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What is going to be the best performing cryptocurrency subsector of 2022?  This year, we have seen a rise of many different trends, starting with decentralized finance and non-fungible tokens, to memecoins. Since 2021 is coming to an end, many people are wondering what will be the next big thing in the cryptocurrency space in the next 12 months. As of now, one emerging subsector is starting to stand out and is gaining more and more attention. And that is the sector of DeFi 2.0.

Are there problems with DeFi?

The sector of decentralized finance is trying to make sure that everyone on the planet has access to the same financial products and services no matter the race, religion, age, profession, gender or skillset. Thus, the main goal of the sector is to make all financial items more available via decentralization to the general public.

We have seen the rise of decentralized finance mainly in the end of the year 2020 and beginning of the year 2021. During that time, many projects like Uniswap, Sushiswap, Yearn.Finance, Compound, Aave and many others, have gained a lot of attention and provided the early investors with nice gains. Even though there are not that many people talking about DeFi now, the sector is still well, growing and improving.

Without any doubt, progress is needed, since the DeFi projects are far from perfect. Numerous DeFi platforms have suffered significant hacks, rug pulls, bugs etc, that cost a lot of their investors huge capital. Moreover, as of now, DeFi projects tend to have problems with liquidity and long term sustainability. And on top of that, their interface and user experience are on many occasions far from ideal and easy to use. All these drawbacks that the sector of DeFi is still having, have caused the rise of several platforms that are trying to build on top of DeFi and improve services and products that this sector offers. And that is exactly what DeFi 2.0 is doing.

What is DeFi 2.0?

Simply said, DeFi 2.0 is a subset of new projects emerging in the world of decentralized finance that has the main aim of improving the first DeFi projects. In essence, DeFi 2.0 still has the same goals as the DeFi 1.0, but these new platforms are trying to learn from the mistakes of their ancestors. Therefore, DeFi 2.0 projects are mostly concerned with the security of decentralized finance, with scalability or with user-friendliness of this sector.

DeFi 2.0 can also refer to projects that do not necessarily try to improve some drawbacks of the first generation, but that are built on top of the first generation. However, in most cases, building on top of some decentralized platform means a way to improve the given platform and make the sector a more sustainable place.

It is also interesting to note that many proponents of DeFi 2.0 have been vocal about the fact that this new subsector should make sure to move away from fiat backed stablecoins. This is simply because the whole crypto space is aspiring to create an alternative to the traditional finance world as we know it now. However, if the crypto space is still relying on fiat and fiat-backed stablecoins, it will not be able to cut itself off from the old traditional system and will simply duplicate the traditional finance world just by using different technologies. Even though it still might be an improvement, the difference between the two financial systems would not be that huge.

The DeFi 2.0 is also expected to bring more emphasis to DAOs (Decentralized autonomous organizations). These are usually managed by the community and token holders and aim not to work like centralized companies with a board of directors. While the concept of DAOs is nothing new, it is expected that the era of DeFi 2.0 can bring many more projects in this sector.

Difference between DeFi 1.0 vs DeFi 2.0, Source: keplerswap.io

What is DeFi 2.0 trying to solve?

Most of the bigger problems that DeFi 2.0 is trying to solve have already been introduced. But to better understand how they can do it, here is an example of where DeFi 2.0 can provide an improvement on top of the current system.

DeFi 1.0 introduced a concept of liquidity pools (LPs). So far, these pools have been a great success since they allow providers of liquidity to earn a fee for staking pairs of tokens in the given pools. However, they also have one major problem, which is called impermanent loss. Impermanent loss is a risk connected to a rapid change in a price ratio of tokens in the liquidity pools, that can cause the investors to lose money. The solution that some DeFi 2.0 projects are already looking at right now is a provision of insurance against this type of risk, in exchange for a small fee. If insurance becomes popular, it incentivizes more people to provide liquidity to LPs, since they will be viewed as less risky, thus boosting the whole DeFi world.

Other than the risk connected to impermanent loss, the DeFi 2.0 is aiming to solve several other problems. Most of them are somehow connected to scalability, centralisation, oracles, security or, as mentioned above, liquidity. Overall, the reliability of the whole sector, as well as its usability should thus be improved. This can lead to improved user experience as well as lowering the barriers to entry for anyone that is willing to enter the sphere of decentralized finance.

Which projects show the biggest potential?

The aim of every investor is to try to find “the next gem” before the rest of the market figures the potential of the given project. The same applies to cryptocurrencies and thus also to DeFi 2.0. Even though the sector has only started to gain attention there are some projects that have already shown promising potential. However, it is important to note that this article presents these projects only briefly. It does not go into depth, so if you are eager to learn more about them, we recommend that you do your own research.

OlympusDAO (OHM)

Probably the project that has been getting the most attention. OlympusDAO is an algorithmic cryptocurrency protocol that is aiming to become a stable cryptocurrency. It has its native token, OHM, which is supported by a mix of crypto assets that are creating Olympus Treasury. These assets include projects such as FRAX or DAI. The goal of OlympusDAO and its token is to become a decentralized reserve currency backed by its own treasury.

Olympus DAO, Source: olympusdao.finance

Convex Finance (CVX)

Convex Finance is a project that is built on top of Curve, a popular DEX mostly known for its services connected to stablecoins. It is aiming to improve the overall user experience of this platform via launching a one-stop platform forCRV pledging and liquidity mining. To put it simply, Convex Finance is trying to help Curve users to put their assets into working more efficiently, essentially leading to higher returns.

Staking CRV on Convex Finance, Source: convexfinance.com

Abracadabra (SPELL)

Abracadabra is a DeFi 2.0 project that aims to improve lending through its incentive token – SPELL. In many ways, this project is working as MakerDAO, but the assets pledged to Abracadabra should also be interest-bearing assets.

There are however other projects that at least need to be mentioned in our article. These are projects such as Wonderland (TIME), Alchemix (ALCX), Tokemak (TOKE), Rari Capital (RGT), Tranche Finance (SLICE) or Popsicle Finance (ICE). However, even if these projects offer great potential for abnormal returns, there are numerous risks that need to be listed.

Potential risks of DeFi 2.0

Overly complex

As with DeFi 1.0, most of the DeFi 2.0 projects are really difficult to grasp, especially for newcomers. Even though the platforms are trying their hardest to make everything as simple and clear as possible, some of them use technologies, processes or ideologies that are so new that even crypto analysts and experts can have hard time understanding them. Unless this changes, there is almost no way for retail to enter DeFi 1.0 or DeFi 2.0 in huge numbers.

Just another hype

It is also important to take into account the fact that the cryptocurrency world is extremely fast-paced. This simply means that all the trends can emerge just as fast as they can disappear. We have seen that this year, where we have seen almost three month cycles of hype around memecoins, DeFi, NFTs and Metaverse. The same can happen to DeFi 2.0.

Extremely new

As with everything that is new, people and especially investors should always be more cautious. This is simply because it is really hard to assess all the risks that can arise. And this difficulty of risk assessment is, sadly, one of the biggest risks of DeFi 2.0 as well. However, this risk tends to disappear fairly quickly once the given asset, subsector or asset class establishes itself.

Unpredictable regulation

And one of the risks that is extremely difficult to assess is a risk connected to regulation. This applies to the overall cryptocurrency world as well, however, newer subsectors that show potential for the future can be under more scrutiny by regulators around the world.

Hacks and risks connected to security

Hacks and weak security will definitely be a concern for DeFi 2.0. It would be naïve to believe that one of the biggest problems of DeFi 1.0, will somehow magically disappear with the emergence of new projects. Yes, it is possible that there might be fewer hacks or bugs but that does not necessarily mean that they will completely go away.

Conclusion

Many expect the year 2022 to be the year when Bitcoin hits the 100 000 dollars mark. However, it might also be a year, when new trends will emerge, which can lead to bigger profits as well as bigger risks. One of these trends might just as well come from the DeFi 2.0 world, which is already getting more attention by a day. 

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