In the past few months, when institutional money was flowing into Bitcoin (BTC), crypto made headlines – at least as a novelty, at most as a must. There is undoubtedly a trend in the market for greater awareness and acceptance of digital assets as a new investable asset class.
A June 2020 report by Fidelity Digital Assets found that 80% of institutions in the US and Europe have at least some interest in investing in crypto, while more than a third have already invested in some form of digital asset, with Bitcoin being the largest is popular choice of investment.
A good starting point for institutional investors would be to differentiate between crypto (especially Bitcoin) and decentralized financial products. So far, the biggest institutional interest has been to simply hold Bitcoin (or Bitcoin futures) with few players diving into more exotic DeFi products.
There are a variety of reasons for the recent Bitcoin rage. Some would cite the relative maturity of the market and increased liquidity, which means that substantial business can now take place without excessive market movement. Others would cite the asset class’s unusually high volatility, high return, and positive excessive kurtosis (which means a greater likelihood of extreme values compared to the stock market). Bitcoin’s backstory and its limited supply that makes it comparable to digital gold were also highlighted, making it increasingly attractive in a world of inflated asset prices and unruly monetary and fiscal policies.
However, the main reason for the recent institutional interest in crypto is much less philosophical, much more practical, and has to do with regulations and existing infrastructure.
Financial institutions are ancient giants who manage other people’s money worth billions of dollars, so they are legally required to abide by a plethora of rules regarding the types of assets they hold, where they hold them, and how to hold them .
On the one hand, the blockchain and crypto industry has made strides in terms of regulatory clarity in at least most developed markets over the past two years. On the other hand, the development of a high standard infrastructure that provides institutional actors with an operating model similar to that offered in the traditional world of securities now allows them to invest directly in digital assets by keeping them in custody or indirectly through derivatives and funds . Each of these is the real driver to give institutional investors enough confidence to turn their toes into crypto for good.
Maintaining Institutional Interest In Life: What About Other DeFi Products?
With 10-year US Treasuries yielding just over 1%, the next big problem for institutions would be to invest in decentralized yield products. It might be a no-brainer when interest rates are in the doldrums and DeFi logs for US dollar stablecoins are between 2% and 12% per year – not to mention more exotic logs that are north of 250% per year.
DeFi is still in its infancy, however, and liquidity is still too low compared to more established asset classes for institutions to bother to upgrade their knowledge, let alone their IT systems, to put capital into it. In addition, there are real, serious operational and regulatory risks related to the transparency, rules and governance of these products.
There are many things that need to be developed – most of which are already underway – to ensure institutional interest in DeFi products, be it at the settlement tier, the asset tier, the application tier, or the aggregation tier.
The main concern of the institutes is to ensure the legitimacy and conformity of their DeFi colleagues at both the protocol level and the sales processing level.
One solution is a log that detects the status of a wallet owner or other log and informs the counterparty whether it meets their compliance, governance, accountability, and also code auditing requirements, rather than the potential for malicious actors to exploit the system has been proven time and time again.
This solution must go hand in hand with an insurance process in order to transfer the risk of error, for example during validation, to a third party. We are gradually seeing the emergence of some insurance protocols and mutual insurance products, and DeFi needs to have enough adoption and liquidity to warn the investment of time, money and expertise to fully develop viable institutional insurance products.
Another place that needs improvement is the quality and integrity of the data through trusted oracles and the need to increase trust in oracles in order to achieve a compliant level of reporting. This goes hand in hand with the need for sophisticated analysis to monitor investments and activities in the chain. And it goes without saying that certain regulators who have not yet issued an opinion need more clarity on accounting and taxation.
Another obvious problem concerns network charges and throughput, with requests taking anywhere from a few seconds to tens of minutes, depending on network congestion, and charges varying from a few cents to $ 20. However, this will be resolved with plans to develop Ethereum 2.0 over the next two years and the emergence of blockchains that are better adapted to faster transactions and more stable fees.
One final, somewhat fun point, would be the need to improve user experience / interfaces to turn complex protocols and code into a more user-friendly, more familiar interface.
Regulation is important
People like to compare the blockchain revolution to the internet revolution. They don’t remember that the internet disrupted the flow of information and data, both of which were unregulated and had no infrastructure in place, and it’s only in the last few years that such regulations have been passed.
However, the financial sector is heavily regulated – even more so since 2008. In the US, the financial sector is three times more regulated than the healthcare sector. Finance has an older operating system and infrastructure that make it extremely difficult to cause disruption and arduous to transform.
It is likely that over the next 10 years we will see a fork between instruments and protocols that are completely decentralized, completely open source, and completely anonymous, and instruments that fit within the tight framework of the tight regulation and archaic infrastructure of financial markets This leads to a loss of some of the above properties along the way.
This is in no way going to slow down the fantastic creativity and relentless, rapid innovation in the industry as a large number of new products are expected in the DeFi space – products that we haven’t even predicted yet. And within a quarter of a century, when DeFi has first adapted to capital markets and then absorbed them, its full potential will be unleashed, resulting in a smooth, decentralized, self-governing system.
The revolution is here and it’s here to stay. New technologies have undoubtedly shifted the financial industry from a socio-technical system controlled by social relationships to a technosocial system controlled by autonomous technical mechanisms.
There is a fine balance between technology-based, fast-paced crypto and outdated, regulated fiat systems. Building a bridge between the two only benefits the whole system.
This article does not contain any investment recommendations or recommendations. Every step of investing and trading involves risk, and readers should do their own research in making their decision.
The views, thoughts, and opinions expressed here are the sole rights of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Amber Ghaddar is the founder of AllianceBlock, a globally compliant decentralized capital market. With extensive experience in the capital markets industry over the past decade, Amber began her career at investment banking giant Goldman Sachs before moving to JPMorgan Chase, where she held various roles in structured solutions, macro-systematic trading strategies and fixed income trading. Amber received a B.Sc. in natural sciences and technology before graduation with three master’s degrees (neurosciences, microelectronics and nanotechnology as well as international risk management) and a doctorate. She is a graduate of McGill University and HEC Paris.