DeFi 2.0 – The future of institutional finance

Words by Gabriel Zanko, Tech Advisor, CEO of MobileyourLife ( Investment Banking for Deep Technology and Renewable Energy), CEO of Urano Capital( the future Seed Fund for Deep Technology), researcher and speaker

With the gains in momentum of both the cryptocurrency market as a whole and Decentralized Finance (DeFi) as a sector within said market, the attention of the user base is moving towards platforms in the DeFi sphere in both the personal and private level and the institutional level, with the latter becoming more interested since the DeFi boom that started in the last few months.

Jamie Burke, CEO and Founder of Outlier Ventures, defines institutional DeFi as the collective of platforms, companies and institutions that are either (a) built around already existing cryptocurrency networks, (b) not particularly focused on crypto but show interest in DeFi services like derivatives or ETFs, (c) Fintech firms, since they would benefit from offering the kind of products and yields seen in DeFi, and (d) the general underbanked population.

The key to mainstream adoption of DeFi in the largest institutional level comes from certain features associated to this type of platforms, which could help them develop tools that may attract new clients. The first of these features is non-fungible tokens (NFTs), which are programmable digital assets that do not necessarily represent a currency. NFTs could give institutions ways to provide access to entirely digital representations of real-life assets.

Another great advantage of adopting DeFi at an institutional level comes with the benefits inherent to blockchain systems in terms of security and recent improvements made in the field of transaction confidentiality. With privacy primitives like zero-knowledge proofs becoming more popular, the need to trust in the ethical behavior of the users becomes less worrying to enthusiasts, and adding solutions like transaction mixing, Layer-2 scaling and other methods of general confidential computing, institutions can create ecosystems that are both secure and inviting to clients.

However, the implementation of this kind of systems brings with it a number of questions that can make users doubt is DeFi is able to hold up to the hype or if it could keep up with the demands in innovation that institutional clients would bring with them. The main concern comes in terms of security, as the fast-paced and permissionless nature of DeFi gives opportunities to users with high technical knowledge to create or copy an unaudited and unregulated contract or network.

This issue could be tackled by tightening the regulations, but that would also be acting against the nature of DeFi, which could end up driving away more users than it brings in. And even if there were intentions to regulate this kind of activities, would they be able to do it? “Is there a threshold where its net benefit becomes irresistibly better than the current system in encouraging innovation, competition and economic expansion?”, Burke asks.

Of course, the answer to this question is not one that can be found by simple discussing the topic. Much like what happened in the early days of Bitcoin or Ethereum, which regulators have come to accept as beneficial, the perception of DeFi may become less stern as time moves on and more high-profile users or institutions become knowledgeable in the benefits of implementing this tools in their services, but there are ways to improve the current systems in order to reduce the entry barriers and turn it into a friendlier landscape for newcomers.

A topic that deserves special attention to catch the attention of institutional clients is risk management, since the fast-paced behaviour of DeFi makes it vulnerable to different modalities of malicious attacks, along with the safety issues inherent to the permissionless nature of the platforms we mentioned earlier. Institutional users that would like to mitigate this risk for their clients can offer solutions that range from basic insurance of investments, which may prove useful but also difficult to test in such new environments, to custody mechanisms, although the implementation of these systems should be performed carefully not to turn the institution into a centralized auditor, thus defeating the point of implementing DeFi services.

This problem of potential centralization could also arise from the implementation of KYC/AML measures. Since these can be applied at both protocol-level and transaction-level, a wide range of applications can be seen between platforms where no measures are applied at all (under certain jurisdictions when this is possible) and others where the measures are incredibly tight and regulated in a centralized manner.

On the other hand, one of the ways in which DeFi might improve without sacrificing its decentralization is in accessibility aspects. Should institutions put in the effort in migrating their current systems and databases or support the development of bridges between CeFi and DeFi, this process would not only become smoother for them as adopters but also for their potential clients. Furthermore, the movement towards an almost-entirely digital environment might facilitate a large number of processes that are either time-consuming, complicated, or prone to human error in today’s standards.

In their analysis, Outlier Ventures managed to pinpoint the main topics that should be considered in discussions for adoption of DeFi at an institutional level, an idea that a year ago was nearly non-existent and that has gained great momentum in the last few months, and focusing on these topics might prove crucial in the near future, when the viability of DeFi tools and services at the institutional level will be repeatedly proposed, analyzed and tested.

About SiGMA Europe Virtual Expo:

The future of events is here. SiGMA Europe is delighted to announce, for the very first time, an innovative new Virtual Expo taking place on 24th and 25th November, 2020, from the comfort of your own screen. Hot on the heels of the success of the SiGMA Asia and SiGMA Americas Digital Summits, we are elevating your online event experience even further in the form of a fully interactive, state-of-the-art virtual events space, including a brand-new cutting-edge expo floor. Check the full agenda here and register for free!