As the world continues to shift from traditional and centralized financial services to P2P finance enabled by several blockchains like Ethereum, Solana, Polkadot, and more, the DeFi ecosystem is expanding at an unprecedented rate.
In the last couple of years, DeFi has attracted millions of individuals and leading financial institutions by offering yields that starkly surpass those traditional finance (TradFi) offers.
Based on the exceptional growth in the first three quarters of 2021, it’s not hyperbole to claim that DeFi has some of the most promising opportunities for institutional investors.
As such, it shouldn’t come as a surprise that financial regulators worldwide are taking a keen interest in better regulating this nascent yet burgeoning sector.
Take, for instance, the recent announcements from the US Security and Exchanges Commission (SEC). Just days ago, SEC Commissioner Caroline Crenshaw underlined the benefits of DeFi while highlighting the dangers of not embracing a regulatory framework in her opinion piece titled “DeFi Risks, Regulations, and Opportunities,” as part of the first issue of “The International Journal of Blockchain Law.”
Throughout the opinion piece, the SEC Commissioner outlines her outlook on DeFi. She highlights that although DeFi has immense benefits, the DeFi community must come together to address the ongoing concerns with pseudonymity and transparency while complying with SEC guidelines.
Crenshaw further clarifies that the lack of transparency within DeFi has enabled a two-tier market wherein insiders and professional investors are reaping outsized returns.
Per the opinion piece, DeFi projects should maintain an open communication channel with the SEC to find potential solutions to ensure that both pseudonymity and compliance can go hand-in-hand.
The need to implement a well-thought regulatory framework for the DeFi sector is at an all-time high, especially given the continuous flow of institutional investors into the ecosystem.
Lack of regulations in DeFi is no longer a problem for the SEC or other regulatory bodies but for the DeFi sector itself. As of date, institutions are increasingly becoming hesitant to enter the DeFi ecosystem due to unclear regulations.
Luckily, there’s a consortium of new and old projects, some working directly with traditional institutions to ensure better collaboration alongside others that offer services that make it easier for institutions to enter DeFi.
Merging Blockchain Technology With Traditional Finance
When it comes to showcasing blockchain’s real-world use cases, Tezos is spearheading the efforts. The platform has its fair share of experience and collaboration with the traditional financial ecosystem.
As an open-source and decentralized blockchain platform, Tezos addresses key barriers facing blockchain adoption for assets and applications in the real world. Several banks and financial organizations are currently using the infrastructure provided by Tezos to deliver on-chain financial products.
One of the largest B2B banks, InCore Bank, in partnership with Crypto Finance AG and Swiss IT consulting firm Inacta, has launched a new tokenization tool based on the Tezos blockchain.
Built using the Tezos FA2 standard, the DAR-1 token standard unlocks a world of opportunities for blockchain-based smart contracts to be customized to support traditional financial markets, including asset governance and regulatory mechanisms for AML (anti-money laundering).
Besides the DAR-1 token standard, InCore Bank will also launch its institutional-grade storage, staking, and trading services. As such, financial organizations that use InCore Bank’s integrated services will offer customers a gateway to the DeFi market.
Additionally, Tezos has been selected by the European Central Bank (ECB) as one of the blockchain networks fully compatible with its current fiat-based model.
Another project that is using blockchain technology to change the lives of the global unbanked population is Gluwa. The team behind Gluwa aims to give everyone access to financial opportunities without any geographical barriers.
Using the CreditCoin blockchain, Gluwa gives the unbanked in emerging markets access to much needed credit through peer-to-peer lending.
To further its mission, Gluwa recently partnered with Nigerian fintech Aella. Together, both teams achieved a significant milestone in bringing peer-to-peer credit to the forefront in Africa.
Since Gluwa integrated with Aella’s consumer credit app in June 2021, more than a million financial transactions have been authorized and recorded on the Gluwa-made Luniverse Sidechain.
Talking about the rapid transition to P2P credit in third-world countries and the need for better regulatory frameworks for DeFi, Gluwa CEO and Co-Founder Tae Oh adds, “Regulations are a reality, and everyone should embrace them. They also bring clarity, which is positive for crypto adoption; Service providers can confidently provide allowed features, and users can safely use them without looking over their shoulder.”
Bridging The Gap Between TradFi And DeFi
As regulators turn their focus on DeFi, the need for access to regulation compliant DeFi liquidity increases.
Alkemi Network is one such project that offers CeFi institutions access to DeFi liquidity without the fear or headache of falling on the wrong side of regulation.
Alkemi offers financial institutions and individuals direct access to professional DeFi through its institutional-grade liquidity network. Using a permissioned liquidity pool of digital assets, Alkemi Earn (Earn), the platform’s flagship protocol, facilitates lending and borrowing within a compliant environment.
Furthermore, Alkemi Network uses bank-grade KYC/AML procedures to screen liquidity providers while creating compliant bridges for CeFi institutions to access DeFi, thus enabling institutions entering the crypto ecosystem to access highly-compliant DeFi pools.
More than 40 institutional-grade liquidity providers (LPs) like Quantstamp, Radar, and LedgerPrime, among others, have deposited over $25 million of USD into the network.
“The real opportunity here is to maintain the non-custodial nature and efficient mechanisms of DeFi but set up KYC/AML networks for digital asset pools, where institutional users can interact with the safety of knowing their clients as part of a trusted-counterparty liquidity environment.
This approach could help to provide an additional level of security and transparency to not only the regulators but also DeFi participants,” said Ben Cooper, Co-founder and Chief Experience Officer at Alkemi Network.
Acala Network, the DeFi hub for Polkadot, is another promising project positioning itself for success in mainstream DeFi thanks to active partnerships from unicorn fintech startups like Current, Blockdaemon, and BisonTrail.
As a layer-1 smart contract platform that’s scalable, compatible with Ethereum, and optimized for DeFi while offering built-in liquidity and ready-made financial applications, Acala will play a critical role in helping lower DeFi’s entry barriers for institutions. The platform is one of the prime contenders of the ongoing Polkadot parachain slot auctions, raising upwards of $1.3 billion from more than 75,000 community members.
Securing Blockchain Assets Amidst Surging Institutional Demand
Due to the DeFi ecosystem’s exponential growth, prominent financial institutions from TradFi are increasingly finding a taste for decentralized financial products.
As a result, there has been a surge in demand for institutional-grade security solutions within the DeFi market.
This is where Prosegur enters the picture, offering a solution that adds another layer of security in DeFi, especially for institutional investors. Backed with more than four decades of experience in managing assets for institutions in TradFi, Prosegur has now stepped into the cryptoverse.
Prosegur recently launched its institutional-grade crypto asset protection model, Crypto Bunker, which uses the Israeli cybersecurity firm GK8’s patented cryptography to eliminate the need for the user to be online when executing transactions. Using Crypto Bunker, institutional investors can create, sign, and validate on-chain transactions via a unidirectional connection.
Prosegur’s Crypto Bunker is touted as a 360-degree security solution for institutional investors, as it implements more than a hundred different protection measures to ensure end-to-end security for the custody chain.
The platform works seamlessly with all prominent crypto assets like BTC, ETH, USDT, XRP, LTC, and many more. It also allows institutions to include any other tokens in the vault without any restrictions or limits.
The Key Takeaways
With the SEC and other regulatory bodies voicing opinions on better DeFi regulations alongside the corresponding rise in institutional investments in the DeFi ecosystem, a strategic collaboration between both ecosystems is the need of the hour.
While the projects listed above are playing critical roles in helping expand the core idea of global financial inclusion while connecting the CeFi and DeFi ecosystems, regulatory support will go a long way towards strengthening fintech’s foundation in this newly burgeoning economy.