defi 2.0

DeFi 2.0: Ponzis, innovation, or everything in between?

By d-core | D-CORE | 21 Jan 2022


Since 2020 the DeFi space has had unprecedented growth and a wave of innovation that propped up what many are now calling DeFi 2.0. Some general issues such as bad user interfaces, operational mishappenings and lack of professionalism tend to get better as the industry matures, but the changes DeFi 2.0 brings are much more significant.

A notable issue with “first wave” DeFi liquidity farming protocols is liquidity mining, that is the practice of issuing more of a protocol’s tokens as rewards to liquidity providers, artificially increasing percentage yields on pools. This process propels depreciation of the token’s price (which will make it look like a failing project), and although initially effective to attract users seeking massive yields, those users are quick to jump ship when returns inevitably get to normal levels. Research by nansen.ai confirms that only 25% of users stay in a new liquidity farming smart contract for more than one month.

Innovations of what we’ve come to refer as DeFi 2.0 address the liquidity mining issues, while improving algorithmic stablecoin minting and flash loans as well. Their approaches involve the new Liquidity as a Service (LaaS) model and detaching liquid and volatile asset contributions for liquidity pools to eradicate impermanent losses. Let us take a closer look at some of the most prominent DeFi 2.0 projects:

 

Olympus accepts liquid assets as deposits for OHM bonds, a way to buy OHM at a discount with a 5 day vesting period. Those liquid assets go into Olympus treasury to back the token’s value and to provide liquidity for OHM. Olympus owns almost all of its own liquidity and earns from the fees on liquidity pools. They also offer staking as a way to reduce the circulating supply and incentivize holding the token in the long term. OlympusDAO offers the “own your own liquidity” approach to other projects through their Olympus Pro bond marketplace.

In Tokemak, users can stake ETH or USDC (single-sidedly) for fixed returns, or stake volatile assets to corresponding Tokemak “reactors” and earn higher net variable returns. Before being distributed to volatile asset contributors, returns pay ETH/USDC users’ fixed rates and compensate for their impermanent loss. Owners of their token decide how much ETH or USDC goes into each reactor. Ondo Finance is very similar to Tokemak, but a user decides to which pool their liquid assets will go.

Interest-bearing tokens like xSUSHI or yvUSDC can be used as collateral to take a self-paying stablecoin loan (no interest due). If the proportion between collateral and borrowed funds gets too small, a premature liquidation may occur. What’s special about Abracadabra is that the borrowed amount can be leveraged up to 10 times to increase yields albeit with a tighter threshold for liquidation.

Alchemix offers self-paying loans of up to 50% of the collateral value through automatically investing locked collateral in yield farming protocols. There is no risk of liquidation: devaluation of the collateral only makes the full repayment take longer. The borrowed funds may be added to their staking pools to earn rewards in ALCX, the protocol's governance token.

Second-order protocols are a new tendency on DeFi where new protocols add functionality to existing protocols in a Layer-2 like way. Cross-chain yield optimization, auto-compounding, and reward token recycling are some of the features these solutions offer.

But is this really “DeFi’s next stage” or just a fad?

Current DeFi solutions are still young and unpolished, and their convolutedness contributes to keeping out potential TradFi entrants from the ecosystem. In that regard, DeFi 2.0 already brings a couple of key victories to the table.

#1 - Existing DeFi primitives are used as an infrastructure to build upon, leveraging their proven reliability and providing improved interfaces and more functionality, which is critical to foster adoption.

#2 - Composability and openness are still crucial components of DeFi 2.0, allowing good solutions to be adopted by competitors, as is common in crypto, bolstering the DeFi sector as a whole.

In the traditional finance industry, solutions like Tokemak aren't easily accessible to everyone everywhere, and even for high-net-worth individuals, they can take a long time to set up and come with a slew of legal and bureaucratic issues. It's not just about "how much" your capital earns; it's also about how it's earned: it's never been more transparent or straightforward. DeFi yields have been greater than those offered by any commercial bank for some time, but enhancements like self-paying loans, stable yields, crypto bonds, and LaaS brought on by the newest projects entering the DeFi ecosystem justifiably deserve to be labelled DeFi 2.0.

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