Recent technology developments are enabling institutional investors to use decentralized finance tools, according to a new report by the board of the International Organization of Securities Commissions.
“Until very recently, institutional investors largely appear to have limited their participation in DeFi protocols, which they have indicated are due to issues around DeFi protocols’ compliance with applicable jurisdictional regulations, as well as the institutional investors’ ability to ensure compliance with their own internal or regulatory requirements,” noted the report.
“However, this past year saw the launch of multiple vendor products and services that were aimed at institutional investors, including those involving trading, best execution and custody, which appears to have encouraged more institutional firms to commence DeFi activity.”
Institutional investors are attracted to the high-yield lending and liquidity pools offered in the DeFi ecosystem, said the report. However, despite the enthusiasm, using the emerging technology used to require assets to be held by individuals rather than organizations, rendering their widespread adoption by institutional investors impossible.
While recent advances, including ones which allow for institutional control of cryptocurrency wallets, have enabled some institutional investors to begin using DeFi tools in a limited manner, the report concluded it may be some time before adoption is widespread.
“Although blockchain data and smart contract code is transparent for all to see, understanding this data and code requires technical capability and knowledge. Without basic regulatory safeguards, including those that are the purpose of traditional financial services regulation, such as requirements for the disclosure of material information about a product, service or the individuals and underlying entities, investors may not necessarily receive sufficient information to make informed investment decisions.”
DeFi tools are built on the same blockchain technologies used to create cryptocurrencies. Rather than being used as a representation of value, in the DeFi context, blockchains are used to build smart contracts. These contracts are self-executing agreement written in code on a decentralized blockchain network. When tied to cryptocurrency accounts, which are known as wallets, these smart contracts can execute complicated transactions automatically.
Depending on how these contracts are built, they may provide financial services like money transfers and trading at very low costs. More specialized tools have also been developed, including ones that allow for apparently risk-free arbitrage.