A primer on insto-DeFi.
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A primer on insto-DeFi.
Who’s involved ?
“Insto-” (institutional) DeFi refers to a sub-category of decentralized protocols, that provide financial services to traditional big players such as investment funds or banks, through a specific infrastructure which enables them to comply with strict regulatory requirements.
Why it matters ?
While decentralized finance has moved beyond the hype of the food-sponsored summer of 2020, its development keeps being challenged in rapidly evolving technological and legal landscapes.
Yet again, recent banking blow-ups both sides of the Atlantic continue eroding confidence in the current system, impaired by central points of failure, opacity, and regulatory lapses.
DeFi carries the promise of more transparent, auditable, and resilient financial services at scale for sovereign individuals.
That’s the typical reason why “permissioned” DeFi is not really anchored in crypto culture. Nevertheless, over the past few years, its value proposition has become increasingly attracting to the hears of institutions themselves.
Now, imagine you’re an Associate at a VC fund, and need to make a rock-solid argument for your Partners to dip their toes into startups building in this vertical.
Let’s find another way to reformulate the challenge : what do you think would happen if the 100 major banks could put just about 1% of their assets under management into DeFi, as an interest-bearing instrument for example ?
Well, according to this detailed article from my friends over at Blockdata, $ 940 billion of fresh liquidity would flow into decentralized finance. That’s a pessimistic x20 compared to where DeFi TVL lies today…
What’s the issue ?
Problem is, recurrent hurdles such as smart contract vulnerabilities, asset (self-)custody or unclear regulations have created a stumbling block in terms of adoption for these entities so far. Regardless of the tech, they remain legally bound to ensure simultaneously the protection and privacy of their counterparties.
Where to start ?
Here’s a list of articles on this captivating topic, that I’ve scoured for you over the past few days :
Before we go through the key insights, a short disclaimer : this post was co-written with the help of AI assistants such as ChatGPT & LEX, for which I have embedded an invitation link so the 1st of you to sign up can skip the waitlist ! (no referral involved).
Under the hood
Right, let’s go : up to that point, you might still wonder what drives institutional interest for DeFi.
When you look under the hood, it’s bringing forward innovations that not only increase the efficiency and the resilience of the actual system, but also pave the way for a brand new world of investment and yield generation opportunities.
Distributed ledgers ensure the validity of all records, corroborated with information instantly accessible to all parties involved such that investors are able to track the performance of their assets in real time, and have a much greater visibility managing their risks.
Tokens enable instant trading for previously inaccessible / illiquid securities, while reducing delivery risks as well as transaction costs.
Smart contracts streamline the transaction process between regulated entities, reduce the probability of human errors and can automatically enforce the terms of any transaction (e.g. interest rates, payment schedules, taxes etc.).
Interoperability and composability of protocols and blockchains allow for the aggregation of liquidity across asset classes into global markets, where actors aren’t siloed into specific verticals anymore.
Decentralized Autonomous Organizations (DAO’s) are able to take over roles traditionally assumed by centralized third parties such as trustees or rating agencies.
Permissions in a permissionless world
Permissioned DeFi involves a selective process, where only entities or individuals that have completed a KYC (Know Your Customer) or KYB (Know Your Business), and comply with anti-money laundering / anti-terrorism / anti-bribery policies are allowed to access a blockchain, a wallet or a protocol.
Private clubs are a form of permissioned DeFi, where only certain counterparties are allowed to provide loans to each other.
Zero-knowledge proofs are another technology enabling the validation and verification of information on public blockchains, without fully revealing the information itself : an interesting way to for financial institutions to achieve data privacy and identification in their functions.
Concrete examples
Some prominent examples of permissioned, institutional DeFi platforms are Aave Arc, MetaMask Institutional, or 1inch Pro that have all launched between 2021 & 2022.
Under- or non-collateralized loans, as well as the tokenization of private equity, debt or real estate are more examples of DeFi products that mainstream institutions are closely following and supporting.
Many projects such as Maple Finance, Goldfinch Finance, Backed Finance, Obligate or Realio are working to bring these new asset categories to the ecosystem. Note they are listed here in no particular order : these examples do not constitute any investment recommendation, nor any other form of personal endorsement 😉.
More to come !
Regulated investment vehicles re-packaging complex DeFi strategies into traditional funds are another appealing way for financial institutions to dip their toes into the crypto world, and unlock alternative sources of yield.
On this matter, I’m currently investigating another promising startup, on which I hope to be able to report very soon !
In the meantime, let’s make today’s message clear: regardless if permissionless or persmissioned, DeFi will ultimately revolutionize the way financial institutions interact with each other, as much as the way we interact with them.
I firmly believe that if we (crypto community) keep our heads down, and work with all stakeholders involved, we’ll be able to make this paradigm shift a positive-sum game for everyone 🚀.
Julien
Who am I ?
🏎 Former F1 engineer.
🏆 15+ years contributing to the success of high performance organizations, on & off-track.
🕵🏻♂️ 5+ years extracting signals from the crypto noise.
📊 On-chain data & crypto analytics specialist.
🧠 Unlocking access to business education with the dMBA.
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This week, I had the privilege to announce this :
If you are as well a founder or investor on a mission to make the global financial system more accessible, transparent & positively impactful : let’s connect. Besides fundraising, I’d be stoked to support with on-chain data, analytics or any research work specific to crypto (e.g. tokenomics, governance).
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⚠️ Disclaimer : the content of this newsletter is for educational & entertainment purpose only. In no situation should it be considered investment, tax or legal advice. The reader is invited to build his/her own opinion about the views expressed, and take appropriate decisions for his/her specific situation or objectives. Digital assets are highly volatile and the risk of capital loss must never be underestimated : do your own research, and only invest what you can afford to lose.