A balance must be struck between decentralization and security.
Article author: Curve Finance founder Michael Egorov
Source: Cointelegraph
Article translated by: Ada, MetaEra
Decentralized Finance (DeFi) is rapidly becoming one of the most important trends affecting the financial world. With DeFi activities continually increasing and total locked value surpassing $100 billion, the field is becoming increasingly popular among institutional investors.
However, as institutional interest in DeFi grows, it inevitably raises questions about the industry's future. Can DeFi maintain its decentralized and democratic principles while ensuring the safety of all participants? Or will it alter the essence of 'decentralized' finance to meet the demands of large participants, thereby harming it?
Institutionalization of DeFi
We can see that institutional investors' interest in DeFi is increasing, such as BlackRock's BUIDL fund, which manages assets exceeding $550 million. This also marks a transformation in the field, as tokenized securities, once regarded as a niche concept, are now seen as a bridge between traditional finance (TradFi) and the blockchain ecosystem.
Even companies like Securitize are struggling to ensure that these tokenized assets meet relevant regulatory requirements. Various intermediaries will also play an important role in driving more funds into DeFi.
But the road ahead is not all smooth sailing — integrating institutional investors into DeFi still faces many challenges. Regulatory and legal uncertainties, as well as compliance issues related to Know Your Customer (KYC) and Anti-Money Laundering (AML) standards, are all influencing factors. In addition, there are issues such as trading liquidity and transparency, technical security, and economic risks. All these obstacles make it difficult for institutional investors to move forward in this environment, thereby slowing down the adoption of DeFi.
Although the prospects for DeFi are promising, large investors remain cautious about the safety of their funds. The key issue is how to find a balance between the core principles of decentralization and meeting the security requirements of institutional investors.
Market reports from institutions like Blockworks and JPMorgan support the involvement of institutional investors in the DeFi space, stating that the field needs to provide support for these investors and adopt the necessary infrastructure for scalable development. However, the reality is much more complex.
Institutional participation can enhance trust in the decentralized financial ecosystem, pushing its development to new heights. However, it also brings a higher degree of centralized risk, making the system deviate from its original design purpose and the very attraction for many.
Risks of RWA tokenization
A major development in the DeFi space is the tokenization of real-world assets (RWA), which includes everything from tokenized commodities to tokenized stocks. According to McKinsey, the market size for these assets could reach $2 trillion by 2030.
Although RWA marks a significant step forward for DeFi, they also come with security risks that must be addressed. One of the most pressing challenges is 'custodial' risk — when assets are tokenized and transferred to DeFi. In this case, the security of these assets relies on legal agreements rather than automated smart contracts.
For example, the two most widely used stablecoins — USDC and USDT — are backed by traditional banking institutions rather than decentralized protocols. Because they rely on centralized entities, they are easily subject to manipulation and prone to errors.
Assets that need to comply with AML and KYC rules are more tricky. For example, short-term Treasury bill tokens (STBT) can operate in a permissionless DeFi environment as long as they are accepted. The acceptance of these assets seems to be limited because users are unwilling to accept the accompanying KYC requirements. These compliance issues have become obstacles to promotion.
If traditional financial giants can leverage their infrastructure to safeguard RWA, it may help address the security issues associated with tokenization. If done professionally, then theoretically, stablecoins with appropriate support from large traditional financial institutions could become very popular, gaining greater trust and adoption. Tokenized stocks and commodities may also attract attention, providing new investment opportunities that merge traditional financial structures with blockchain.
The future of DeFi
The future of DeFi is likely to be a hybrid model that combines decentralized principles with regulated centralized elements. This approach can help enhance security while preserving the essence and advantages of DeFi: reducing intermediaries and increasing transparency.
Many times, the future is not about the victory of the old paradigm or the new paradigm, but finding a compromise result. Even without large institutional participants, true DeFi can stand firm. However, certain areas in DeFi may need to accommodate centralized elements to ensure better security and regulatory compliance.
Ultimately, it will be a financial ecosystem with fewer intermediaries compared to today's traditional financial system. This hybrid model is likely to become the foundation for how the global financial system operates in the future.