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The past year has been a rollercoaster of sorts for the crypto market, as is highlighted by the fact that after reaching a total valuation of $3T late last year, this figure currently lies under the $1T mark. This monumental growth can largely be attributed to the exponential rise of the decentralized finance (DeFi) market, with the total capitalization of this relatively nascent sector topping $150B last November.

However, the recent slew of insolvencies that have hit the DeFi sector — with projects like TerraLuna, Celsius, Vauld, and Babel Finance going caput seemingly overnight — has resulted in investors losing some of their confidence in this space. That said, in recent months, the idea of DeFi 2.0 has started to garner a lot of mainstream traction, and rightly so. This is because this new technological paradigm harnesses several crucial elements of the first generation of DeFi products — such as established customer bases, pre-existing operational and governance frameworks, etc — while allowing for the development of new products and services that are capable of safeguarding the sector's long-term viability.

Breaking down DeFi's primary growth drivers and existing challenges

According to Kenny Li, core contributor for Manta Network, a universal private blockchain platform, the last few years have seen the DeFi market experience tremendous growth due to its permissionless nature coupled with its ability to deliver massive yields, especially when compared with traditional financial products. Li added:

"However, the DeFi market has been experiencing some turbulence due to various factors, including security vulnerabilities which have led to a series of unwanted exploitations, hacks, and scams; general macroeconomic conditions resulting in reduced utilization; and questionable token models that have led to unsustainable yields and general economic unsoundness."

However, Jeremy Musighi, a key leadership member at Balancer, believes that contrary to popular belief, recent turbulence has exposed the weaknesses of centralized financial (CeFi) services while highlighting certain unique strengths of DeFi, adding that most of the projects that collapsed over the last few months — such as Celsius, BlockFi, and Voyager — were primarily CeFi operations.

Moreover, he highlighted that DeFi lending protocols like Maker DAO, Aave, and Compound, which were exposed to the same volatility as their CeFi counterparts, handled the pressure quite well and were thus able to stave off the pressure efficiently. Musighi further opined:

"There was no solvency crisis for DeFi protocols because they are designed specifically as a solution to the age-old problem of obscure centralized financial institutions abusing consumer trust. One of the big takeaways of this market turbulence has been a strong validation of DeFi's core value propositions: Decentralization, transparency, and immutability."

DeFi 2.0 stands to be a game changer, here's why

According to Li, the next wave of DeFi products stand to usher in a new level of operational maturity alongside sustainable token models and scalable on-chain privacy. By combining all of the above-stated elements, DeFi 2.0 will allow for increased institutional adoption as well as provide ecosystem participants with secure and direct access to more liquidity and sustainable yields. "This level of adoption also means that platforms operating within this space must do a better job on general security," Li noted.

Similarly, Mark Smargon, founder and CEO of Fuse, a decentralized EVM-compatible public blockchain focused on payment and DeFi, thinks that the pace of innovation that was witnessed during the DeFi 1.0 run (aka DeFi Summer) was thanks to the open-source nature of the tech, more of which can be expected in the near term now that the prospect of DeFi 2.0 is looming large on the horizon. However, he did concede:

"As the stakes get bigger, attracting more mainstream audiences, it is of the utmost importance for leaders to manage risk correctly and realize that fast growth cannot come at the expense of security."

Musighi reminds us, moving forward, DeFi developers have the opportunity to build a new layer of products and user experiences atop battle-tested DeFi protocols that have proven to be secure, resilient, and reliable even during difficult market conditions. In this regard, projects like Balancer, Maker DAO, and Aave provide an infrastructural backbone for the continued growth of this space, allowing new DeFi entrants to innovate on existing open-source code and solve new problems without needing to reinvent the wheel.

Looking ahead

As the world continues to move towards a decentralized mode of operation, it stands to reason that the composable nature of blockchain-based smart contracts can potentially lay the groundwork for DeFi's continued growth at an exponential rate since each platform operating within the DeFi realm can be used permissionless as a Lego piece to develop newer, more advanced solutions. Therefore, it will be interesting to see how the market continues to mature from here on out.