Introduction
The blockchain sector is made of decentralized protocols and entities that have shaped financial development. It has led to the creation of DeFi as a dedicated investment market. This article talks about DeFi and what are its various classifications.
What is DeFi?
DeFi is a portmanteau of two short forms ‘De’ is adopted from decentralized and ‘Fi’ is rooted from Finance. In essence, DeFi means decentralized finance and it deals with all types of virtual currencies, tokens, blockchains, and other autonomous protocols that are decentralized.
It is important to understand that decentralized entities are trusted entities that are able to operate without any sort of centralized governance or verification units such as banks and private companies.
What is DeFi 1.0?
Before diving into DeFi 1.0, it is time to learn about DeFi 1.0. The duration 2018-2020, the era of DeFi developments and often regarded as DeFi 1.0. It marks the first ever and the foundational network for DeFi developments with new utilities and innovations.
The era saw DeFi markets reaching a collective TVL or total value locked estimated to be around 150 million USD. Some important characteristics of DeFi 1.0 are introduction of basic operation models and limited participation. DeFi 1.0 duration developed when there were fewer regulatory restrictions.
What is DeFi 2.0?
With the initiation of 2021, a visible increase in mainstream and commercial adoption of DeFi became visible. To this effect, the overall valuation of DeFi TVL reached $612 million. This period for DeFi development marks increased participation and better motivation for the patrons to engage with decentralized protocols.
At the same time, DeFi 2.0 introduces various governance models that paved the way for ecological development of the DeFi systems. This version of DeFi has made the decentralized environment more sustainable.
Advantages of DeFi 2.0
Here are the advantages associated with DeFi 2.0 listed as under:
- This upgrade offered flexible staking for asset classes. They are present in the form of liquidity pools or LPs. Users may stake and earn yield in the form of specialized LP tokens.
- DeFi 2.0 introduced collateral accounts using LP tokens that are earned from yield farming. This had made Day trading and other short-term trading activities more incentivized and accessible.
- DeFi 2.0 paved the way for flash loans that is a better, faster, and more efficient method to perform leveraged trading.
- DeFi is also called the infrastructure layer as it contains layer-2 scalability solutions such as Lightning network.
- DeFi 2.0 mitigates the risk of lack of insurance by offering back up, audits, and APIs to mitigate price imbalance in decentralized trading pools.
- DeFi 2.0 ensured a flux of user interaction with the normalization of simple user interface and design. In this manner, non-technical users were able to comprehend and navigate the blockchain ecosystem without facing any obstacles.
- DeFi 2.0 reduced the risk of impermanent losses that took place on account of time-locked cryptocurrencies in LPs and smart contracts.
- A distinct feature of DeFi 2.0 is protocol-controlled LPs or PCVs. These decentralized entities invest in other crypto projects and divide the profits among its native investors.
What is DeFi 3.0?
It is not possible to discuss DeFi 2.0 without talking about the next phase of DeFi protocols namely DeFi 3.0. The upcoming version of DeFi is going to address all the limitations that this type.
DeFi 2.0 is still largely centralized. However, there are some new designs and protocols in decentralized finance such as DAO or Decentralized Autonomous Organizations to address the issue. At the same time, this version of DeFi increased network security.
Attributes of DeFi 3.0
Here are some important and visible attributes of DeFi 3.0:
- DeFi 3.0 is an automated entity that decreases governance bias and increase decentralized management.
- It is a neutral environment for profit-sharing ventures and transactional buybacks.
- DeFi 3.0 has more liquidity in comparison to previous versions that reduces the price volatility for assets present in LPs.
- DeFi 3.0 protocols may offer passive income as high as 10% on first purchase of their native token in projects like Cross Chain Capital.
Conclusion
DeFi 2.0 is the successor to DeFi 1.0 and predecessor to DeFi 3.0. It has assisted in adding new features for the decentralized protocols, improved performance efficiency, and addressed the limitations and risks associated with the legacy version.
DeFi 2.0 still deals with regulatory uncertainty, security issues, and price volatility. However, with the introduction of the next rendition of the sector namely DeFi 3.0 will undertake new innovations and implement better measures.
