Institutional DeFi: A New Era of Financial Innovation

Decentralized Finance ( DeFi ) is driving significant changes in the financial sector. It is expected to create a new financial paradigm based on cooperation, composability, and open-source principles, built on an open and transparent network. This article explores the development history of DeFi and its potential in institutional applications, focusing on how this will impact institutional financial services.

Decentralized Finance Overview

Definition of Decentralized Finance

The core of DeFi is to provide financial services on the blockchain without relying on traditional centralized financial intermediaries. Typical DeFi services include:

• Self-custody wallet
• Smart Contract Custody
• Staking Contract
• Asset Exchange Protocol
• Securitization and Rehypothecation Structure

Institutional Decentralized Finance

Institutional DeFi refers to the adoption and adaptation of DeFi structures by financial institutions. It seeks to explore DeFi within a regulatory framework, bringing its advantages into traditional financial markets, paving the way for increased efficiency and creating new growth pathways.

Key features include:

• Assets Custodied by Regulated Institutions
• KYC/AML through digital identity
• Governed by specialized organizations and professionals

The development history of Decentralized Finance

• The summer of 2020 saw DeFi projects ignite the crypto market, ushering in a new era.
• By the end of 2021, the number of DeFi users surged to 7.5 million, with a peak TVL of $169 billion.
• In 2022-2023, the market corrected, entering a phase of cautious rationality.
• By the end of 2023, the United States approved spot cryptocurrency ETFs, opening the door for institutional participation.

The Institutional Application Potential of Decentralized Finance

New Market Structure

The market structure driven by DeFi features dynamic openness, challenging the norms of traditional financial markets. Institutional DeFi needs to seek a balance between decentralization and regulation, which may result in a more streamlined market structure.

Institutional Decentralized Finance Use Cases

1. Interoperability: Self-custody wallets enable distributed asset custody, and smart contract bridges connect different blockchains.

2. Refinancing: Tokenized financial instruments as collateral to obtain stablecoins

3. Asset Management: Tokenized fund units are distributed via the blockchain, enabling quick subscriptions and redemptions.

Factors to Consider When Participating in the Decentralized Finance Market

Institutional participation in DeFi requires weighing the pros and cons of public and private chains:

Public Chain:

• Advantages: Strong openness, many innovation opportunities
• Disadvantages: Higher risk, significant regulatory uncertainty

Private Chain:

• Advantages: lower risk, easier to control
• Disadvantages: High cost, limited liquidity and interoperability

Key considerations:

• Blockchain Maturity
• Liquidity
• Regulatory Perspective
• Network Security
• Degree of technical standardization

Regulatory Challenges and Progress

1. Lack of a regulatory framework for intermediaries
2. Market Integrity and Investor Protection
3. Balance Sheet Treatment

Important progress:

• The International Organization of Securities Commissions has released policy recommendations on Decentralized Finance.
• The Basel Committee released standards for the prudent handling of crypto assets

Future Outlook

2024 will be a key period for the development of Decentralized Finance. Regulatory implementation will continue to affect institutional participation. Although DeFi brings challenges, its potential benefits cannot be overlooked.

Future development direction:

• Upgrade the proof of concept to a scalable commercial product
• Improvement of cross-chain interoperability
• Digital identity solutions are improved
• The regulatory framework is further clarified.

The development of institutional DeFi will be an exciting journey, leading us into a new era of financial innovation.