Innovations in decentralized finance (DeFi) like yield farming, DAOs, and token lending established the foundation of DeFi 1.0 and secured a loyal user base for founding DeFi protocols. Yet, as is often seen in early versions of new technology, limitations within groundbreaking DeFi apps led developers to build solution-oriented projects on top of foundational blockchain protocols. Protocol modifications address project sustainability concerns such as liquidity constraints while expanding the utility of the ecosystem and ushering in DeFi 2.0.
Open-source protocols and permissionless composability enable DeFi 2.0 by allowing developers to build applications upon the reputable DeFi protocols that came before. Akin to the concept of open-source development, permissionless composability describes the ability for anyone to develop new protocols that integrate with existing DeFi projects to create unforeseen use cases. Both development infrastructures fuel the breakneck growth of this increasingly complex digital ecosystem.
The Ethereum network’s revolutionary smart contract protocol served as the developmental foundation of the ecosystem now known as DeFi. DeFi initially established itself via an evolutionary array of decentralized applications destined to expand the utility of Ethereum. For Ethereum and its blockchain successors, developers augmented blockchain use-cases via applications designed to interface with leading blockchain protocols. DeFi 1.0 developers largely centered innovation around resolving Blockchain Trilemma obstacles: upholding decentralization, security, and scalability.
An example of an early DeFi innovator is Uniswap. Uniswap developers identified the need for a user-friendly decentralized exchange (DEX) to seamlessly exchange ERC20 tokens on the Ethereum blockchain.  Uniswap became one of the first DEXs to allow users to swap tokens without relinquishing custody of the asset on loan. Uniswap has since grown to become the largest DEX in the world by enabling peer-to-peer transactions in DeFi. Another early DeFi success story is Aave, an open-source protocol that offered the first uncollateralized loan and introduced decentralized lending to DeFi.
The expanded utility and investment returns offered by trailblazing DeFi protocols continue to inspire enormous development and user growth. The ecosystem is increasingly shaped by projects incorporating the most reputable aspects of established DeFi protocols while improving upon long-standing pain points. Developers resolving user experience (UX) and user interface (UI) concerns are helping onboard and retain the next generation of DeFi 2.0 users. This new wave of DeFi users is overwhelmingly investing and participating in community-centric projects. For a DeFi 2.0 project to succeed, the protocol must foster a strong connection between users.
Creative liquidity incentive protocols are perhaps the defining feature of DeFi 2.0. Emerging projects require sizable, reliable capital in order to launch and sustain themselves while community building within this competitive sector. Developers launch ‘native tokens’ to brand and fund new projects. Unproven projects inevitably encounter liquidity constraints if they are unable to attract investors willing to purchase their native tokens in exchange for popular digital assets.
Emerging projects often entice investors to loan popular assets, like ETH and stablecoins, in exchange for high-yield reward structures. Known as yield farming, this strategy has led to unhealthy cash flows due to farm and dump scenarios within DeFi 1.0 protocols. Investors attempting to maximize yields without skin in a project hop from one high-risk-high-return investment strategy to another. DeFi 2.0 ecosystems like decentralized autonomous organizations (DAOs) are a member-owned, democratized solution designed to circumnavigate this destructive practice.
OlympusDAO is a protocol that pioneered this movement and is now helping define DeFi 2.0 ecosystems. As with most DAOs, prospective OlympusDAO members must first purchase the DAO’s native token, OHM, to buy membership into the DAO. Ownership of OHM contributes to the treasury and fuels the community’s purchasing power. DAO members may purchase more OHM to increase their ownership share, and thus voting power. Community members may temporarily loan or transfer token shares to other community members to boost that member’s decision-making power. Valuable community members may also be rewarded with additional governance tokens by the DAO to incentivize meaningful participation.
The Future of DeFi 2.0
The industry's TVL (Total Value Locked) continues to soar. Yet, the biggest obstacle facing nascent protocols is overcoming DeFi lending’s low utilization ratio––there are more assets and lenders than borrowers. However, the enormous untapped potential of this prolific ecosystem continues to attract progressive development and enterprising users. DeFi 2.0 developers benefit from bootstrapping to proven DeFi 1.0 protocols. Existing foundations and prior development allow 2.0 projects to spend less on building new infrastructures from scratch. Emerging projects are now free to take more risks, community build, and facilitate interoperability while nurturing mutually beneficial B2B relationships. DeFi 2.0 innovators are positioned to mainstream decentralized finance with community-friendly protocols designed to welcome the next generation of DeFi proponents.