If you use crypto-currencies, you're bound to have heard of decentralized finance, which is also known as DeFi. Some place its origin as early as the arrival of Bitcoin in 2009, which is in itself the first dematerialized financial system, others believe that true decentralized finance dates back to the advent of Ethereum and smart contracts.
In both cases, we are talking about financial flows on blockchain networks. Today, a new era in decentralized finance may well be born, and very quickly. So what are the particularities of DeFi 2.0? Let's get started!
Innovations follow one another at a frantic pace on the blockchain. It must be said that developers around the world are turning to this very promising technology. There are possible applications of blockchain in all areas of the economy today. The first sector to see transformations brought by blockchain is finance.
"Traditional" Decentralized Finance 🏦
Algorithms using smart contracts allow today to automate many financial calculations. The protocols will simply take care of the calculations automatically, which allows a massive diversification of the applications of decentralized finance. For example, there are hundreds of services offering Farming, Lending, Stacking thanks to smart contracts.
However, the first limits of these uses are gradually being discovered. Indeed, these protocols have many advantages, but with the massive diversification of protocols, but also, and especially blockchains, the ecosystem is fragmented.
The major problem with the diversification of blockchains and protocols is that the available liquidity is divided among all the existing protocols. The more protocols there are, the less liquidity is available in their treasuries.
According to Defillama.com, the site that lists the protocols of decentralized finance, there are 275 billion dollars on 750 applications, themselves spread over more than 70 blockchains.
The model applied today on decentralized finance is what is called Yield Farming. That is, someone comes to deposit liquidity in a protocol and receives LP tokens (Liquidity Providing Token). These tokens are the proof of deposit in the liquidity pool.
Currently, it is a race against time where protocols compete with billions in Liquidity Minning to attract new users. It is a reward program that will be consumed during a short period of time to over-reward the liquidity providers. The concept is simple: the protocols need liquidity to function, this liquidity is provided by the users in exchange for a yield.
This high remuneration of protocols to liquidity providers gives rise to liquidity mercenaries. These are users who will constantly move their funds to the protocols with the best remuneration. These are not people who fundamentally believe in the protocol, but investors looking for high returns. Thus, the protocol ends up with a strong selling pressure on its governance tokens, as the mercenaries immediately get rid of their rewards. Making the liquidity mining program almost useless.
In addition, liquidity providers are subject to Impermanent loss. This is a calculation made automatically to maintain the stability of liquidity pools. When the price of a cryptocurrency fluctuates sharply up or down. The provider of the liquidity can take heavy losses. These losses will not necessarily be compensated by the rates of return offered by the protocol. This is a risky bet for the providers. During strong variations, the suppliers can withdraw massively the liquidities which will decrease the viability of the protocol.
I invite you to learn more about the impermanent loss, because it is not definitive. If the price of the cash is back to the original price, i.e. the entry price, then you will not have any loss. On a variable pair, this calculation is almost impossible.
So there is a lot (too much) risk in the current DeFi model. We have seen the risks associated with the bursting of protocols and the division of liquidity, then the risks of Yield Farming associated with Liquidity Mining programs and finally the risks inherent in liquidity pools such as Impermanent Loss.
The objective of DeFi 2.0 will therefore be to make these protocols more sustainable and durable in the future. On the one hand, by avoiding a massive turn-over of liquidity between the different protocols and on the other hand the risks linked to the provision of assets for the suppliers.
Decentralized Finance 2.0 🏣
So how is the new decentralized finance also called DeFi 2.0 going to propose solutions and come to stabilize definitively the finance within the blockchains?
Some protocols are revolutionizing decentralized finance (which is already a revolution in itself). The pace is now very fast, a protocol can be born and die the same day if it is not approved by the community.
Previously, someone who provided liquidity in a protocol received LP tokens (Liquidity Providing Token). When he came back to get his liquidity, he would give the protocol the LP tokens back and leave with his liquidity.
Now, liquidity providers become guarantors and have an incentive to permanently lock liquidity to the protocol. They then sell the LP token and receive a discount on the protocol's governance token in exchange. This is a reliable way for the protocol to own all of its LP tokens itself.
In sum, the protocol no longer fears withdrawals from suppliers and thus low liquidity supply of its cash, since it now owns the cash.
OlympusDAO is called "The Decentralized Reserve Currency". This protocol builds a community-owned decentralized financial infrastructure to bring more stability and transparency to the world.
Specifically, Olympus is a decentralized reserve currency protocol based on the OHM token. Each OHM token is backed by a basket of assets (e.g. DAI, FRAX) in the Olympus treasury, giving it an intrinsic value below which it cannot fall. Olympus also introduces economic dynamics to the market through Stacking and Bonding.
To understand Olympus, you need to understand the difference between "Pegged" and "Backed".
For example, in the case of some stablecoins, their value will mirror that of the dollar, this is called the "Peg" which means that if the dollar falls, the associated asset will suffer the same losses.
In the second case, the asset is backed "Backed" by a basket of values. This means that the cash flow of the protocol is backed by assets that maintain a stable or increasing price. Thus, this basket of assets makes it possible to define a floor price below which the price of the governance token cannot fall.
OlympusDAO can be compared to the mechanisms of traditional finance, banks own their own stores of value, just as Olympus owns its own stores of crypto-assets. However, banks have an opaque governance core, whereas OlympusDAO is governed by the liquidity providers themselves through transparent decentralized governance (DAO).
As a pioneer in this field, OlympusDAO is certainly at the origin of the new Decentralized Finance 2.0. New protocols are massively following Olympus in this direction. The real problem with Olympus right now is that it is only available on Ethereum, so it doesn't touch the entirety of current decentralized finance.
The topic of Olympus DAO is very broad. A single article is not enough to explain all the mechanisms of this protocol. Nevertheless, it is useful to understand Olympus' approach to understand DeFi 2.0.
Soon, Olympus will be the subject of a particular article on the functioning of "Stacking" and "Bonding". As well as the strategy (3; 3) resulting from the dilemma of the prisoner to really understand the mechanisms underlying the protocol.
Currently, new innovative initiatives are proposing real solutions for the new decentralized finance. We will also see what the Tokemak is, a futuristic reactor allowing the rapid launch of DeFi protocols. It is clear that by then, new mechanisms will have already been created within DeFi 2.0
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