Decentralised finance (DeFi), an entire ecosystem built on blockchain technology and that doesn’t rely on a central authority, is booming. The total value locked – the overall value of assets deposited in DeFi transactions – grew from $601m at the beginning of 2020 to $239bn in 2022, according to blockchain data provider Amberdata. However, unlike what we have seen before, this rise hasn’t been driven mainly by professional and retail investors, but instead has been led by institutional investors who have either recently joined or are strengthening their presence in DeFi.
Indeed, according to blockchain data platform Chainanalysis, large institutional transactions – those above $10m – accounted for over 60 percent of all DeFi transactions in Q2 2021, up from around 10 percent in Q3 2020.
Additionally, a September 2021 survey, carried out by Nickel Digital Asset Management (Nickel), of institutional investors and wealth managers who don’t currently have exposure to cryptocurrencies and digital assets found that 62 percent expect to invest in these for the first time within the next year. The speed at which institutional investors have joined DeFi in the last year hasn’t gone unnoticed, so many people are wondering; what is driving this trend?
A popular answer has been that institutional investors have recently realised the opportunities available in DeFi. While this response explains the reasons for joining crypto, investors’ success stories in DeFi and crypto have been making headlines for around 10 years. Instead, I would argue that, in recent years, DeFi has become more accessible, transparent and secure. This has not only made the decentralised markets more appealing to institutional investors, but has enabled them to meet the internal and regulatory requirements necessary for these organisations to enter DeFi.
Just a few taps away
DeFi started as an intimidating sector, the domain of the tech-savvy. However, much has changed since then and we are now seeing many platforms that allow investors to easily connect their digital wallets, exchange their fiat, such as US dollars and euros, into cryptocurrency and access the yields available in DeFi with just a few taps.
Although these platforms initially focused on retail investors, in the last year, new solutions aimed at institutional investors have been developed to enable them to maintain close oversight over their investments, as well as to meet asset custody and ‘Know Your Client’ requirements, to name a few. Asset custody, for instance, is not only a legal requirement for large funds and financial institutions, but according to a 2022 survey carried out by Nickel, asset security was cited by 79 percent of investors surveyed as their main consideration.
So, before these tools became available, many institutional investors – even those keen about entering DeFi – were unable to do so because they couldn’t secure the necessary internal buy-in as they didn’t meet key internal and regulatory requirements. Most companies in DeFi are small businesses that, while they may be very good at what they do, don’t have the credentials needed to reassure investors that they are legitimate. Consequently, many institutional investors have been unwilling to trust them with their assets. Fortunately, some DeFi-focused companies have been leading the shift towards more transparency in the DeFi sector by becoming publicly listed companies. As listed companies, these organisations are providing regular information on their activities and their expertise, reassuring investors that their money is in trusted hands.
Bank grade security
The media’s coverage on DeFi has led many people to mistakenly believe that, if they invest in the decentralised markets, their money will fall into the hands of hackers. While nobody’s money is ever completely safe (in a bank or in DeFi), the risks in DeFi have been greatly exaggerated.
Nonetheless, to provide reassurance to investors that their money is safe, many DeFi companies are learning from traditional finance and implementing solutions that banks use. For example, AQRU.io uses multi signature wallets, which require two or more private keys to sign and send a transaction, and next generation protocols to ensure the safety of the assets in the platform. While DeFi still has a long way to go before investors feel completely safe, these efforts have already started helping secure the buy-in from many large investors and they will continue doing so in the coming years.
Since it started, DeFi has proven to be an innovative sector that has sought to appeal both to institutional and retail investors by becoming more secure, accessible and transparent. We shouldn’t be surprised if DeFi continues innovating to attract new investors and keeps growing until it becomes a true competitor to traditional finance.