In this episode of the Bankless podcast, host David talks with Paradigm's research lead Dan Robinson and policy lead Justin Slaughter about Paradigm's recently released report (TradFi Tomorrow: DeFi and the Rise of Extensible Finance).
This report surveyed 300 traditional finance professionals, covering traditional banks, investment banks, payment companies, and other financial institutions. The results were almost unanimous: there is an astonishing interest in cryptocurrencies, especially DeFi. The survey found that two-thirds of traditional finance companies are currently actively experimenting with or researching DeFi.
Below are excerpts from the interview.
Q1: Dan, as a researcher and investor, what insights does this report provide for you? What excites you?
Dan: I think one very exciting part is that it shows which parts of DeFi traditional finance people are most interested in. The top ones include:
Asset Tokenization
Stablecoins
Decentralized Exchanges
Prediction Markets
Lending and Interoperability
These are exactly what I, as a native DeFi enthusiast, am looking forward to; it's what we think is currently the most successful content in the crypto space. I believe if you had asked this question eight years ago, the banks' responses would have been completely different, as they were then completely oblivious to decentralized cryptocurrencies, and obviously, DeFi was not yet mature at that time.
So these are now things that have huge market values and total locked value (TVL) on Ethereum, possibly except for asset tokenization, because I think in this area, traditional finance is actually ahead of the crypto industry and is very interested in it. But we are just beginning to see growth in this area; I think the interest here is very important because it will be a massive trend in the future.
Q2: The report emphasizes that TradFi values DeFi's faster settlement, higher transparency, and lower costs. This makes me think of stablecoins, but I'm worried they are too focused on stablecoins and neglecting other DeFi applications?
Dan: First of all, I want to say that stablecoins are indeed the most attention-grabbing tokenized real-world assets (RWA) on-chain right now. But I think traditional finance companies are even more interested in the tokenization of other assets. They are talking about things like stocks, bonds, derivatives, etc., and other ways to bring more traditional financial assets on-chain. I think part of this is because these assets can gain the same advantages as stablecoins.
Yes, stablecoins are very important for traditional finance, but I think what they are really excited about is what these technologies can do for other assets. If you don't have anything to trade against stablecoins, their value is limited. But if you can settle multiple assets on-chain or across chains atomically, then you really gain a lot of benefits. So I think they are very excited about this, and overall, pilot projects for issuing other types of assets seem to be one of the pilot types these companies are most interested in.
I also want to point out that I am pleasantly surprised to see that the interest gap between tokenized assets and decentralized exchanges is not very large. You can see that at the top is tokenization, with 131 out of 300 choosing this, but decentralized exchanges only have 122, just down by 9. This is actually quite good; I think it shows that even for traditional finance, they see this as more than just a tokenization machine. Overall, I am pleased; I originally thought traditional finance was only interested in very limited use cases, but they seem to have an open attitude towards the entire ecosystem that DeFi can offer.
Q3: Besides stablecoins and government bonds, what other tokenization progress is there?
Justin: As we are recording this show, the SEC is holding a discussion on how to trade securities on-chain. So I think we can discuss in the report later that a big issue right now is the regulatory environment. How many additional assets you can tokenize depends on the clarity of regulation.
Nevertheless, the lesson from this report is that there is a huge demand for various additional tokenized products; it's just currently unclear how much can be done before regulation is clarified. However, you can see on slides 36 and 37 that we already have bonds and stablecoins. Slide 37 is a classic example showing the beginning of an S-curve, so I think you can definitely see that interest in one asset is likely to spark interest in other assets.
Q4: Why is TradFi keen on putting assets on-chain? What are the selling points of public blockchains?
Dan: I remember back in 2016, as a traveling blockchain salesman, trying to convince traditional financial institutions to be interested in blockchain. When you talk to those who are slightly distanced from the underlying technology, like those in the front office, they find it interesting but say, 'Isn't this just a database? Why do I really need this?' Then you go talk to people in the back office, those involved in reconciliation and various manual processes, and they tell you some horror stories about how inefficient and manual the underlying infrastructure of the traditional financial system is.
I think this survey shows that much of the interest comes from: 'Maybe we can avoid the absurd manual costs of settlement and processing that traditional financial tools require.' This makes issuing new assets, settling, lending, and trading much cheaper. This is very important because we learned in this survey that a major reason traditional finance uses technology is to increase efficiency and reduce costs.
When we asked them why there is widespread attention on new technologies, not limited to just DeFi, the top two answers were:
Investing to improve efficiency
Reduce manual labor
We often forget that traditional finance is just that—traditional finance, filled with people doing simulated work, doing things your parents or grandparents might have done in the '80s, '70s, and '60s. Setting aside the normative issues of employment, this way of working is incredibly slow and costly. And, as Dan has taught me time and again, humans are more prone to error than smart contracts. Therefore, this not only increases compliance costs but also slows things down. These are all the 'potions' that make using technology (especially DeFi and cryptocurrencies) attractive.
Q5: For many years, the slogan of 'tokenizing everything' has been shouted for a long time, but progress has been limited, with only stablecoins and government bonds standing out. This time feels different, like TradFi is really catching up. Justin, what do you think?
Justin: I think you're right. In many ways, we have to first build the infrastructure before they will come. It's like that saying: 'If you build it, they will come.' That’s what’s happening now.
Throughout the report, you will see that what we have been discussing theoretically is now turning into reality. By removing intermediaries and lowering infrastructure costs, transaction costs can be significantly reduced.
You can see that the fees for traditional domestic remittances are $25 or $30, whereas blockchain transaction fees, like those of Solana, even Ethereum and Base, are very low. Five or six years ago, this could not have been achieved in the same way. We had to propose the theory first and then demonstrate the reality.
In addition, I think regulation and understanding also play a part. With a new government management team in place, we started preparing this report last fall when the elections hadn't started yet, knowing that there would inevitably be a new president, and we wanted to take advantage of that opportunity while understanding the situation at the start of the new term.
But another fact is that the crypto industry has developed to a point where you can finally make a clear argument within traditional finance companies. Over the past decade, many banks or hedge funds have tried to create internal crypto projects, but what often happens is that those young, thirty-something 'newcomers' face resistance from existing business lines. The company doesn't want to question or risk changing existing business lines, so these people go out and start their own ventures.
Now, there are enough people who have spent time in the crypto industry, the infrastructure has been built, and enough people have pointed the way forward that even within those very large institutions, they are now starting to see: 'Oh, this is worth participating in; in fact, we want to participate deeply; we want to dominate in this space.'
Now, at the back of the report, we can see that the main issue seems to be regulation, but even that issue is gradually dissipating.
Dan: I agree with Justin's view that regulatory barriers have always been the biggest, and progress in this area is a huge factor. I also want to say that scalability is also very important. If you look at the reasons people are most interested, it’s faster settlement times and lower transaction costs; this is basically saying:
Increase bandwidth
Reduce latency
I believe that blockchain has developed to the point where we can finally achieve very cheap transactions, which actually makes it more attractive for financial institutions.
Q6: TradFi seems to be preparing for regulatory green lights, like setting up pieces before the 'land grab.' Justin, how do you feel about this metaphor?
Justin: I think you're right. What essentially happens is, you know, the last piece of land that was opened up in America was the Oklahoma Territory, which was traditionally reserved for Native Americans. When the U.S. government decided to open it to non-Natives, people lined up at the border of Oklahoma, and then one day at some moment, like a wall coming down, the U.S. military said, 'Alright, you can go now.' Then everyone rushed in to grab the land.
In many ways, what we see now is just that. Everyone understands that this frontier is about to open up to many existing entities, and I think they all want to secure a favorable position in the initial 'land grab.' Even if you have deep pockets, you can't just walk in with a checkbook a few weeks after the approval process or the SEC's green light. You have to understand the space first to build or invest within it. That’s what we think they are doing.
However, the situation is not that once there is regulatory clarity, everyone immediately jumps into the pool like flipping a light switch. It will be a process. We still have one-third of traditional finance companies stating that they are not participating in or exploring DeFi. But in the short term of 5, 10, or 15 years, we are starting to see a profound understanding from traditional finance practitioners about how DeFi will reshape their overall business operations.
Q7: The report ultimately calls for policies that allow building on public blockchains. Justin, the SEC has made progress; what’s next?
Justin: You can imagine accessing DeFi as water flowing through a sluice, with multiple gates. The first gate is to allow those already in the crypto industry to use DeFi fearlessly without worrying about violating compliance laws. That's good and great, and that gate has effectively been opened by the SEC.
But next, you need to open the last gate, which is to allow existing regulated entities, such as banks, hedge funds, and credit card companies, to access DeFi as well. This often requires cooperation from other regulatory agencies, such as the FDIC, OCC, and the Fed.
What I want to say is that we see these entities have already allowed existing traders to access cryptocurrencies, but they mainly refer to centralized finance (CeFi). There is still no clear allowance for accessing DeFi. We need both. We need to be able to say: not only can you now have a Coinbase account, like Fifth Third Bank, but we also need to allow you to access Uniswap or participate in DAOs. This is more complex.
Additionally, on Capitol Hill, most legislative actions are still focused on CeFi, and there are good reasons for that. Currently, all other developed economies have already legislated for CeFi; the EU has passed MiCA, and the UK, Japan, and Singapore have passed legislation on payment stablecoins. We are the only ones lagging behind. But no one has legislated for DeFi, partly because there is no corresponding template. No one has a regulatory model for DeFi like CeFi, so this is very difficult.
I think, at Paradigm, we have indeed worried that overly early or burdensome DeFi regulation could bring a burden. Our first principle is to 'do no harm' on DeFi issues. But at the same time, you have to find a way to allow existing companies to access and understand this space, because unless they start trying, they will never understand how to use it.
So, this requires not just SEC action, but I think certain parts of the Trump administration could really release the sluice gate.
Q8: Dan, how does this report influence your investment direction?
Dan: For me, the biggest update is that it confirms something I had vaguely felt before, which is that their greatest interest lies in tokenization and real-world assets (RWA). This has been almost a joke in the crypto industry for years, the reality of non-stablecoin real-world assets, but I think the massive demand from traditional finance to put these assets on-chain makes me feel, 'Well, maybe issuing these assets really has a lot of commercial potential.'
But more importantly, what can we do once these assets are on-chain? I think this could greatly expand the scale of decentralized lending markets or change the types of decentralized exchanges we need to consider, with assets not just being volatile assets but potentially more interesting, different types of bonds or other things.
So I think this report makes me more optimistic about real-world assets as a direction worth noting. Everyone knows stablecoins are already very important and will continue to grow, but this report clearly shows that the pressure from traditional finance is very apparent.
