Crypto-curious institutions have not missed the growth of DeFi within the digital asset space. According to blockchain research firm Blockdata, institutional DeFi could grow into a $1 trillion space by 2025. The significant yield potential from DeFi trading, staking, yield farming, and lending makes the space attractive on its own, but in many ways, institutions have no choice but to create their own DeFi solutions. DeFi smart contracts stand to replace many functions currently performed by traditional finance – money storage, lending, trading, etc. – so innovation is necessary for long-term survival of traditional financial institutions.
But what's the right approach for institutions to enter DeFi while addressing compliance challenges, reputational risks, and customer concerns? Many of the challenges to acquiring the data needed to understand DeFi markets apply to taking the "build" approach – the need for deep subject matter expertise, hard-to-find specialized talent, and lack of pre-existing experience. In addition, getting market traction for a purely institution-created project may be difficult from both crypto-experienced (distrust of institutions) and crypto-naive (lack of familiarity, adversity to risk) customer spaces.
Instead of building their own, institutions are probably better served at first by building partnerships with existing DeFi projects, much like banks partner with payment processors like Visa to offer credit card solutions. Such partnerships would allow both sides to leverage their strengths towards a single goal of driving consumers' adoption of a chosen project.
Benefits of a Partnership Between Institutions and DeFi Projects
Faster time to market
Avoiding the build approach will significantly decrease the time an institution needs to get a DeFi product to market and the amount of money it will need to spend. Given the rapid pace of change being driven by the growth of digital assets in general and DeFi in particular, time is of the essence.
Instead of worrying about finding the right talent and building the right infrastructure to build a smart contract-based DeFi project from the ground up, a partnership will allow the institution to focus on incorporating DeFi into its product lineup and marketing it to customers.
Improved KYC/AML compliance
The relative anonymity that's built into DeFi means that maintaining compliance with KYC/AML regulations requires different approaches. The most practical solutions are via whitelisting (limiting access exclusively to trusted wallets) or blacklisting (keeping unwanted wallets out, which requires judicious maintenance).
Both methods can work well for institutional purposes. The benefits of a partnership are similar to the time-to-market ones – the institution combines its deep knowledge of compliance requirements with the DeFi partner's technical expertise to develop a robust, institutional-grade compliance mechanism that satisfies customer concerns.
Given how new DeFi is, the number of DeFi projects created by unknown teams, and the (unfortunately) growing scams, convincing customers that an app or smart contract is safe and can be trusted is critical to growth. A DeFi dApp developed with, or backed by an established institution is more likely to be seen as trustworthy and secure, giving it a competitive advantage in the marketplace.
In addition to an established reputation, an institution is likely to have security knowledge that it can leverage to improve the DeFi project's security and reduce the likelihood of a potential breach.
Due Diligence is Critical…
Because a substantial part of the value of the partnership is an institution's reputation, it is critical that potential DeFi partners are thoroughly evaluated before discussions begin. While getting to market as fast as possible is enticing given the potential returns, the reputational risk of partnering with a project that ends up being fraudulent cannot be understated.
This can be challenging given that many DeFi teams are distributed and communicate entirely via the Discord messaging platform, their identities intentionally obfuscated. Several steps that can be taken to evaluate a project's legitimacy:
- Review the project's Discord as well as the social media accounts (Twitter, Medium, LinkedIn, etc)
- Review the resumes and social media of key people in the project to the extent possible
- Get an audit of the project's smart contracts
- Review liquidity pool data and key metrics, including Total Value Locked (TLV), Annual Percentage Yield (APY), and duration of activity
…and Impossible Without Blockchain Data
Regardless of how you plan on performing due diligence on a potential DeFi partner, you will need blockchain data. As we've mentioned at the beginning of this post, this data is hard to acquire and work with on your own. That's why before they start looking into potential DeFi partnerships, institutions should have a digital asset data partner in their corner first.
The Amberdata platform collects and processes blockchain data from the most active cryptocurrency networks and protocols (as well as market data from the most popular crypto exchanges), building data sets in easy to consume formats familiar to institutions – all served through a single integration point.
Request a demo to find out how the Amberdata platform enables institutions to analyze DeFi projects, identify opportunities in this fast-growing space, and helps manage financial and reputational risks for both the institution and its clients.
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