By: Sergej Kunz, co-founder of 1inch
Institutional investors are keeping a close eye on the developments in decentralized finance (DeFi). Establishing secure and compliant DeFi platforms is crucial for fostering trust and enticing more institutions into the space.
Clear waters attract big ships
In the last four years, the proportion of hedge funds involved in DeFi has surged from 10% to 47%, with projections suggesting it could reach 65% by 2025. Goldman Sachs is actively exploring DeFi for initiatives such as bond issuance and yield farming.
Early movers like Visa are already making strides in onchain finance, having processed over $1 billion in cryptocurrency transactions since 2021 and currently testing cross-border payment solutions. Over the next couple of years, the momentum for institutional adoption is expected to accelerate. To engage with confidence, a regulatory framework that upholds the fundamental advantages of DeFi is essential.
The DeFi institutional trilemma
It is widely known that DeFi platforms experience numerous security exploits annually. The recent Bybit breach resulted in a staggering $1.4 billion in losses, occurring through a vulnerable transfer process. Such incidents raise red flags regarding multisignature wallets and blind signing, where users approve transactions without full transparency, making blind signing particularly risky. This situation underscores the need for enhanced security measures and improvements to user experience.
The threat of theft due to weaknesses in smart contracts or errors made by validators often causes institutional investors to hesitate before depositing substantial amounts into staking pools. Furthermore, a lack of clear regulatory guidelines raises compliance concerns, making institutions wary of entering the DeFi landscape.
DeFi user interfaces typically cater to those with technical knowledge, leaving institutional investors in need of more accessible experiences that allow DeFi staking without the reliance on third-party intermediaries.
Build it right, and they will come
Interest from institutions in transferring traditional assets onto the blockchain is booming, with the tokenized asset market expected to reach a staggering $16 trillion by 2030. For successful participation in DeFi, institutions require verifiable counterparties that comply with regulatory mandates. The involvement of traditional institutions has prompted privacy advocates to suggest that this could potentially undermine the fundamental principles of decentralization that underpin the ecosystem.
Recent: Innovative measures to launch a tokenized fund on DeFi using RedStone price feeds
Institutions need to trust that DeFi platforms will adhere to compliance norms while offering a secure and user-friendly interface. Striking a balance is vital. The permissionless nature of DeFi can coexist with compliance through identity profiles that facilitate secure transactions. Additionally, transaction screening tools can enable real-time monitoring and risk management.
Using blockchain analytics tools, institutions can ensure adherence to Anti-Money Laundering regulations and avoid dealing with blacklisted wallets. The incorporation of these tools can help mitigate illicit activities, thus making DeFi safer for institutional engagement.
Intent-based architecture can enhance security
The connection between intent-based architecture and security is clear, as its design aims to minimize risks, leading to a more dependable user experience. This design guards users against MEV (Miner Extractable Value) exploits, a frequent issue caused by automated bots seeking profitable trades to exploit. Intent-based architecture aids in implementing compliance frameworks as well. For example, it can restrict order submissions to verified wallets, ensuring that only permissible orders can be settled.
Traditionally, DeFi transactions often rely on intermediaries like liquidity providers to execute trades or manage funds, which introduces counterparty risk, unauthorized executions, and potential settlement failures. Intent-based architecture promotes trustless settlements, allowing users to commit only when all conditions are satisfied, thereby reducing risk and eliminating blind trust.
DeFi platforms must enhance the user interface and experience for institutional investors. This system bridges essential gaps. By conducting offchain activities while ensuring security, intent-based architectures make DeFi both safer and more efficient. However, challenges remain, especially in balancing offchain order matching with onchain transparency.
Late adopters of DeFi will struggle to keep up
For early DeFi adopters, a competitive edge exists in terms of liquidity access and yield generation, while latecomers will likely encounter heightened regulatory scrutiny and obstacles to entry. By 2026, institutional players who have not embraced DeFi may find themselves struggling to stay relevant. This is becoming evident through the examples of early adopters, such as JPMorgan and Citi, who have launched tokenization initiatives. Traditional finance leaders like these are already preparing for a transition to onchain finance.
The way forward
Regulatory authorities, supervisory entities, and policymakers must establish clear, standardized guidelines to encourage broader institutional engagement. Efforts to develop uniform protocols that support institutional involvement are already in the works. DeFi platforms must be strategically prepared to deliver the necessary frameworks of compliance and security to institutions eager to achieve mainstream adoption. Implementing these measures will require collaboration from regulators, developers, and institutions.
By: Sergej Kunz, co-founder of 1inch.
This article is intended for informational purposes only and should not be considered as legal or investment advice. The views expressed in this piece are solely the author’s and do not necessarily reflect the opinions of any other entity.