It is increasingly clear that Centralized Finance (CeFi) and Decentralized Finance (DeFi) will need to intersect within a regulated environment and support the convergence of traditional and digital assets activity. The key challenge is how to apply regulation,
which was designed for a centralized world, to an environment that will be increasingly hybrid (centralized and decentralized).
Bridging the gap between traditional and digital capital markets, so that they are interoperable, whilst effectively mapping to evolving regulatory frameworks will be essential, even if this is not what the decentralized purists want to hear. Increasing
regulation in the crypto assets space is inevitable, and this presents an opportunity to broaden mainstream institutional adoption.
What does the future hold for intermediaries?
Whilst we will see fewer intermediaries over time, the ones that remain, whether newer players or established ones, will have the opportunity to add more value. There will continue to be a need for innovative banks, brokers and exchanges predicated on great
service, liquidity, and technology-enabled digitally focused business models. Greater intermediary efficiency, supported by evolving DeFi models, will reduce frictional costs and enable a wider range of products. This, supported by smart contract driven automation,
will have a positive impact on the market.
Blockchain can be the catalyst to make trading, clearing and settlement more efficient!
Currently many ventures embracing blockchain technology are doing so by applying it to the traditional centralized model. By contrast, the decentralized exchanges and broader DeFi plays, whilst increasing their liquidity flow, have some perceived KYC/ AML
concerns. Financial Action Task Force (FATF) guidelines suggest that Decentralized Applications (DApps) will need to comply with country specific laws enforcing FATF, AML, and Counter-Terrorism Financing requirements. These guidelines call for countries to
identify individuals with “control or sufficient influence” over DeFi initiatives, which could potentially result in founders of such initiatives becoming subject to rules requiring them to provide beneficiary information relating to transactions. This has
spawned a new term called ‘Regulated DeFi’. This is seen as essential for DeFi to become more usable for institutions.
We are beginning to see some traditional banks, brokers and exchanges reinvent themselves through a combination of their innovation arms, through acquisitions and external investment. The newer digital financial services players are also positioning themselves
with elements of this, which makes for a very exciting time in financial services as we will begin to see innovation on an unprecedented scale over the next few years.
How will CeFi and DeFi converge and can it be green?
The convergence of CeFi and DeFi presents great business opportunities. For example assets in custody can be pledged and lent through collaboration with DeFi players, facilitated by an API-driven approach from centralized exchange and custody platforms as
part of a distributed hub model. This hub model also allows the digital assets to sit in custody and be rehypothecated.
This also has a green element as less energy is utilized through continuous movement of assets on public blockchains. In addition, this type of distributed hub model can be used to connect fragmented carbon markets and multiple registries across the globe
to facilitate carbon credit transfer and associated payments in a sustainable manner.
How will institutional activity in digital assets adapt to this change?
There is strong client demand for the full spectrum of digital and hybrid services. According to new insights from the Fidelity
Digital Assets’ 2021 Institutional Investor Digital Assets Study, the majority (84%) of U.S. and European institutional investors are interested in purchasing institutional investment products that hold digital assets, and in the U.S., investors favour
accessing these products through traditional financial firms.
However, interoperability and time to market remain a challenge, with traditional and multiple types of blockchain-enabled digital asset infrastructure being severely fragmented. Institutional players largely want exposure to digital assets in the same way
as they do for other asset classes. Ease of integration into what they already do is essential, as opposed to creating yet another silo. Provision of knowledge and practical guidance is as important to them as the products and services. Many institutions are
at nascent stages of their digital assets journey, whilst others are evolving their initial thought process in line with fast moving developments in this space. Institutions want to cut through the hype and get to grips with what this can mean for their business.
In order to surmount these obstacles and achieve greater efficiency in digital asset facilitation, financial players need to optimise digital asset infrastructure. This can be achieved through the use of platforms offering services by way of a distributed
hub model integrating private ledgers and public blockchains into traditional market infrastructure. This will facilitate better portability of digital assets as well as enable them to seamlessly trade, clear and settle them.
By harnessing such a distributed hub model, the activity which ensues from such adoption can facilitate services between participants bidirectionally. Multiple B2B financial participants (exchanges/ trading venues, banks, brokers, market makers, asset managers,
FinTech vendors, custodians, asset servicing and post trade providers) can gain access to well regulated tokenized digital assets and market infrastructure delivered through a Platform-as-a-Service (PaaS), microservices distribution-model.
Centralized and decentralized technology enabled business needs to coexist, therefore creating the need for hybrid solutions (both traditional and digital) as buy side institutions, banks, brokers, exchanges and other capital players increasingly adopt digital
assets as part of their digital transformation agenda.
Financial market infrastructure and digital asset infrastructure increasingly needs to become interoperable and combine and evolve into hybrid digital market infrastructure to enable Hybrid Finance (HyFi). A distributed hub model acting as a ‘neutral multi-asset
network of networks’ is essential to facilitate such interconnectivity and will be well suited to service the trading, clearing, settlement and custody needs of institutional participants in a regulated environment. This needs to be adaptable and flexible
in terms of how it can be used to consume and deliver services within the broader market in ways that also meet firms’ broader Environmental, Social, and Corporate Governance (ESG) goals.