DeFi 1.0 vs DeFi 2.0 in 2023


Do you know the key differences ? 👀

  1. DeFi 1.0 protocols were primarily dependent on attracting liquidity by allocating a substantial portion of their native tokens into liquidity mining incentives. For example, SushiSwap, a popular decentralized exchange, incentivized users to provide liquidity by offering generous SUSHI token rewards. However, these programs can be unsustainable as they could lead to an excessive supply of tokens, devaluing the native token over time. DeFi 2.0 protocols, on the other hand, are focusing on novel protocol designs and innovative tokenomics to attract liquidity. Uniswap V3, for instance, offers concentrated liquidity positions, allowing liquidity providers to earn more transaction fees by focusing on price ranges where they believe the most trading activity will occur. This is a more sustainable way to attract liquidity, as it doesn’t rely on inflationary token rewards.

  2. DeFi 1.0 was characterized by “hot potato” liquidity, where liquidity providers would jump from one protocol to another chasing the highest yield. This caused significant price instability for native tokens. For example, when yield farming rewards on the Yam protocol decreased, there was a rapid exodus of liquidity, which destabilized the token price. DeFi 2.0 seeks to foster loyal liquidity. Protocols like Alchemix are pioneering this trend by offering self-repaying loans, which gives users a compelling reason to keep their assets in the protocol long-term, fostering a more stable liquidity pool.

  3. In DeFi 1.0, the token price was often intertwined with the project’s overall perceived quality. A drop in token price could potentially destabilize the project, as was the case with Iron Finance’s stablecoin Iron Titanium token (TITAN), which experienced a bank-run type scenario, leading to a loss of confidence and collapse in price. To avoid such scenarios, DeFi 2.0 protocols are working on mechanisms to decouple the overall success of a project from the price of its native token. For instance, the Terra ecosystem uses an algorithmic stabilization mechanism to keep its stablecoin, UST, pegged to the USD, irrespective of the price movements of its native LUNA token.

  4. Vesting was a common practice in DeFi 1.0 to alleviate the issues related to liquidity mining. While this delayed immediate sell-offs, it didn’t eliminate the possibility. Once tokens were fully vested, token holders could still sell en masse, leading to price instability. DeFi 2.0, represented by protocols like OlympusDAO, is introducing bonding models where tokens are sold at a discount in exchange for other assets. This enables the protocol to own its liquidity. In effect, it’s buying back its tokens using treasuries funded by protocol profits, fostering long-term stability.

  5. DeFi 1.0 was heavily reliant on a protocol’s brand and reputation to retain users and liquidity once liquidity mining incentives ended. This was a limitation, as any reputational damage could lead to a rapid exodus of liquidity. Compound, for example, experienced a drastic reduction in liquidity when its liquidity mining program ended. In contrast, DeFi 2.0 is creating mechanisms that make it more appealing for users to stay, without relying on brand reputation. Curve Finance’s veCRV token, for instance, gives users voting rights and boosted yields, incentivizing them to lock their tokens for longer periods.

  6. Liquidity mining programs in DeFi 1.0 were usually limited to a certain amount of tokens, putting pressure on the protocols to succeed within a certain timeframe. Once the tokens allocated for rewards were exhausted, the protocol might struggle to retain liquidity. DeFi 2.0 is seeking more sustainable and long-lasting liquidity

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