DeFi (Decentralized finance) is the biggest reason for me to enter the circle. As a libertarian, seeing innovations like AMM can allow ordinary users to participate in various financial activities and jointly earn the money that traditional institutions are making. I feel that it is extremely powerful, and the value is blended. Since then, I have fallen into the rabbit hole and indulged in it. At one time, I also had the vision and drive to “replacing traditional finance with DeFi”. After all, I have been in the financial industry, and I have long been unaccustomed to the institutional ecology and long and complicated transaction processes that rely on one license to enjoy it; I also feel that all financial products are on the chain. After all, the world has become more efficient and transparent, and the world should move towards a fairer, more decentralized, and more free direction.
I still have this idea to this day, but we always have to know where we are now before we can know the distance from our ideals. This article attempts to re-examine the meaning of decentralization in DeFi (decentralized finance); explore the reasons why institutional investors (big money) began to play DeFi; and look at the conditions and current position that DeFi needs to meet to unify the financial world.
What exactly is decentralization in DeFi?
When we talk about “decentralization”, we often think of the following concepts: distributed, anti-censorship, no access, etc. Distributed is an important feature of blockchain but not unique to blockchain; we mainly talk about “anti-censorship” The concepts of “censorship” and “no access required”.
The feature of “censorship resistance” is mainly applicable to the protocol layer. The reason why Vitalik has the confidence to tweet that “if the supervision censors nodes, it will be regarded as an attack on Ethereum” is because the decentralized protocol layer is the value of the blockchain and the encryption community. Bottom line; Second, because the main chain such as Ethereum does not directly handle financial transactions (handled by each specific DeFi project on the chain), the protocol layer is not a regulated object;
The feature of “censorship resistance” is not very suitable for DeFi projects. A DeFi project consists of two parts (1) the smart contract itself; (2) the operating company of the DeFi project. The smart contract part of DeFi cannot be directly regulated (the code itself cannot be held responsible); but the operating companies of DeFi projects, because they provide various centralized Internet services/financial services, will be regulated by existing laws – such as Uniswap Labs must hide the trading interface of those illegal securities tokens from the front end of the web page, even if Uniswap’s smart contracts have not changed accordingly; for example, Aave holds the British EMI financial license, which will also have additional regulatory requirements. Satisfy.
Of course not every DeFi project has an operating company, some will be fully run by the community in the form of DAO, which can make them not need to be as strictly regulated as traditional companies (or just a matter of time); but they will need to face pure virtual Limitations of assets – completely abandon the relationship with people and assets off the chain, and also face the problem of less liquidity.
No admission required:
The core and advantage of DeFi is that it does not require access. There are three levels of access-free: no access for developers, no access for nodes, and no access for users; corresponding to open source code, global consensus (anyone can become a bookkeeper), and complete openness of the network. Teacher Pan Chao said in the article “Theory and Practice of DeFi” that he thinks that financial projects that only need to satisfy users without access can belong to the category of decentralized finance, and developers and nodes do not need access. Generally, there is a trade-off between efficiency, security and decentralization.
Although anyone can use DeFi without access, there are no licenses and asset size restrictions, but there is an implicit threshold – cognition. Playing DeFi requires not only blockchain knowledge, but also financial knowledge; and playing well requires experience accumulation, plus the scale advantage brought by large capital. This is why more than 60% of transactions in DeFi from 2021 will be conducted by institutional investors (according to chain analysis).
So will institutional investors become the mainstream players of DeFi and DeFi will no longer be decentralized? Noono. Let’s take a look at the types of institutions in the financial system — in China, we like to divide financial institutions into buyers and sellers. The buyer refers to institutions that manage money (also known as institutional investors), such as fund companies, asset management companies, Venture capital institutions, what they are doing is to use their professional skills to invest in good assets and make money generate money; sellers refer to institutions that provide services for money (buyers), such as market makers, brokers, investment banks, and banks. They are doing all kinds of intermediary services to help money find good assets. Blockchain technology can replace seller institutions (intermediary service providers) to a certain extent; and the buyer institutions representing money do not belong to middlemen, they are representatives of big money.
Why do institutional investors want to play DeFi?
In February of this year, VALK conducted a market survey on 100 institutional investors (total AUM greater than US$1 trillion) in 8 major markets (UK, US, France, Germany, Hong Kong, New Zealand, Australia and Pakistan). The result is that of these 100 institutional investors, 30% are already using DeFi, while the other 68% plan to gradually explore it in the next year.
Why do institutional investors (big money) play DeFi? Because the money always goes to the place where the capital utilization rate is higher. There are different needs behind money, not only high-yield needs, but also various special needs such as trading, lending, and hedging. DeFi has its advantages in meeting any of the aforementioned needs, but currently only for digital assets. Therefore, when the big money/market finally gradually accepts digital assets (crypto) as an investable financial asset, various demands for this asset are also rising.
Specifically, in response to high-yield needs, DeFi generally has Staking (POS), liquidity mining, and Lending. The income comes from the economy of the underlying chain, the transaction volume in the pool, and the loan demand. APY, Additional governance tokens, and capital gains are shown. In the current global market environment with generally low interest rates, the rate of return in DeFi is still quite attractive.
For the needs of trading, lending and hedging, they correspond to DEX (decentralized exchange), lending agreement and decentralized derivatives exchange. They have technical advantages over Cefi in matching, pricing, clearing and custody. and cost advantage.
More importantly, the composability of DeFi can also greatly improve the efficiency of asset and capital utilization.
How does DeFi realize the vision of unifying the financial world?
If DeFi wants to completely replace the seller and unify the financial world, it needs to meet all the needs of all kinds of money. Money comes from four categories: individuals, corporations, governments, and institutional investors.
- Personal money needs: deposit, loan, remittance, payment, investment (most of which are left to institutions to manage)
- Corporate Money Needs: Borrowing, Payments, Cash Management, Hedging, Trade Finance, Capital Markets Finance
- Demand for government money: foreign exchange management, stable investment, infrastructure investment…
- Institutional money needs: asset security (custody), trading, investment, lending, derivative services
Obviously, so far is because DeFi is only for digital assets, and the demand for money is still mainly legal currency, so it is still a little far from meeting all the needs of money, but it can still be cut in from some points.
- For individual needs, we can mainly start from the payment side (especially payment in areas lacking Internet coverage/financial infrastructure); small-scale investment can be expanded by lowering the cognitive threshold
- According to the needs of the company, it can mainly start with payment and trade financing (the trade financing part involves the synchronization of off-chain assets and on-chain information is a bit difficult)
- For government needs, ummmmm
- For institutional needs, we can start from the perspectives of digital asset services and more assets on the chain. Let’s talk about this part in detail.
- For the needs of institutions/big money, the previous article tells the parts that DeFi can meet. The following lists the parts that it cannot meet at present, and discusses the solutions.
1. Few types of assets
DeFi currently only has one major asset class, crypto, and the number of cryptos that can be invested in for a long time is limited. This part requires the development of Web3 to give crypto greater value.
At the same time, crypto fixed income products/structured products/standardized products that directly meet the needs of big money are insufficient.
Off-chain assets on the chain can also increase the types of assets in DeFi. It is a practice for ReFi to put carbon emissions on the chain; and a larger practice lies in the chaining of traditional financial assets. At present, many investment banks are tokenizing private assets (gold, debt, stocks). The following figure lists some examples of tokenization.
2. Asset security and private key custody issues
Different from individual investors, as long as they keep their private keys, they keep their assets; institutional investors generally help people manage money, so it involves the multi-signature wallet transaction process and the custody of multiple private keys. In the institutional investor survey conducted by Nickel in 2022, 79% of institutions are most worried about private key custody in DeFi.
This part is also the business that major crypto-native institutions and traditional banks are robbing. At present, almost all investment banks have launched crypto custody services; and crypto-native institutions such as Coinshares and fileblocks also provided custody services at the earliest. Gnosis Safe, a wallet company in DeFi, and Cobo are also focusing on custody services.
3. Compliance Issues
A great feature of DeFi is the anonymity of counterparties, which is a departure from the KYC & AML requirements for institutional investors in the real world. At present, DeFi projects specifically for institutional investors are gradually emerging. For example, Aave Arc has a permissioned protocol, and the lending pools are all counterparties who have done KYC; for example, Clearpool and Maple Finance are also targeted at institutional investors with high compliance. lending DeFi projects. In addition to these, crypto-native institutions also provide institutional investors with compliant lending and trading services.
This issue requires regulation and DeFi to accommodate and connect with each other. Regulations for DeFi have not come out yet, we can only wait and see.
As you can see, traditional banks, crypto-native institutions and DeFi companies are all trying to fill this gap in order to meet the demand for big money.
At present, DeFi only occupies a small position in the modern financial system, mainly providing some limited services for digital assets (crypto). As the development of Web3 brings mass adoption of digital assets and more integration of DeFi and traditional assets/off-chain scenarios, its location will gradually become more important. For now, the most intuitive and the most natural next step is to meet the needs of institutional investors, thereby attracting big money.
Reference DeFi Is On The Move To The Institutional Market: More A Marathon Than A Sprint What is Institutional DeFi? (https://www.fireblocks.com/institutional-DeFi/) https://finbold.com/study-nearly- a-third-of-institutional-investors-in-crypto-are-already-using-DeFi/Insights | Chao Pan: DeFi Theory and Practice Crypto-legal experts debate WEB3 regulation: compliance or decentralization?
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/explore-the-place-of-defi-in-the-modern-financial-system/
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