TL;DR
DeFi v2 aims to adapt to new market conditions and technological advancements.
Developer's Perspective: Shift to "DeFi micro-primitives" for more granular and flexible protocol design.
Institutional Perspective: Emphasis on risk management, structured products, and lowering entry barriers.
Risk modeling and sophisticated risk management services are crucial for institutional adoption.
Structured protocols combining micro-primitives can offer services like margin lending, insurance, and credit.
Regulatory framework development in DeFi v2 is important for institutional adoption and risk mitigation.
Retail Perspective: Challenges for retail investors in DeFi; focus on improving user experience for broader adoption.
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Decentralized Finance, or DeFi, has undeniably left its mark on the world, with its inaugural version, DeFi v1, withstanding tumultuous market conditions and still achieving commendable success. The question at the forefront now is whether DeFi's next iteration can adapt to new market conditions and technological advancements and achieve widespread acceptance. For this to occur, either the market needs to transform, or the technology should evolve to captivate a new wave of customers. The following sections will outline the milestones DeFi v2 needs to hit, segmented into developer, institutional, and retail perspectives.
The Developer's Perspective: Emergence of DeFi v2 Micro-Primitives
For the developers, DeFi v2 introduces a shift in the design of protocols. Previously, protocols followed a monolithic design structure; however, DeFi v2 is evolving towards smaller, more granular components referred to as "DeFi micro-primitives". For instance, Morpho Blue is developing atomic primitives for lending, which can be integrated to create more complex functionalities.
New ecosystems, like EigenLayer or Celestia/Manta, are also surfacing, providing fresh foundations for the development of new financial primitives in DeFi. Early pioneers of these ecosystems include protocols like Renzo or EtherFi.
The Institutional Perspective: Risk Management and Structured Products
In DeFi v1, adoption was primarily spearheaded by cryptocurrency-based companies. However, for progress to continue, DeFi v2 must enhance its core constructs with robust financial services to lower the entry barriers for institutions.
Risk management is poised to become a fundamental component of DeFi v2, allowing institutions to accurately model risk returns in DeFi. This evolution could give rise to more sophisticated risk management services. In addition, the adoption of DeFi v2's architecture could lead to more complex challenges for institutions.
To resolve this, micro-primitives need to combine to form structured protocols that offer the sophistication and resilience institutions demand – services such as margin lending, insurance, and credit would unlock the next phase of DeFi for institutions. More structured products suitable for institutional frameworks could include a DeFi vault offering yields across different protocols combined with risk management and lending or insurance mechanisms.
Although regulation remains a wildcard in the institutional adoption of DeFi, a well-thought-out regulatory framework is almost impossible without institutional primitives such as risk management and insurance. From this viewpoint, the development of institutional-grade capabilities in DeFi v2 is not just about increasing adoption but also about mitigating existential risks to the space.
The Retail Perspective: The Role of User Experience
DeFi markets have posed significant challenges for retail investors. However, new ecosystems are gradually enticing retail investors back to DeFi. Yet, the reality remains that DeFi is still largely a crypto-to-crypto market, and engaging with DeFi protocols is a foreign concept for the majority of retail investors.
The key to unlocking retail adoption is improving the user experience. This implies going beyond merely simplifying interactions with DeFi protocols. The experience of using digital wallets, which have remained largely unchanged over the past five to six years, needs to integrate DeFi as a core component.
Retail investors also need simpler primitives that abstract their interactions with DeFi protocols without the necessity of expert knowledge. The idea is to create a one-click solution where users can request a loan with the right amount of collateral and protection mechanisms.
Navigating the intersection of macroeconomic conditions and the current state of the crypto market will enable a new phase in DeFi. DeFi v2 should provide more granular and composable financial primitives for developers, robust financial services for institutions, and an improved user experience for retail investors. While DeFi v1 was driven by artificial financial incentives, DeFi v2 should focus more on utility, simplicity, and organic growth to substantiate its viability as a concurrent financial system to traditional finance.
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