In recent years, there has been no shortage of complaints about Web3, with no groundbreaking innovations in the industry and no new breakout effects; talent has returned to Web2 or shifted to AI; VC coins are facing a crisis, and Meme has surprisingly become the main character. We have long missed the excitement, shock, and anticipation we felt during the DeFi Summer and NFT Summer.
However, innovation is actually happening quietly all the time. At least in the DeFi space, I see waves beneath the surface — the emergence of DeFi 4.0.
To understand what DeFi 4.0 is, let's first conduct a generational analysis of DeFi.
DeFi 1.0: Decentralization of basic financial products
Time: Approximately between 2018 and 2020
In this phase, first-generation DeFi protocols like MakerDAO, Compound, Uniswap, and Aave were born, achieving decentralization of basic financial services such as trading, lending, and asset management. Especially with the invention of AMM, a previously unseen paradigm was created, sparking a movement for 'everyone can provide liquidity' and creating a wave of wealth myths related to liquidity mining.
DeFi 2.0: Enhancing capital efficiency
Time: Approximately between 2021 and 2022
During this period, a number of new DeFi protocols emerged. Overall, these protocols lack the simplicity and beauty of the first-generation DeFi protocols, with more complex mechanisms, but their goals mainly revolve around improving capital efficiency, especially liquidity efficiency, while also attempting to address the accessibility and sustainability of liquidity.
Typical representatives include: Abracadabra, Alchemix, and Frax Finance, which attempt to bypass over-collateralization through various mechanisms; Tokemak, which aims to help newly launched DeFi projects gain liquidity through LaaS (Liquidity as a Service); and OlympusDAO, which addresses liquidity sustainability issues through self-held liquidity.
It is worth mentioning that Uniswap V3 was also born during this period, and the interval market-making algorithm significantly improved LP's capital efficiency compared to the previous full price range market-making.
Another significant innovation is the Gauge Voting of the Curve protocol, which is the veToken governance mechanism. This is a token governance scheme that effectively realizes the sustainability of liquidity. This mechanism has been widely adopted by many protocols in the DeFi industry.
DeFi 3.0: Expansion of composability
Time: Approximately starting in 2022
There is still a lack of consensus in the industry regarding the definition of DeFi 3.0. Some believe it is LSDFi and Restake, others believe it is cross-chain/full-chain DeFi, and some think it is Farming as a Service. This reflects that during the 3.0 stage, DeFi has made innovations and progress in multiple areas. Overall, however, the developmental trend of DeFi in this phase mainly manifests as an expansion of composability.
In the 1.0 era, the term DeFi Lego was already widely mentioned and discussed, but its composability, comparable to Lego, was only fully realized in the 3.0 era.
Image source: Internet
Since the Shanghai upgrade, Ethereum has officially completed its transition from PoW to PoS, and ETH LSD has become a fixed income product similar to dollar bonds in the DeFi space. Against this backdrop, many protocols have begun to develop Restake scenarios based on ETH LSD to provide users with stacked yields, notable projects include Eigenlayer and Puffer; some protocols also leverage the earning characteristics of LSD to provide users with interest rate swap products and diversified arbitrage strategies, such as Pendle.
With the improvement of infrastructure, the cost of creating chains has become lower and lower, leading to a proliferation of L2s and new public chains, which has brought diversification but also fragmentation. Some DeFi protocols, empowered by underlying cross-chain protocols, attempt to create composability across different chains, allowing users to perform cross-chain fund access, asset exchanges, cross-chain staking, lending, and other operations. Representative projects include the full-chain DEX Stargate, the full-chain lending protocol Radiant, and the full-chain LSD protocol Bifrost.
With the enhancement of DeFi composability, various 'one fish multiple eats' strategies have emerged. Some protocols have started to offer users FaaS (Farming as a Service) services, providing automated strategies through smart contracts, offering users a variety of high-yield strategies while simplifying operations, providing users with a 'hands-free' earning service. Representative projects include Rari Protocol, Harvest Protocol, and Yearn Finance, which has traversed from the 1.0 era.
DeFi 4.0: Self-custody and personalized finance
Time: Starting in 2023
Finally, we must talk about DeFi 4.0. Due to the performance limitations of Ethereum, DeFi protocols on Ethereum cannot provide independent agent computing capabilities for each user, hence a single contract management model was adopted. Whether it is Uniswap, Compound, or MakerDAO, as well as the vast majority of DeFi protocols on Ethereum, they require users to authorize their funds to the contracts and conduct uniform configuration and management within the contracts.
However, with the birth of various L2s and high-performance new public chains, this performance limitation has practically ceased to exist. However, for a long time, the strong inertia of past paradigms is still at play. In fact, for high-performance new public chains, DeFi can be built into a higher-order form.
In this new form of DeFi, every user can deploy their own smart contract agent to interact with protocols in a customized manner and independently engage in personalized financial services.
There is currently no unified name for this new form within the industry. New lending protocols like Morpho, Ajna, and Euler Finance have created a new term called 'modular lending.' Expanding on this, we can arrive at a new concept — 'modular DeFi' or 'modular finance'; the Arweave/AO ecosystem popularizes the term AgentFi, meaning 'agent finance.' A term I personally prefer is Sovereign Finance, emphasizing 'individual provision of financial services' and 'individual financial independence.' This concept was first mentioned in a tweet by EverVision's initiator outprog, and the Permaswap developed by EverVision is a leading DEX in the Arweave/AO ecosystem. The tweet mentions that Sovereign Finance emphasizes 'individual provision of financial services' and 'individual financial independence.' In simple terms, it allows everyone to establish their own exchange, create their own bank, and provide any financial services.
Image source: https://x.com/outprog_ar/status/1853102029620805912
Regardless, as the industry develops and narratives arise, consensus will inevitably coalesce around a particular name, so for now, let's put aside the naming issue and call it DeFi 4.0.
The core features of DeFi 4.0 are three:
Firstly, autonomous control. Users do not need to authorize assets to a unified contract but can manage their own funds and participate in financial services through an agent contract controlled by themselves;
Secondly, personalization and customization. Users can set the content and parameters of financial services according to their own needs;
Thirdly, peer-to-peer. The trading model is no longer pool-to-pool but rather peer-to-peer, or point-to-network.
For example, Permaswap allows LPs to autonomously set market-making curves and intervals, matching with traders through a peer-to-peer mechanism. Users of so-called 'modular lending' protocols can create their own lending pools, autonomously set over-collateralization ratios and lending rates, and transact with borrowers through a peer-to-peer matching mechanism. It is worth mentioning that to avoid future interoperability issues among agent contracts developed in different ways, Permaswap has proactively created a standard protocol — FusionFi Protocol. All agent contracts (Agents) built according to this standard can communicate with each other, facilitating mutual matching, which potentially allows Permaswap to transcend a mere DEX and become a liquidity aggregator, even merging into a super aggregator of various financial forms.
Summary
New problems give rise to new solutions, and new solutions may contain new problems. Like the development of most things, DeFi is also continuously evolving through this dialectical process. Looking back at the journey from DeFi 1.0 to DeFi 3.0, we can see that the DeFi space is always full of vibrant creativity, with some innovations visibly bringing change, while others, though less noticed, may have equally far-reaching impacts.
At the beginning of 2024, we vaguely discovered new trends in the DeFi space — autonomy and personalization. We faintly see a new decentralized financial paradigm — DeFi 4.0. It currently seems to be little heralded and not yet significant, but 0xmiddle believes it will eventually form a powerful narrative.
The era of Sovereign Finance is coming!
