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What is DeFi 2.0? Prepare for the next mega trend

publish_by Quang Phan at 15 tháng 10 2021

The keyword “DeFi 2.0” has recently emerged as a phenomenon with the tremendous growth of some tokens like OHM, SPELL,... So what is DeFi 2.0? Why is DeFi 2.0 a possible alternative to the whole current DeFi? What for us to prepare?

What is DeFi 2.0?

DeFi 2.0 is an upgraded version of DeFi attempting to fix the existing weaknesses and leverage the strengths of the current DeFi, which can open even more promising possibilities for users.

Thanks to the development of Blockchain technology, Decentralized Finance (DeFi) allows people to access and use Decentralized Applications anywhere, anytime, without being under the control of any entity or organization.

Nevertheless, it still possesses multiple weaknesses, which is why DeFi 2.0 is a compulsory complementation.

The existing limitations of DeFi

Before going into what solutions DeFi 2.0 is trying to provide, we have to acknowledge the problems that it’s trying to resolve. A few obvious limitations can be seen as:

  • Scalability: High gas fees, long waiting time ⇒ badly affect users’ experience.
  • Liquidity: Liquidity is like the “blood” of any market. In DeFi, it still remains low.
  • Centralization: In spite of the fact that it is “Decentralized Finance”, a majority of existing Dapps are still centralized.
  • Security: DeFi contains enormous underlying risks, while security is still mostly unnoticed.
  • Oracle Attack: DeFi heavily relies on Oracles. However, there are still projects that do not comprehend their importance and refuse to integrate with a trustworthy Oracle. As a result, a wide range of protocols have got attacked and had to compensate for the losses.
  • Capital Efficiency: Technology advancement has increased capital efficiency, but there is still a massive amount of assets not being optimally utilized.

DeFi 2.0 - The solution for DeFi’s obstacles

In fact, DeFi 2.0 started since users and projects realized the limitations of DeFi, which lead to them developing relevant solutions. Each solution for each obstacle has created small upward market trends, which are what the market really needs.

Now let’s review the solutions that have contributed to the growth of DeFi 2.0.

Scalability - Layer 1, Layer 2

To DeFi users, especially newcomers, interacting with the Ethereum network has been a major obstacle. Expansive gas fees and long waiting time have prevented most users from experiencing DeFi.

Transaction fees of different blockchains.

At the same time, DeFi offers a wide range of opportunities, hence being incredibly attractive. So a question is raised: How can users experience DeFi without having to face scalability issues of Ethereum?

⇒ The rise of other Layer-1.

It was not random that the cash flow went to BSC, Polygon and Solana, which are some blockchains that can provide what users need the most. Solutions for the Scalability problem will possibly be the catalyst for the next market wave.

Liquidity - Yields

To tackle the liquidity problem, or in other words, to attract more users and capital into the DeFi market, the simplest approach is to help them earn yields. From projects with 10x, 100x ROI, to farming pools with thousands of APY, or airdrops worth thousands of dollars,... all contribute to onboarding new users and enriching the liquidity of the market.

Did you join the Crypto market for one of those reasons?

Centralization - DAO

Let’s start with the case of Uniswap. The project set out a proposal to sell $20 million dollars worth of UNI tokens in order to create a “DeFi Education Fund”. However, the notable point is that the Uniswap community was kept completely in the dark until the very last day. No matter how the community reacted at that moment, the number of “Yes” votes was overwhelming. This showed how centralized the Uniswap Governance was.

Aside from the fact that people come to DeFi to make profits, they also join DeFi to pursue freedom and be independent of any third parties. Nevertheless, numerous DeFi protocols are still heavily controlled by a group, leading to a loss of faith among DeFi users.

To resolve this situation, DeFi projects are having the tendency to put the Decentralized aspect on top priority. DAO (Decentralized Autonomous Organization) - where everyone has the right to vote on the project’s development, has grown dramatically during recent times.

DAO Landscape.

Capital Efficiency - The next interest

DeFi is growing extremely fast. At the time of writing, the TVL (Total Value Locked) in DeFi has increased to $217B and is continuing to rise.

Nonetheless, a major obstacle of DeFi is that most of those assets remain static and unused. For example:

  • AMM: Although AMM is the “Liquidity Pool” of DeFi and attracts a huge amount of TVL, most of it is not being utilized. This comes from the design of AMM that makes liquidity unable to be concentrated.
  • Lending: Possess a low Utilization ratio, or in other words, there are much more lenders than borrowers.
  • Aggregator: Users after depositing assets into Aggregator protocols and receive Agtokens, cannot use those tokens elsewhere.
  • And many more factors that lead to assets being used in a suboptimal way: The current farming model, assets not being deposited into optimal pools,...

From those problems, many projects have started to develop suitable projects, such as Olympus DAO (OHM) or Abracadabra (SPELL),... which is slowly becoming the catalyst for the next wave of the Capital Efficiency branch.

Capital Efficiency and the ability to revamp the whole DeFi

It is not out of the blue that I mentioned Capital Efficiency being the beginning of the next market wave, and there have been some clear evidences supporting this thesis.

Too much money being poured in: Ecosystems have continually announced their Ecosystem Fund to push the ecosystem’s growth. Sooner or later, that money has to be deployed and used. Besides being spent on projects to develop their products, a large amount will also be used as an incentive to draw more users into the ecosystem.

The incentive programs of different ecosystems.

The limitation of Liquidity Mining: Liquidity Mining must have been widely acknowledged by DeFi users; after a project launches, there is usually a Liquidity Mining program to bootstrap the project’s liquidity and userbase. However, it has become a “double-edged sword” as the Liquidity Mining program can only attract new users and assets in a short term, which ends up in the situation of: APY decreases ⇒ Farmers dump tokens ⇒ The cash flow moves away.

Given that weakness, it is being the most used model by both existing and new DeFi protocols at the moment. This phenomenon has created an unhealthy cash flow when users focus only on farming ⇒ dumping ⇒ farming ⇒ dumping, without any intention of contributing to the project’s development.

TVL being considered too seriously: The reason for the above circumstance is that the TVL index is being overemphasized as a standard. Most users only pay attention to the TVL without understanding that, how that TVL can be converted into revenues is another story.

⇒ Innovative products have been introduced and have shown good signs.

Projects focusing on Capital Efficiency will enable DeFi to:

  • Optimize TVL: Allow deposited assets to be utilized at maximum possibility.
  • Create a healthy cash flow: From the example of Olympus DAO (mentioned below), preventing an unhealthy cash flow will make projects grow more sustainably and adopt more supporters.

Prepare for DeFi 2.0 with the massive upcoming wave

I hope that the aforementioned information has helped you understand the nature of DeFi 2.0 and which sector will receive the most attention, as well as the cash flow in the near future. Projects aiming towards Capital Efficiency are highly likely to create a new standard for the market, thus, we have to prepare the necessary knowledge to adopt this market wave.

Look into Capital Efficiency when scanning projects

Instead of focusing solely on TVL, we should also pay attention to how the project utilizes that TVL. Each model will have a different way to optimize the TVL and it will be the key criterion for us to look into.

For example: With AMMs, we can judge their Capital Efficiency with the ratio Trading Volume/TVL. With Lending protocols, we can judge their Capital Efficiency with the ratio Outstanding Loan/TVL,...

Pioneers in improving Capital Efficiency

As mentioned above, each project will have a different approach to maximize capital usage. I’ll list some of the most outstanding names and the model they apply:

  • Uniswap v3 (UNI): The first AMM to create the Concentrated Liquidity model, multiplying Capital Efficiency of providing liquidity.
  • Olympus DAO (OHM): The mechanism of swapping LP tokens for Bonds, reducing the frequency of the farm and dump situation, and creating sustainable liquidity.
  • Abracadabra (SPELL): Allow using yield tokens (yvYFI, yvUSDC, xSUSHI,...) as collateral to borrow the stablecoin MIM, opening a new lending market.
  • Tokemak (TOKE): Reduce Impermanent Loss as the protocol acts as a market maker and navigates liquidity.
  • Curve (CRV) + Convex (CVX): Apply Incentive + Game Theory to direct the governance in a positive way + optimize Curve’s enormous liquidity.
  • Popsicle Finance (ICE): Help users manage their liquidity more efficiently.
  • And a lot more developing projects.

As you can see, there are many ways to improve Capital Efficiency. Hence, our job is to find projects in this sector and evaluate their performances.

Anticipate the DeFi 2.0 trend

Here are some of my predictions about DeFi 2.0:

  • Projects working on Capital Efficiency will create a new standard in the market, and TVL usage will become as important as TVL.
  • Overall, there have not been many effective models, which is our opportunity. The success of projects like OHM, SPELL,... will be considered the catalyst to boost the next market wave and put users’ Capital Efficiency to the next level.
  • There is a high chance that top projects will stand their ground as they can optimize liquidity sources and prevent the circumstance of users withdrawing assets.
  • Many innovations will be created when they are combined together, similar to the current DeFi.
  • Capital Efficiency is only a branch of DeFi 2.0, so there will be other market waves in other branches. Those waves are not necessarily limited to 1 (the wave of Layer-2 can come after the wave of Layer-1) as well as not necessarily happen at the same time.

Conclusion

Putting all the puzzles together can give us an overall perspective and anticipations of what may possibly come next.

I hope it has helped you in gaining more valuable insights into DeFi 2.0, and understand what you need to prepare for the next market wave.

If you want to know further about this topic, please feel free to leave a comment below and join Coin98 Community for further discussions!

Quang Phan

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