What does DeFi need to do next to keep the interest of institutional participants?

The influx of institutional funds into Bitcoin in the past few months has made cryptocurrency the headlines — at least as a novel asset, at most a must-have asset. There is no doubt that there is a trend in the market-more and more people realize and accept digital assets as a new investable asset class.

A report by Fidelity Digital Assets in June 2020 found that 80% of institutions in the United States and Europe are at least interested in investing in cryptocurrencies, while more than one-third of institutions have invested in some form of digital assets. Bitcoin is the most Popular investment option.

For institutional investors, distinguishing between cryptocurrencies (especially Bitcoin) and decentralized financial products is a good starting point. So far, most institutional investors are only interested in holding Bitcoin (or Bitcoin futures), and few investors will get involved in more exotic DeFi products.

There are many reasons for the recent Bitcoin frenzy. Some people will mention the relative maturity of the market and the increase in liquidity, which means that a large number of transactions can now be conducted without causing excessive market volatility. Others will mention the unusually high volatility, high returns, and positive excess kurtosis of this asset class (compared to the stock market, it is more likely to have extreme values). The background of Bitcoin and its limited supply (which makes it similar to digital gold) have also been highlighted, which makes it increasingly attractive in a world where asset prices are inflated and monetary and fiscal policies are out of control.

However, the main reason for recent institutions’ interest in cryptocurrencies is not philosophical, but more practical, related to regulations and outdated infrastructure.

Financial institutions are ancient behemoths, managing billions of dollars worth of funds of others, so the law requires them to comply with too many regulations regarding the types of assets they hold, where they are held, and how they are held.

On the one hand, in the past two years, the blockchain and encryption industries have made leaps in regulatory clarity, at least in most developed markets. On the other hand, the development of high-standard infrastructure has provided institutional participants with an operating model similar to that of the traditional securities field, and now allows them to directly invest in digital assets through custody, or indirectly invest in digital assets through derivatives and funds. These are the real driving forces that give institutional investors enough confidence to finally get involved in cryptocurrencies.

Keep the interest of the agency: what about other DEFI products?

With the US 10-year Treasury bond yield slightly above 1%, the next big thing will be that institutional investors consider investing in decentralized yield products. When interest rates are sluggish and the annual yield of the DeFi protocol for USD stablecoins is between 2% and 12%, this seems to be a breeze—not to mention those agreements that have an annual yield of more than 250%.

However, DeFi is still in its infancy. Compared with more mature asset classes, liquidity is still too weak, and institutions cannot bother to raise awareness, let alone deploy funds into IT systems. In addition, when it comes to the transparency, rules, and governance of these products, there are real and serious operational and regulatory risks.

In order to ensure the institution’s interest in DeFi products (whether it is the settlement layer, asset layer, application layer or aggregation layer), many things need to be developed-most of which are already in progress.

The main focus of institutions is to ensure the legality and compliance of their DEFI products at the agreement level and the sales execution level.

One solution is a protocol that can identify the wallet owner or another protocol and inform the counterparty whether it meets its requirements for compliance, governance, accountability, and code auditing, because malicious actors use the system The possibility has been repeatedly proven.

This solution needs to work in conjunction with an insurance process to transfer potential risks of possible errors to third parties, for example, risks in the verification process. We are beginning to see the emergence of some insurance agreements and co-insurance products. The adoption and liquidity of DeFi need to be large enough, and we need to invest carefully in time, capital and expertise to fully develop viable institutional insurance products.

Another area that needs to be enhanced is the need to improve the quality and integrity of data through credible oracles, and to increase confidence in oracles to achieve compliance report-level reporting. This is closely related to the need for sophisticated analysis to monitor investments and on-chain activities. Needless to say, some regulatory agencies that have not yet expressed their opinions need to be more clear about accounting and taxation.

Another obvious problem is network cost and throughput. Depending on the network congestion, the request may take a few seconds to a few minutes, and the cost ranges from a few cents to 20 dollars. However, this will be resolved in the next two years through the development plan of Ethereum 2.0 and the emergence of a blockchain that is more adaptable to faster transactions and more stable fees.

Finally, the interesting point is that the user experience/user interface needs to be improved in order to transform complex protocols and codes into a familiar interface that is more user-friendly.

Regulatory issues

People like to compare the blockchain revolution to the Internet revolution. What they fail to remember is that the Internet disrupts the flow of information and data, neither of which has been regulated, nor has the existing infrastructure, and this type of regulation has only been adopted in recent years.

However, the financial industry is subject to strict supervision-even more so since 2008. In the United States, the financial industry is regulated three times as much as the medical industry. The financial industry has an outdated operating system and infrastructure, which makes it difficult to be subverted and difficult to carry out cumbersome transformation.

In the next ten years, we may see a fork between tools and protocols that are completely decentralized, completely open source, and completely anonymous, and these tools and protocols will need to adapt to the strict framework of strict financial market supervision and outdated infrastructure , Which will also cause the loss of some of the above characteristics.

This will definitely not slow down the amazing speed of creativity, as well as the uninterrupted, fast-paced innovation in the industry, because there are a large number of new products in the DeFi field-products that we did not even predict-are expected. In 25 years, once DeFi first adjusts and absorbs the capital market, its full potential will be released to form a frictionless, decentralized, and autonomous system.

The revolution is here, and it will continue. It is undeniable that new technologies have transformed the financial industry from a social technological system controlled by social relations to a technological social system controlled by independent technological mechanisms.

There needs to be a good balance between technology-based, fast-paced cryptocurrencies and outdated, regulated fiat currency systems. Building a bridge between the two will only benefit the entire system.