What Is DeFi 2.0, And Why Does It Matter?

Decentralized Finance (DeFi) is one of the blockchain network’s most innovative and versatile protocols. The hassles that come with traditional financial institutions like the administrative bottlenecks, oversight supervision, and regulation by the government have made the DeFi protocols the best alternative.

Blockchains have powered the launch of various Decentralized Finance (DeFi) protocols with built-in smart contract capabilities and secure oracle networks. Since the first DeFi protocol was launched, blockchain developers have continued to improve in technological advancement, permissionless composability, and open-source development culture. In recent times, liquidity-focused decentralized finance projects are taking over and have ushered in the “next level” of DeFi, known as DeFi 2.0.

What Is DeFi 2.0, And Why Does It Matter?

Decentralized Finance (DeFi) 2.0 is ushering in a new and advanced generation of blockchain-powered financial services. The DeFi 2.0 refers to the DeFi innovation phase, a subset of DeFi protocols built on prior breakthroughs like yield farming, lending, and other innovations.

Tech enthusiasts, DeFi protocol users, and blockchain developers have continued to devise ways to solve the liquidity constraints that have characterized many on-chain systems using native tokens. The solution and implementation form the basis of DeFi 2.0.

The first DeFi protocols, like Automated Market Makers (AMMs), Uniswap, and Bancor, allowed users to swap tokens without giving custody. The likes of Aave and Compound allowed their users to lend and borrow. On-chain yield for deposits and permissionless access to operating capital was available on Aave and Compound. MakerDAO provided a decentralized stablecoin for its members.

All the popular Decentralized Finance protocols (mentioned above) had excellent use cases and brought a new wave of seamless financial services. However, the transparency and user control features of these DeFi protocols are below par. It is therefore worthy of note that DeFi 2.0 prioritized these technological implementations.

The pioneers of DeFi 2.0 are focused on developing mechanisms for long-term liquidity and intend to build decentralized reserve currency. Olympus DAO is an example of a DeFi 2.0 protocol that has implemented these advancements. Another important mechanism that DeFi 2.0 is looking into is the launch of protocols that will enable DAOs to compete with companies, allow other DeFi protocols to use the bonding mechanism to gain their liquidity, and demonstrate Business to Business (B2B) focus.

How Does DeFi 2.0 Work?

Blockchain technology allows for innovation, and it is open-sourced and allows developers to launch their protocols and build other network layers to improve scalability. The DeFi 2.0 protocols are layers of technological advancement to complement the first generation of Decentralized Finance; it is, therefore, suitable to identify how these advancements work.

Since the first generation of DeFi struggles with scalability, security, centralization, liquidity, and accessibility to information, DeFi works to improve these issues.

The first point of call is how DeFi users interact with the Ethereum network. The scalability issue continues to bother DeFi protocol users that use the Ethereum network, and DeFi 2.0 works by building new network layers that will trigger the scalability problem.

Another advancement that shows how Decentralized Finance 2.0 works is to provide solutions to the liquidity problems and entice users and their capitals to assist them in earning yields. Instead of sourcing liquidity from third parties, the DeFi 2.0 is introducing yield farming, leading to the rise in Decentralized Finance activities. Yield farming has become a viable method of bootstrapping funding for DeFi project creators.

Relevance of DeFi 2.0

Some of the notable advantages of DeFi 2.0 include;

Insurance to liquidity providers: DeFi 2.0 adds insurance to protect liquidity providers. These liquidity providers fund liquidity pools from losses caused by unstable crypto prices. DeFi 2.0 audits the contracts by providing insurance and guarantees no vital fault.

Transparency: DeFi 2.0 improves the clarity of Decentralized finance protocols. It ensures loan repayment by building a self-repaying mechanism. The self-repaying tool is an arrangement whereby the loans use yield farming collateral or the crypto staked in liquidity pools to repay debts.

Long-term liquidity: DeFi 2.0 introduces new methods for long-term liquidity. DeFi protocols can use bonding mechanisms to gain liquidity and strengthen business-to-business transactions.

Security: DeFi 2.0 introduces an additional layer of protection that existing DeFi protocols can integrate into their security architecture. The DeFi 2.0 comes with security audits that help to keep the smart contract always protected and trigger alarms whenever unauthorized individuals want to gain access.

Conclusion

The Decentralized Finance (DeFi) 2.0 comes with technological advancements and innovations that are significant to blockchain technology and decentralized financial services.

DeFi 2.0 has the potential to democratize finance while minimizing risk, examine issues raised in the first set of DeFi protocols, and improve user experience.

While several developers have started rolling out their DeFi 2.0 protocols or adding its layers to existing DeFi protocols, it has shown increased use of these protocols alongside improved scalability and security architecture.