Things are not getting any easier for those who want to stay current in the lightning-fast DeFi world. Just when you think you are updated with the latest token or protocol, something new comes along, and to be honest, having half of Twitter’s Feed full of JPEGs does not facilitate the task.
Everyday is exciting in the crypto space, we know that, but this time feels even more special. New players like OlympusDAO, Abracadabra, Tokemak & Curve are changing the game forever. In general, the whole DeFi sector is reinventing itself, developing rapidly new solutions to leverage the learnings the first generation left on us.
In this opportunity we’ll talk about Defi 2.0: the next big wave in crypto.
Existing limitations of Defi 1.0
As the name implies, DeFi 2.0 represents an updated version of our current model of DeFi, seeking to address the existing weaknesses and leverage the strengths to offer the users new promising possibilities in the path to financial freedom.
Since DeFi summer in 2020, we’ve been experiencing exponential growth in the sector achieving a capitalization of $ 150 billion. The staggering amount of capital flowing into these protocols justifies the power of new supply-side innovation. Having said this, let’s recap some of the few obvious limitations of the cycle.
The first obstacle is related to the usability of DeFi platforms. There’s evidently a UX & UI complexity that represents a difficulty for newcomers to use decentralized products, so the large bulk of active users is made up of experienced crypto enthusiasts. It’s true that people want digital inclusion and better alternatives to TradFi but as in every other sector, solutions that ignore design ignore people. The potential of Defi 2.0 projects to take crypto mainstream will determine the next DeFi run.
In addition, scalability doesn’t make things easier. High fees and long waiting times for a transaction to be approved keep adding pressure on the UX. As we know, most Defi solutions are built on Ethereum and due to the large influx of users on the network, there are long delays, and the cost of the transactions is getting ridiculous. This makes using DeFi products unprofitable for users with less than a few thousand dollars.
People have short attention spans, especially in crypto, and you can feel that people are shifting away from Dapps in search of better capital opportunities. Yields aren’t as attractive as they used to be, especially for DeFi’s blue chips. This has created a farm and dump repetitive scenario which results in unhealthy cash flow for protocols and many more factors that lead to assets being used in a sub-optimal way. In general terms, capital efficiency is something we’re working towards but we’re far away from being where we want..
At a fundamental level, DeFi continues to rely heavily on stablecoins linked to fiat, with DAI, USDT, and USDC for example. Beyond how paradoxical it can be the dependencies of the fiat system we are trying to leave, there’s an emerging criticism of the risks associated with the current stablecoin system such as inflation, centralization, and irresponsible monetary policy. Just remembering Tether’s controversy we can get a sense of this. Is it fully backed by U.S. dollars? Maybe someday we’ll know. What is certain is that Defi 2.0 will have to address the quiet power players of the cryptocurrency space.
We cannot finish this list without mentioning the liquidity problem at all. All cryptos require liquidity to trade in DEXs and AMMs without affecting the token’s price. Incentive programs can offer some temporary relief, but it’s far away from being the optimal solution and represents a bigger underlying risk for small investors.
Defi 2.0: Revamping the whole Ecosystem
Although it is too early to give a concrete definition of DeFi 2.0, the efforts and claims that we see in the new protocols indicate the path in which the new space will develop.
DeFi 1.0 attracted users by rewarding them with a high yield, yet the actual capital return obsession of investors doesn’t take into account the project’s worth or roadmap. Rather, users are focused on flipping capital between protocols to obtain higher APY. Defi 2.0 intends to change this by experimenting with new ways of capturing users, this time with the new challenge of getting them to stay.
Tyler Reynolds, an angel investor, and crypto advisor sums it up perfectly in an interview with the Defiant:
“DeFi 2.0 is mostly about DAOs changing the relationship between capital providers and the protocol itself. The move-in DeFi 2.0 is for protocols to own their own liquidity,” … “This contrasts to ‘DeFi 1.0’ where protocols earned TVL by providing the best user experience or rented liquidity via liquidity incentives”.
In essence, DeFi 2.0 will amend the network shortcomings mentioned before, including scalability, liquidity protocol, and governance, which all fall under the umbrella of capital efficiency.
It’s a fact that people come to DeFi to make profits, but there’s something deeper than that: to pursue freedom and be independent of any old-world traditional financial institution. Nevertheless, numerous DeFi protocols are still heavily controlled by a group, leading to a loss of trust among the community. That’s why new DeFi projects are having Decentralization as a top priority on their backlogs. We can already see this in the growth of DAOs (Decentralized Autonomous Organizations), member-owned communities without centralized leadership.
The next generation DeFi 2.0 will target the entire community, not just enthusiasts, and is built to meet today’s challenges. This explanation may seem very general, so let’s get a bit technical and look at the value proposition of one of the main catalysts of the new DeFi space.
Olympus is one of the new Defi 2.0 DAOs looking to create a currency to compete with the fiat dependency we currently have (U.S. dollars). There’s over $100B in dollar-pegged stablecoins circulating crypto right now and as we mentioned before, this is not a desirable scenario for DeFi.
Its native token, OHM, is a free-floating currency (not pegged to anything) backed by a basket of assets held in its treasury. Either for high APY when staking or the (3,3) profiles all over Twitter, this new Ethereum project is stealing people’s attention. And beyond the hype, there’s definitely a technological disruption we have never seen before and is worth understanding.
Although Olympus has been compared to a private bank issuing its own bills, another interesting similarity is the Federal Reserve or a Reserve Bank, where the currencies it manages and issues are fully backed by their assets. In this case, the OHM algorithm utilizes the assets in the treasury to help keep the price as close to $1 as possible. An algorithm that is based on game theory (the 3,3 scenario), where all players create a positive-sum environment based on cooperation.
Bonding is the biggest innovation introduced by OlympusDAO. Simply put, if you put crypto as collateral (e.g. DAI, OHM-FRAX LP tokens) you can get OHM at a discount, OlympusDAO then will use the collaterals as reserve assets (treasury). The value of OHM relative to that asset will determine whether the protocol will increase the supply (minting) or burn them to maintain a market-driven price.
Beyond helping with growth, bonding plays a key role in that it also helps to indefinitely secure the liquidity of OHM. The protocol flips the liquidity mining model upside down and incentivizes users to permanently sell their LP tokens to the protocol in exchange for OHM at a discounted rate. Through this way, Olympus now owns this liquidity from the user which means that it can stay within the protocol.
As we saw before, preventing an unhealthy cash flow can make projects grow more sustainably and adopt more supporters. In addition to this, Olympus is able to lower the risk and offer its users no exposure to impermanent loss.
One of the great things to highlight about the project is the true crypto spirit behind the model. Fair distribution, no VC-accommodating, sustainable growth, and most importantly, offering the whole DeFi space opportunities to be better. Very recently they developed a bond marketplace solution (Olympus Pro) for all crypto projects that want to own their own liquidity to stop relying on CEXs and Liquidity Mining to distribute their tokens.
With OlympusDAO we have seen one of the many faces that the Defi 2.0 can take. It is a great example of how new protocols can leverage the teachings of DeFi 1.0. The space is getting matured not only in terms of improving algorithms or adopting new financial instruments, solutions like OlympusDAO are a clear attempt to re-introduce the decentralization spirit in the community and that’s a good sign. In the future we will
Will we have a Defi Summer in 2022? Who knows. What is certain is that we will start looking at new DeFi solutions being born everyday to disrupt the current model and bring us closer to financial freedom. Back then we only had Ethereum, let’s see what Avalanche or Solana protocols can bring to the table.
These are exciting times.