Beyond DeFi 2.0 - What Is Driving DeFi’s Current Innovation?

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After a prolonged stagnation, DeFi has once again resurfaced among crypto's leading narratives. The resurgence is primarily being led by the contentious term "DeFi 2.0", coined by the pseudonymous developer of Alchemix Finance, Scoopy Trooples. In a recent Twitter thread, Scoopy highlighted a number of second generation protocols building upon the 0 to 1 innovations created by the first generation of DeFi protocols such as MakerDAO, Uniswap, Compound, and Yearn. This classification sparked infighting over the categorization of DeFi protocols and pulled the attention away from the actual shifts occurring under the hood. Twitter timelines have been left in constant confusion with everyone asking the same question about their favorite OlympusDAO fork:

Rather than debate the differences between arbitrary naming conventions (DeFi 1.0 vs DeFi 2.0), let us take a step back and examine the macro themes that are driving the latest wave of DeFi innovation. A year ago, such a report would have covered trends like vampire attacks and launch strategies. Today, we will explore the birth of Liquidity-as-a-Service (LaaS) protocols in addition to the rise of protocols that automate, enhance, or extend existing DeFi economic models.

Liquidity-as-a-Service

Liquidity mining, the heart and soul of DeFi Summer 2020, has recently fallen out of favor as protocols struggle to cope with the after effects of mercenary capital providers draining value from their systems. The liquidity mining model provides short term incentives for liquidity providers and creates a perpetual expense on protocols' balance sheets. As a result, projects are realizing they need better systems to ensure sustainable liquidity while aligning long term incentives for investors. As the problem becomes more well known, projects are beginning to specialize in LaaS. Using a LaaS provider, protocols may buy their liquidity outright from the market or rent it from protocols that are designed to offer the cheapest, yet highest quality liquidity.

Olympus Pro

Olympus DAO was the first project to create a viable alternative to the liquidity mining model using its novel bonding mechanism. By issuing its native token OHM at a discount, Olympus is able to purchase LP positions from the market to create “protocol owned liquidity” (POL). The recent launch of its Olympus Pro service marked DeFi’s first LaaS offering by introducing Olympus’ bond model to the wider DeFi ecosystem. Olympus Pro provides projects with a custom implementation of the Olympus bonding mechanism while also introducing a new demand channel for their native token. Projects that purchase their own liquidity will accrue any revenue generated from trading fees but will also bear the impermanent loss (IL) associated with price changes. This approach will likely be best suited for larger projects with less volatile token prices in order to minimize IL.