Decentralized Autonomous Organizations & DeFi 2.0
Updated: Sep 26, 2022
Decentralized Autonomous Organizations (DAOs) are an efficient and secure method to collaborate with like-minded people worldwide. They are member-owned communities without any centralized leadership – instead, they are collectively owned and managed by their members. Thus, they are safe for committing funds to a specific use case rather than trusting a single party.
Figure 1: Traditional organizations vs. DAOs ¹
How do DAOs work?
A DAO's smart contract serves as its foundation - it establishes the organization's rules and serves as the group's treasury. Only a vote may modify the rules once the contract is live. The transaction will fail if somebody tries to do something against the code's rules and logic. Thus, no one can spend the treasury money without the group's agreement. DAOs, as a result, do not require a centralized authority. Instead, the group takes choices collectively, and payments are automatically allowed when votes pass.
Which forms of DAO membership exist?
Membership based on tokens
These governance tokens are freely exchangeable on decentralized exchanges like Uniswap. Depending on the token used, it is usually wholly permissionless. In any case, simply owning the token makes holders eligible to vote.
Membership based on shares
Share-based DAOs are more restricted but still quite open. Shares signify ownership and direct voting power. Any potential member can propose to join the DAO, generally in the form of tokens or labor, in exchange for some tribute. Members can withdraw their fair part of the treasury at any moment.
What is DeFi 2.0?
DeFi 2.0 is a movement attempting to improve and correct the issues that plagued the initial DeFi wave. DeFi was a game-changer in giving decentralized financial services to everyone with a cryptocurrency wallet - but it still has flaws. DeFi 2.0 aims to tackle missing transparency, low liquidity, and centralization problems. It can help lessen these risks and difficulties that keep crypto users away by utilizing novel economic models, game theory, and statistics.
There are already several DeFi 2.0 use-cases operational:
Unlocking additional value of LP tokens
Users that stake a token pair in a liquidity pool receive Liquidity Provider (LP) tokens in return. With DeFi 2.0, those LP tokens can get utilized as collateral for a loan - unlocking additional value besides earning pool rewards. The goal is to unlock LP tokens' value for new possibilities while also generating APY. Thus, it opens the value of staked funds and decreases capital inefficiencies.
Using LP tokens for self-repaying loans
Another opportunity is to use LP tokens as collateral to obtain a self-repaying loan. The idea is that the interest generated by the LP pays off the loan debt without the borrower paying any interest. If the collateral token drops in value, it just takes longer to pay off the loan.
Insurance for smart contract vulnerabilities
When investing in DeFi projects, performing advanced due diligence on smart contracts might be challenging without developer experience. This poses a significant risk because investors can only partially evaluate a project if they don't have this information. With DeFi 2.0, it's possible to get DeFi insurance on specific smart contracts. If investors deposit liquidity into a smart contract and the contract becomes compromised, all funds are vulnerable. To tackle this issue, an insurance project can guarantee the deposit up to a certain threshold for a fee.
Insurance for Impermanent Loss
By investing in a liquidity pool, any change in the price ratio of the two tokens locked may result in financial losses. This outcome is known as impermanent loss. However, new DeFi 2.0 protocols are looking for novel ways to limit this risk. One way is to create liquidity pairs with the constraint that a project's native token is always included within the pairs. Fees paid from swaps build up an insurance fund to cover impermanent losses. Furthermore, the protocol can increase or decrease the supply of the native token to prohibit high price ratio changes.
MakerDAO, one of DeFi 1.0's first projects, established a precedent for the movement by fully transitioning into a DAO. As the movement proceeds, it's becoming more typical for projects to give their community a voice. Thus, many platform tokens already function as governance tokens, granting holders voting rights. It's logical to anticipate DeFi 2.0 to continue this trend and ultimately decentralize the DeFi industry.
At basenode.io, our mission is to eliminate the gap between traditional accounting and blockchain-based accounting. Basenode.io is the first token-based accounting solution that offers seamless fiat-to-crypto invoicing. We provide a self-explanatory user interface with a clean and modern look, that naturally supports your workflow. Furthermore, we will integrate support for the most popular networks like Bitcoin, Bitcoin Lightning, Ethereum, Binance Smart Chain, Polygon, and more.
David Brodhagen is COO and co-founder at basenode.io. Before, he worked in the blockchain ecosystem for two years. Besides studying Business Administration he leads the Blockchain Initiative at the Frankfurt School of Finance and Management. You can contact him via email and LinkedIn.