Compared to the trillions of dollars in assets under management (AuM) in traditional finance, the locked total value (TVL) in decentralized finance is just the tip of the iceberg that could become the total market for DeFi in the future.
2022 was not a bed of roses for the crypto industry. Bitcoin fell more than 50% on YTD, while Ethereum fell nearly 60% on YTD. Extreme volatility was exacerbated by Terra’s wipeout and the bankruptcy of centralized financial lender Seth and the multi-billion dollar hedge fund Three Arrows Capital. We have observed unsustainable business practices and improper risk management strategies that often come at the expense of investor interests. These Black Swan events also triggered increased regulatory oversight by US Treasury Secretary Janet Yellen and demanded stablecoin rules after the collapse of Terra’s UST. Finance ministers in G7 countries have also called on the Financial Stability Board (FSB) to double cryptographic regulations, especially after the crisis.
In Europe, the Cryptocurrency Market Regulation (MiCA), which requires a harmonious legal framework for digital assets, has recently become a law. The regulation covers three major areas: asset reference tokens, stablecoin and other crypto assets.
In the United States, President Joe Biden has signed a presidential order to assess the risks and benefits of digital assets to the government. The directive is guided by six main pillars: consumer protection, financial stability, illegal activity, US competitiveness, financial inclusion and responsible innovation. Given the importance of the order, it is expected to have clearer regulations that will hurt malicious individuals in the short term, but will allow sustainable protocols to strengthen DeFi’s next growth foot. We believe
Organizations remain motivated for crypto assets
Similarly, according to DeFi Llama, DeFi is inevitably subject to a market-wide meltdown, with total lockeds dropping from $ 244.55 billion at the beginning of the year to about $ 87 billion today. However, despite the bleak macro outlook, more and more institutions are looking to gain exposure to the rapidly maturing DeFi sector. These include:
- FIS, a US $ 62 billion publicly traded fintech company that provides everything from payments to wealth management services, has recently turned to a range of crypto services such as trading, DeFi and staking for capital market clients. Announcing a partnership with Fireblocks, which offers full access.
- JPMorgan Chase’s Blockchain Unit has announced plans to tokenize traditional financial assets and invest trillions of dollars in DeFi.
- The Monetary Authority of Singapore (MAS) has also launched a pilot program called Project Guardian involving JP Morgan Chase, Market Node and DBS Bank, and how to use the DeFi protocol in tokenized fixed income and wholesale funding markets. I checked if it could be done.
- In May 2022, Wall Street giant Jane Street signed the first loan agreement with BlockTower Capital to borrow US $ 25 million, with plans to expand to US $ 50 million depending on market conditions.
Onboarding the next wave of DeFi adoption
Within DeFi, especially in loaned spaces, there are small sectors that show signs of resilience despite periods of stress. These DeFi protocols continue to see healthy demand in both lending and borrowing activities of financial institutions, as evidenced by the continued growth of total lending. Veterans of lending spaces such as AAVE and Compound have also entered into highly profitable institutional lending spaces. AAVE introduced AAVE PRO and Compound founded Compound Treatment with the goal of meeting the needs of organizations to gain DeFi exposure.
This amount of healthy demand is in the midst of traditional financial institution clients demanding more exposure to DeFi. According to a 2021 report by Fidelity, 40% of crypto hedge funds and venture capitalists are interested in digital assets because of their opportunity to participate in the DeFi ecosystem. According to Fidelity, the number one reason to be interested in digital assets is the high potential of digital assets. Not surprisingly, the higher the risk-adjusted return on the DeFi lending protocol, the more reasonable it is to invest in an inflationary environment.
On the Coinbase blog, stablecoin lending, a relatively low-risk play, offers more attractive returns compared to traditional money market products. According to PWC’s 4th Crypto Hedge Fund Report in 2022, 41.6% of crypto hedge funds “use the DeFi platform to improve yields on agriculture and asset borrowing, and 78% of crypto hedge funds are in the DeFi sector. Nearly 50% of crypto hedge funds are also involved in borrowing and lending. Cryptocurrency native institutions are currently limited in the amount of money they can raise with traditional funding methods. To address this issue, many DeFi protocols have paved the way for alternative financing methods for these companies.
Challenges to move forward and need to comply
Tightening regulations is expected to be one of DeFi’s major headwinds as it enters the potentially protracted bear market. In particular, the top 10 coins (UST and LUNA) will be wiped out, spilling over billions of dollars in risk. -Three Arrows Capital, a dollar hedge fund currently in bankruptcy proceedings.
The DeFi protocol, which improves existing systems by leveraging the benefits of encryption and decentralization, is, in theory, a welcome sight for regulators who are looking at end users rather than existing institutions. Built in this spirit, the DeFi protocol definitely welcomes regulators’ sights and is ready to initiate constructive dialogue. However, cryptospace regulation is much more likely to start from the edge, with exchanges, on-ramp, and custodians being invited to the regulator’s table first.
Since its inception, the DeFi market has grown exponentially due to the unregulated nature of this sector, which offers attractive risk and reward opportunities. Regulatory uncertainty can discourage some financial institutions from planning to invest in this area until sufficient clarity is provided. But recently, we have witnessed that unsustainable business practices in an unregulated environment can have costly impacts on the market and the DeFi sector, as in the case of the collapse of Terra’s anchor protocol. Did.
Aside from regulatory concerns, many institutions have internal obligations to limit digital assets or require regulatory approval to engage in DeFi activities. The Digital Assets and Institutional Access report by Jane Street also lacks tax or accounting tools to describe this new asset class.
Another hurdle to expanding institutional adoption is infrastructure security. Digital asset security means protecting private keys and multi-signature capabilities. Financial institutions manage trillions of dollars on behalf of their clients and always keep security in mind before making investment decisions. Already at the forefront of addressing this concern, some companies are offering services ranging from storage to DeFi solutions with full customer verification (KYC) / money laundering prevention (AML) compliance and agency-grade security. I’m watching you offer.
Despite regulatory and infrastructure headwinds, DeFi activity in loan spaces remains active and financial institutions continue to leverage the sound risk-adjusted yields offered by these protocols.
As Finance 4.0, known as financial digitization, advances, there is an increasing need to work with traditional financial services to access all types of digital products and services. In the bear market we are currently entering, more emphasis will be placed on infrastructure security, compliance and sustainable business practices. With trillions of dollars trying to take advantage of the aforementioned digital assets, companies checking these conditions can take advantage of the great opportunity of TradeFi. This bear market removes unsustainable business practices and allows strong business models to embark on the next wave of institutional DeFi adoption.