For years, analysts have treated decentralized finance (DeFi) as a fringe sector of finance, and that treatment hasn’t been unwarranted. Until recently, cryptocurrency traders, startups, and individual special interest investors have been the primary proponents of discipline. DeFi is reliant upon blockchain, which many have considered a somewhat novel and experimental form of technology—until now.
The widespread adoption and acceptance of blockchain as a means for verifying information has led industries to discover a range of new applications. This, in turn, has led to interest among institutions in decentralized finance.
Soon, DeFi will be adopted by some of the largest banks and financial institutions. Crypto has already made inroads among recognizable brands like PayPal and even Bank of America (BofA).
Here’s what the rise in the institutional adoption of DeFi means for the financial sector.
Institutional Investors Open the Door for Others
The cryptocurrency market segment has long been viewed as a turbulent and relatively risky investment choice. When cryptocurrency emerged, a handful of investors were among the only ones interested in the market.
But based on analyses of the crypto market, that’s quickly changing. According to an article by FX Empire, in Q2 2021, over 60% of DeFi transactions accounted for executions over $10 million. These types of large transactions are rarely conducted by individual investors and are evidence that institutional investors are finally taking DeFi as a serious business proposition.
According to the article, “The trend likely indicates that large-cap investors are increasingly interested in participating in the expanding DeFi field, instead of only offering Bitcoin-related investment products.”
The analysis also found that much of the most recent DeFi activity is being driven by institutions in major economies. Regulation will be a key component to increasing institutional adoption of DeFi in the future as regulatory bodies, and large financial institutions continue to show interest in DeFi, they will open the doors for others.
Traditional Banks Are Playing Catch-Up to Disruptors
Consumers have adopted online banking at unprecedented levels, but their adoption of digital banking tools has been long underway. As far back as 2013, Pew Research Center found that most U.S. adults (51%) were already banking online.
The recent pandemic has made digital banking even more essential, as many consumers have been unable or unwilling to enter traditional bank branches. This has created fertile ground for digital banking alternatives, and it has renewed interest in non-traditional banks, lenders, and exchanges.
According to The Fintech Times, so-called “challenger banks” received millions of new users alongside some high-level funding over the past two years. Non-traditional entities like Chime, SoFi, Current, Stash, and others are still small compared to industry giants. However, they are attracting customers due to their lack of barriers to entry, like fees, and their embracing of decentralized finance.
“Millions have flocked to the neobanks, which have continued to attract big-ticket venture capital funding,” said Benedict Smith, author at The Fintech Times. “For example, late last year Chime announced a huge $485million funding round, valuing the bank at $14.5billion.”
Now, traditional banks and lenders are trying to play catch-up by adopting DeFi themselves. According to another Fintech Times article, almost a quarter (23%) of insurance, banking, and traditional financial companies have tested services based on DeFi. Meanwhile, over half (55%) are already assessing DeFi and its applications.
Interest in DeFi among large institutions could make competition fiercer for smaller, non-traditional banks, but it also means DeFi will receive some significant investment and a dose of innovation. Larger banks that adopt DeFi could make it more mainstream and substantially alter the financial landscape.
DeFi Opens Doors for Business Financial Services
It isn’t just consumer-facing banks and financial institutions that are adopting DeFi. Defi is becoming a lifeline for small businesses worldwide, especially those in developing markets that can’t access the same financial products as those in developed ones.
According to the World Economic Forum, DeFi platforms are offering small businesses an alternative to traditional client support infrastructures that typically come with a high threshold cost: “DeFi platforms provide an alternative system, not simply a plug-in to existing banks. Their decentralized nature means transaction onboarding and market-based risk assessments are much easier to scale across a business’ wider system because access to relevant information is not dependent on centralized processing or a prior relationship.”
DeFi democratizes business finance by removing the need for trusted intermediaries, making financial products much more accessible to businesses in developing economies. Indeed, non-traditional business lending platforms have seen significant business interest over the past two years. Large financial institutions are already working to make their financial instruments more efficient using blockchain, but the interest in DeFi lending among businesses has also led them to investigate DeFi as a legitimate alternative.
The availability of stablecoin pegged to the USD has made it possible for lenders to offer a stable form of value to businesses and consumers. There have also been significant advancements in interoperability among DeFi networks. For example, the Inter-Blockchain Communication Protocol (IBC) has made it possible to build applications across heterogeneous blockchains and off-chain protocols—this creates numerous new opportunities for financial institutions to enter the DeFi sector.