What is DeFi 2.0? Everything you need to know before investing

When Bitcoin (BTC), the world’s first and largest cryptocurrency by market cap, was invented in 2009, it was considered a joke. However, by 2020 we have seen the growth of decentralized finance or popularly known as the DeFi industry: an industry that improves upon the technology that Bitcoin is based on.

Decentralized finance is a blockchain-based financial industry that combines technical and financial aspects to enable payments and investments. The industry has several promising projects online. Some common DeFi platforms include Ethereum, DyDx, and Cardano.

Although growing, the adoption of DeFi has been limited mainly due to issues such as lack of insurance and loans. DeFi 2.0 is the improved version of DeFi which fixes all the issues that existed with version 1.0 and aims for higher adoption.

Problems with DeFi 1.0

DeFi 1.0 had several issues that slowed its adoption. Some of them are listed below.

• DeFi 1.0 lacks decentralization because the concept of DAO, or decentralized autonomous organizations, is lacking. The current version of DeFi leans towards centralization.
• Most DeFi 1.0 protocols suffer from high gasoline costs and congestion, which should be eliminated. A simple task can take hours.
• When updates are implemented on a platform, previous security audits become trivial, making it more vulnerable.
• In almost all protocols, staked tokens cannot be used elsewhere, reducing flexibility and leading to a lack of capital. In addition, the liquidity pools are spread across different platforms, dividing the liquidity.

What is DeFi 2.0?

DeFi 2.0 includes many blockchain-based platforms that attempt to fill the existing gaps in the DeFi system. The first wave of DeFi platforms like ZCash, Litecoin, and Ethereum attempted to improve on the problems Bitcoin faced.

These networks have been very successful; currently Ethereum is the biggest name in the DeFi industry. However, these platforms also have drawbacks. For example, Ethereum suffers from high gas prices and congestion.

DeFi 2.0 platforms will still have to meet regulations that the government and other regulators will implement sooner or later. However, they are more decentralized in nature and ensure that the original principles of the creator of Bitcoin are incorporated.

“DeFi 2.0 is important because it can democratize finance without compromising risk,” a Binance blog said.

There are several projects on the big blockchain networks like Ethereum, Solana and other platforms compatible with smart contracts, which are the basis of DeFi 2.0.

More income thanks to the funds involved

A major problem with staking is that millions of dollars are stuck in coffers providing cash. When staking a pair of tokens, you get a liquidity token in return, known as an LP token or Liquidity Protocol token.

These tokens can additionally be staked to generate APY, but in DeFi 1.0 they are locked for liquidity provisions. DeFi 2.0 protocols use these LP tokens, which are staked as collateral for a loan from crypto lenders or even new tokens, as in the case of MakerDAO (MKR).

Taking the example of MakerDAO (MKR), which is based on DeFi 1.0’s Ethereum (ETH), the protocol uses LP tokens to strike a stablecoin, DAI.

“The price of DAI is pegged to the US dollar and is secured by a mix of other cryptocurrencies that are deposited into smart contract vaults whenever a new DAI is created,” says CoinMarketCap’s description. .

Smart contract insurance

There is a risk associated with investing in a smart contract-based project – of not being sure about the security aspect. Unless you’re an experienced developer, it’s hard to determine if a platform is worth investing in. However, DeFi 2.0 proposed the concept of insurance for funds.

If the smart contract you invested in is compromised, you can have it reimbursed by your insurance for a fee. Fees vary.

Permanent loss insurance

If one invests in a pool of cash and, due to price fluctuations, loses part of the investment, this loss is called an impermanent loss and is common in the volatile crypto space.

DeFi 2.0 has a solution for this. Taking the example of Mr. X, who understands the risks associated with the crypto space, invests in a one-sided liquidity protocol where he doesn’t need to add another pair. In such a scenario, the protocol will add its governance token on the other side of the pair. For each swap made in the respective pair, both the investor and the protocol will receive a fee.

These fees are used by the protocol to build up an insurance fund that can cover temporary funds. If the fund is not enough to cover the losses, the protocol will hit new tokens and burn or store the excess.

Self-repayable loans

Another major feature of DeFi 2.0 is auto-repayable loans. To understand this, let’s introduce Mr. X and his business partner, Mr. Y, into the picture.

Mr. X needs the money and asks MYM for $ 10. Y agrees, but wants $ 5 as collateral. Once Mr. X deposits this, Mr. Y lends the $ 10.

In DeFi 2.0, this whole process is controlled by smart contracts and is automatic.

The next step in the process is for Mr. Y to use Mr. X’s crypto deposit to earn returns. If the token depreciates, the yielding process will continue until the premium of $ 10 plus has been recovered. Once finished, Mr. X will get his deposit back.

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