Institutional DeFi: the next big thing
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Does the phrase “institutional investors are coming, HODL!!!” ring a bell for you?
If it does, you might have been in the crypto market for longer than many can claim, including some prominent names in the space. However, if it doesn’t, it might be about time that you learn that, in a not-so-distant past, crypto holders fantasized about a time in which Big Money would arrive at our ecosystem.
Oh, and arrive it did.
The call for capital institutions to enter the space happened long before DeFi’s prime days and mainly related to Bitcoin. It wasn’t based on rocket science either, just on a rough notion that a demand peak would send BTC’s price to the moon when richer and more powerful buyers came into the mix.
Those days, however, are long gone, and institutions are a reality in crypto, which has helped the blockchain landscape to evolve in more than one way.
Institutional money, many claim, has been primarily responsible for the recent spikes in crypto prices, along with a positive market cycle (of which they without a doubt benefit).
Nowadays institutional investors make up a sizable part of the volume of cryptocurrency trades, with figures pointing to the possibility that the majority of transactions are institution-related.
In Q1 2021, for example, 64% of transactions on Coinbase were from institutions. Within this sum, over 60% surpassed $10 million, according to Chainalisys’ Global DeFi Adoption Index for 2021.
This paints a picture of awareness and interest in these protocols from institutional firms, although you’d rarely hear anyone refer to DeFi as mainstream.
We stand at a curious point in time. We see institutions using DeFi without fully committing to it, DeFi protocols striving to disrupt Centralized Finance (CeFi), and numerous users and projects jumping into DeFi.
Why is it, then, that these solutions are still regarded as exotic? Well, to know that, we might need to first take a step back.
Institutions are pretty much DeFi’s ideal users
Crypto users and believers tend to see capital firms as centralized institutions representing the exact opposite of what crypto stands for. Therefore, in their minds, the fact that institutions might be DeFi’s ideal users and the point that they’re the next frontier for cryptocurrencies as a whole rarely sit together.
However, in a global panorama with negative interest rates and the ghost of inflation circling around, institutions are actively looking at DeFi as a means to keep themselves from stagnating.
The reasons are fairly straightforward:
- Better yields: In DeFi, APYs of 5–10% are not uncommon, and even products offering over 20 or 30%, depending on the currency, are reasonably easy to find. By simply staking or lending stablecoins within a DeFi protocol, a capital institution can find better deals than they’d be able to find in traditional avenues.
- Fast settlements: One of blockchains’ many innovations is to allow for near-instant settlements regardless of their size or rarity. This allows for more efficient (and, as we’ve seen before, profitable) operations, which usually offsets the often high transaction costs.
- High liquidity: Along with the previous reasons, DeFi introduces capital firms into a truly global, incredibly diverse, unresting panorama. One of the advantages of this is the unparalleled liquidity of the crypto ecosystem. The diversity and sheer number of players in DeFi make it rare to encounter situations in which liquidity is an issue rather than an opportunity.
- High volatility: The crypto ecosystem is volatile and, as DeFi products mature, longing and shorting options make themselves available. Volatility can be a two-edge sword for many investors, but it can also be attractive as a basis for outsized returns.
- Diversity of instruments: As opposed to what happens in CeFi, DeFi makes it very easy for institutions to interact with a variety of instruments and alternatives that would represent enormous challenges in a centralized environment. From providing liquidity to arbitrage, staking, trading derivatives, funding projects, yield farming, etc., institutions can simultaneously participate in all kinds of activities with minimal setup and operational costs.
DeFi transaction volume coming from large institutions rose from around 10% in Q3 2020 to over 60% in Q2 2021. Clearly, DeFi is becoming “a whales game”, and therefore it only makes sense to wonder…
So, if things are so great, why aren’t more institutions around?
Way before its boom, our CTO and Co-Founder Anish Mohammed was covering decentralized finance’s many advantages in this keynote.
Many factors play a part in institutions being hesitant to enter DeFi. However, for most practical cases and, for the sake of argument, we can englobe them into three categories:
- Distrust in code and people
DeFi platforms and protocols have been hacked and exploited multiple times, sometimes for stratospheric figures, which understandably makes high-net-worth users wary about them.
While third-party audits are the gold standard of DeFi, sometimes even the platforms with the highest reputation within the community are subject to attacks, either due to human mistakes or great creativity by the attacking party. Since platforms can rarely reverse the results of these attacks, an institution has to place great trust in the design and team behind a given product. This can also be problematic as many DeFi developers are often pseudonymous or completely anonymous.
2. Lack of Privacy in Layer-1 setups
In the past, we’ve covered the economic problems that transparent blockchains can cause, some of them sandwich attacks, front-running and back-running. All of the above, among other issues, steam from Layer-1 blockchains being transparent and public, creating opportunities for savvy attackers to profit from their trades or tracing their identities. Institutions are particularly attractive targets for this kind of attacker, which explains why capital firms tend to be wary of executing on-chain moves.
3. Regulatory concerns
Perhaps the heart of this issue. Understandably, capital institutions are under heavier scrutiny than individuals and any other kind of institution, which requires air-tight risk management and legal counsel.
When dealing with DeFi protocols, capital firms need to stick to guidelines by bodies such as The Financial Action Task Force (FATF), the global money laundering and terrorist financing watchdog. In particular, they need to keep in mind that these regulations attempt to adjust to reality rather than shape it, therefore having to shift often rather quickly.
Nowadays, in particular, one of the most important definitions DeFi protocols need to comply with (and therefore, that their users need to care about) is that of a Virtual Asset Service Provider (VASP), as the FATF strongly frowns upon any perceived centralization in these protocols. If an entity facilitates a transfer, exchange or custodial service for assets, it’s likely subject to VASP standards, which involve KYC and AML procedures. Therefore “the creators, owners, operators or anyone maintaining control or sufficient influence in the DeFi arrangements” of any of these protocols need to stay away from being identified as gatekeepers. This consideration does not depend on how protocols choose to label or market themselves.
With Institutional DeFi, Panther aims to become the definitive bridge.
If we take into account all the factors above, we can conclude that to create a protocol that incentivizes financial institutions’ entrance into DeFi, Panther needs to be:
- Interoperable, to make the most out of existing networks.
- Private, to avoid the dangers of transparent ledgers.
- Compliant, to remain attractive and stay on the law’s better side.
- Perfectly executed to ease any potential concerns about the safety of utilizing it.
With the complete onboarding of institutions, DeFi may grow by two orders of magnitude to become New Finance, a mega-giant $8T segment. At Panther, we understand that this can only happen by connecting institutions to DeFi through a private layer that is still compliant with the law via selective disclosures.
Above all things, the crypto community should strive to maintain the core Permissionless and Censorless attributes of DeFi intact, as they are at the center of what this technology and its pioneers stand for. Instead of attempting to change this in favor of compliance in a growingly surveilled digital society, Panther creates a straightforward way to align the goals of our society with those of capital firms.
We want to make it as easy to generate income through DeFi as complying with the law to disclose this, both proactively and upon request. In a digital economy with maximum surveillance, and with an opportunity to create a protocol that put human rights first, we’d be hard-pressed not to.
Panther is a decentralized protocol that enables interoperable privacy in DeFi using zero-knowledge proofs.
Users can mint fully-collateralized, composable tokens called zAssets, which can be used to execute private, trusted DeFi transactions across multiple blockchains.
Panther helps investors protect their personal financial data and trading strategies, and provides financial institutions with a clear path to compliantly participate in DeFi.
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