary technology. It offered access to blockchain-based financial services — decentralized banking — to anyone with a crypto wallet. However, as it developed, it revealed certain weaknesses. This was already seen with the early cryptocurrency projects, and it did not come as a surprise.

After all, it is difficult, if not impossible, to develop new technology and make it flawless on the first try. In time, cryptos of the second and following generations improved on Bitcoin’s flaws. Now, this new generation of DeFi intends to fix DeFi 1.0 flaws. For example, DeFi 2.0 will have to react to new compliance regulations issued by the governments.

How does DeFi 2.0 differ from DeFi?

The idea behind blockchain-based financial services is to offer access to decentralized banking services to anyone, anywhere. This improved accessibility could offer people in unbanked and underbanked regions access to global finance. People in such regions cannot take out loans, invest, earn passive income, and alike. With DeFi protocols and through the use of smart contracts and cryptocurrency, that changed.

That said, it is understandable why people might wonder how this can be improved. What is it about DeFi that requires improvement in the first place?

Limitations of DeFi

When DeFi emerged, cryptocurrency users did not take long to realize its first flaw. This first issue concerned the usability of DeFi protocols. Interestingly, it was the same flaw that the crypto industry as a whole experienced. It was simply too rough around the edges and too complicated. The user interface was not intuitive, and you needed a significant understanding of technology. This, of course, negatively impacted user experience. Those who could use it found it too difficult. Those who couldn’t use it simply left.

Another issue was scalability, which did not help matters. DeFi suffered from high fees, long waiting times, and similar problems. This was also easy to understand, given that DeFi emerged on Ethereum. Scalability issues have been Ethereum’s biggest problem for years. However, since this is the leading platform for developing innovative crypto products, it was where DeFi emerged. In doing so, it inherited Ethereum’s problems, and now DeFi 2.0 wants to change that.

Transaction

Another issue was noticed when people started moving away from dApps, seeking other financial prospects. The reason is that yields are no longer as appealing as they used to be, leading to a farm-and-dump scenario. This resulted in an unhealthy cash flow, leading to inefficient asset use.

Liquidity is another issue commonly encountered in DeFi. In order to operate, decentralized exchanges (DEXs) require high liquidity. They need to be able to match customers’ orders from their liquidity pools. However, the funds provided to the pools come from the crypto community. With highly-volatile crypto markets, users do not want to take on the risk of being a liquidity provider.

Defi

The same is true when it comes to hacking attacks. Liquidity pools and token bridges are constantly invaded by online criminals. All of it together discourages participation in DeFi.

Goals of DeFi 2.0

So, what can DeFi 2.0 do differently? For starters, they can change their approach. Early DeFi apps were geared toward users, which was not efficient enough. The new generation of decentralized finance is switching to a business-to-business focus. In other words, DeFi 2.0 intends to capitalize on the initial user base of DeFi and take things further.

DeFi 2.0 can solve most, if not all, DeFi 1.0 shortcomings. It can offer increased liquidity via cross-chain bridges. These bridges connect blockchains, allowing for shared liquidity. And shared liquidity automatically means increased liquidity. The money is still in the crypto sector, only on a different chain. All assets will be shared by combining them into one huge network of blockchains.

Similarly, open-source communities would oversee audits of smart contracts. That way, smart contracts would be protected by insurance.

DeFi 1.0 lending was also not as efficient since users needed hefty collaterals in order to get loans. DeFi 2.0 would make loans self-repaying through yield farming. Yield farming would still allow users to earn, like other DeFi applications. But, combining it with crypto lending would allow users to just get loans and let the algorithm pay it off. All the user would need to do is keep their tokens locked up to ensure they keep earning yield.

In a similar way, DeFi 2.0 would bring improved accessibility, enhanced security, and improved user experience. The crypto industry has learned a lot about how to make itself user-friendlier over the years. Applying it to DeFi 2.0 would bring better UI and, eventually, significantly improved user experience in general.

How to invest in DeFi 2.0?

The majority of investment opportunities offered by DeFi 2.0 would be similar to the ones in DeFi 1.0. However, they would come with a wider scope. For example:

Lending

Lending was a great way to invest in the original DeFi. In DeFi 2.0, users would keep offering loans in exchange for interest. However, since DeFi 2.0 loans would be self-replicating, borrowers would not have to worry about the money. Similarly, lenders would not have to worry about whether their money would be returned.

Yield farming

Yield farming has been a great way to maximize returns through DeFi applications. Some users have boosted their earnings by shifting cryptos from one loan platform to the other. However, DeFi 2.0 could add an extra layer of incentives and utility. That would allow yield farms’ LP tokens to serve as collateral for loans.

Staking

Staking has been the biggest and most popular of all DeFi applications. In DeFi 2.0, it could stay mostly the same. Users would become validators on certain blockchain networks, lock up their coin, and just receive block rewards.

Liquidity mining

Another popular option is liquidity mining, which allows crypto users to lend their assets to exchanges’ Liquidity Pools. This is how DEXes operate, by drawing the funds from pools to fulfill transaction requests. Meanwhile, the liquidity provider earns from the trading fees.

DEX trading

You can also invest in DeFi 2.0 by engaging in DEX trades. It is faster, cheaper, and safer than centralized exchanges. You keep ownership of your money at all times, and it is never transferred to the exchange. Also, modern DEXes can offer margin trading and similar transaction types.

What to look for in upcoming DeFi 2.0 projects?

The biggest problem of a new DeFi wave will be the number of new projects seeking users. Whenever a new trend comes, countless projects emerge, each wanting a slice of the market. This makes it difficult to determine which ones are good and which are not. However, if you know what to look for, even this issue is easily resolved.

The things that a DeFi 2.0 project should have to be considered a worthwhile option include:

  • Healthy tokenomics
  • Enhanced security
  • Audits
  • Active community
  • Understandable core dynamics
  • Strong backing from institutions

Projects that can satisfy these requirements are likely worth a second look. Keep in mind that risk will still remain present, as there is no absolute safety or certainty in crypto. Anything can change overnight, so always remain cautious when dealing with digital assets. But, if you see projects that have done things from the list above right, that is a great starting point. You should still get to know them better before committing your money to them. But, now you at least know where to start.

Risks of DeFi 2.0

While DeFi 2.0 has huge potential to bring advanced changes and improvements, it will not be flawless. No code is, and no technology is, so DeFi 2.0 will not be either. We can already predict some of the risks and flaws that will be associated with DeFi 2.0.

One such risk comes from smart contracts, which people will be interacting with daily. Any of them could have backdoors, fall to a hacking attack, or simply have a weak code. Usually, you can never know for sure, as even audits or bug bounties cannot guarantee security. If you do enough research and learn enough about this technology, you will learn that there is always risk.

Another risk is external, and it comes from the government. The crypto industry is still unregulated, and that includes blockchain-based financial services of DeFi 2.0. If you make a long-term investment, you could find yourself in a difficult situation due to negative regulations. Governments worldwide are finding ways to regulate crypto, which is not always beneficial. Of course, laws and rules are good for the long term, but they could damage your current investment plans.

Impermanent loss is another thing you need to keep an eye on. Even with DeFi 2.0, this is a risk that will not go away. If you intend to be involved with liquidity mining, you will never fully get rid of it.

Finally, you might also find it difficult to access your funds. Staking tokens through the UI of a DeFi project is great for ease of use. However, you should also try to find the smart contract on a blockchain explorer before you drop in the funds. If you only use the DeFi project’s website UI, you could lose access to your money if the site crashes.

Does DeFi 2.0 matter?

Like all aspects of the crypto industry, DeFi 2.0 has its benefits and its flaws. It will certainly change many things for the better compared to DeFi 1.0. However, the crypto industry will likely never have a completely safe sector. Risks are and will always be a part of it. As long as you remember that and make decisions with that in mind, you should be ready for anything.

The improvements will definitely be worth it, just like newer cryptos offer more advanced services than Bitcoin. All it takes is time, trial and error, and learning from mistakes.


FAQs

How do DAOs earn money?

The most common way for a DAO to make money is to issue a governance token. With it, a DAO can raise funds and get new members to vote on proposals.

What is the DeFi 2.0?

DeFi 2.0 is a movement to bring forth the second generation of DeFi protocols. It is intended to be an advanced version of what DeFi is right now and what it offers. With greater security and accessibility, new features, and other aspects, it could revolutionize the DeFi sector.

What is DeFi 2.0, and why does it matter?

DeFi 2.0 seeks to improve the original DeFi sector. It will offer combined services, such as self-repaying loans, enhanced security, better UI, and more. It will not be without risk, but careful risk management and calculated decisions can protect you from losses.