Through CNBCTV18.com August 10, 2022 10:41 am IST (Published)
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The second generation of DeFi protocols aims to improve the shortcomings that projects and users are currently facing in this emerging field. We explain what DeFi 2.0 is and what improvements it could bring to the world of decentralized finance.
In the tech sphere, the first version of a technology is rarely the best, nor is the latest version the last. Whether it’s Android, Bluetooth or the Internet, the technology gets better and more useful with every iteration.
We have already seen such advances in the cryptosphere, where second and third generation blockchains have significantly improved legacy chains like Bitcoin. They introduced features like smart contracts and decentralized finance (DeFi) to the crypto industry.
Today, DeFi is an immensely popular industry in its own right, with a market cap of $36 billion, according to CoinGecko data. However, it’s a relatively young area with its fair share of problems and pain points. This is where DeFi 2.0 comes in.
The second generation of DeFi protocols aims to improve the shortcomings that projects and users are currently facing in this emerging field.
Join us as we explain what DeFi 2.0 is and what improvements it could bring to the world of decentralized finance.
What is DeFi?
Before diving into DeFi 2.0, it is important to understand the first generation of decentralized finance and its implications. In short, DeFi is an umbrella term for multiple peer-to-peer financial services hosted on public blockchains, most commonly Ethereum.
The central premise is to enable anyone with internet access to lend, borrow, trade assets, buy derivatives and more without going through intermediaries. Instead of depending on intermediaries like banks and other third parties, DeFi protocols automate everything through smart contracts.
So what is DeFi 2.0?
DeFi 2.0 is not a revolutionary update of its predecessor. Both concepts are based on the same basic idea and philosophy: to create a peer-to-peer banking system, pseudonymous and open to everyone, free from intermediaries and third parties.
DeFi 2.0 simply aims to solve the problems currently hampering the decentralized finance industry. Therefore, to understand what the next generation of DeFi protocols stand for, we need to look at the problems it is trying to solve.
DeFi is risky
The DeFi space is full of cases of hacks, attacks, and smart contract failures that lead to huge losses for users. There is also a risk of fickle losses. This occurs when a token’s price falls while a user’s funds are locked in a DeFi protocol. Therefore, when the funds are withdrawn, they could be worth a lot less than they were worth when they were deposited.
DeFi 2.0 platforms allow users to insure themselves against such losses. This can be very helpful for novice investors and help protect users from cryptocurrency volatility.
scalability
Despite being a revolutionary concept, DeFi protocols were not scalable. Transactions often took a very long time, and in some cases gas fees made regular banks look sacred. This is because most DeFi protocols were built on top of the Ethereum network, which is sluggish and expensive.
Now, with DeFi 2.0, other popular blockchains such as Solana, Cardano, and Polkadot have also entered the decentralized finance space and helped DeFi break into the mainstream. It also ensures transactions are faster and more affordable.
Convenience
The UI and UX of current DeFi platforms are not user-friendly, especially for newbies. This is one of the reasons veteran crypto enthusiasts are populating the DeFi space. Therefore, if DeFi 2.0 platforms aim for mass adoption, they need to be user-friendly and easy to use.
centralization
While the goal of DeFi was to offer banking services without intermediaries, DeFi projects still suffered from some elements of centralization. Most DeFi protocols store client funds in smart contracts, often controlled by a specific group of people such as core developers and project creators.
A touch of centralization was also evident as a number of DeFi protocols like Celsius, Three Arrows Capital, and Lido began freezing client funds in recent months.
To address this issue, the second generation of DeFi projects have started turning to decentralized autonomous organizations (DAOs) to direct project operations. With a DAO, anyone can vote on the development of the project.
Other benefits promised by DeFi 2.0 platforms
DeFi 2.0 protocols also aim to unlock the value of staked assets. For example, in the first iteration of DeFi, users who staked a pair of tokens in a liquidity pool would receive liquidity provider (LP) tokens in return.
These LP tokens could be reinstated (a process known as yield farming) to generate even more returns. However, this is as far as one could go in terms of value extraction. DeFi 2.0 goes one step further and allows users to submit LP tokens as collateral for loans.
Another benefit that DeFi 2.0 brings is self-repaying loans. Normally, when taking out a loan, there is always the question of interest payments and the risk of liquidation. However, with DeFi 2.0, the collateral you offer could be used to earn returns and repay the loan. Once the lender collects the loan amount plus an additional premium, the collateral posted is returned to the borrower.
Conclusion
DeFi has provided multiple breakthroughs and has also been hit by many failures. DeFi 2.0 aims to build on the breakthroughs and fix the failures to provide simplified and more democratized financial offerings.
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