Blockdaemon Blog

Network Effects and Flywheels in DeFi for Institutions

Industry News
Oct 6, 2021

Recently, The Block hosted a webinar on the topic ‘Network Effects and Flywheels in DeFi for Institutions’.

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The conversation featured four panelists:

All participants are subject-matter experts in the field of DeFi (decentralized finance). Blockdaemon’s CEO & founder, Konstantin Richter, was one of the voices in this discussion, presented by Blockdaemon. Today we’ll recap some of the key highlights from the webinar. This includes:

  • What is DeFi?
  • What’s the current state of institutional adoption in the DeFi industry?
  • Has there been an increase in interest from institutional investors over the past few months?
  • DeFi adoption: where will it come from?
  • Most popular DeFi platforms
  • Winning DeFi platforms of the future

What is DeFi?

Anything that allows you to do what a bank does in a decentralized manner.

This was Konstantin’s answer to the seemingly simple question that kicked off the discussion: what is DeFi? Rewards instead of earning interest. Getting credit with digital assets as collateral instead of cash.

In essence, plugging into decentralized equivalents of traditional financial services. These services leverage smart contracts. Imran Khan, (Lead at DeFi Alliance), agreed with Konstantin. In his words, he views DeFi as a ‘self-driving bank’. Layer-1 DeFi protocols such as the Ethereum blockchain and Solana facilitate new types of behaviour, using smart contracts. An example here is lending. DeFi loans use smart contracts which govern the risk, loan-to-value (LTV) and collateral size.

No central bank authority governs these rules, except for the smart contract creators themselves.

What’s the current state of institutional adoption in the DeFi industry?

Konstantin splits institutions into three different categories.

  • Crypto-native institutions (Kraken, Coinbase, Anchorage, etc.).
  • Traditional asset management firms.
  • Traditional banks.

All of these institutions sit on different areas of the spectrum when it comes to DeFi adoption. According to Konstantin, each has different thinking about touching, integrating and offering DeFi services. Crypto-native institutions, for example, are further along this DeFi journey. Large scale exchanges make investments directly in DeFi. Infrastructure firms (such as Blockdaemon) build integrations into solutions such as UniSwap, to access liquidity pools. Liquid staking is a major point of interest for more traditional institutions. This is particularly important for fintech companies who allow their customers to hold proof-of-assets. Tokens locked into Ethereum will be able to earn yield with the launch of Ethereum 2.0, for example.

Companies who want to deliver a compelling wallet infrastructure will need to offer some form of liquid staking. How are institutions playing in DeFi today?

According to Aya Kantorovich (Head of Institutional Coverage at Falcon X), this “really depends on the background of the trading team.” “If they’re comfortable on off-shore exchanges they may be engaged in derivatives.” Many institutions are focused on staking and lots are focused on futures. Crypto-native institutions may be more involved in specific protocols, participating in on-chain voting and DAOs.

Has there been an increase in interest from institutional investors over the past few months?

There is absolutely no doubt that institutions are getting more involved”. These were the words of Aya in response to this question. Aya says Falcon X receives between 10 - 15 inbound institutional client requests weekly. Institutions are beginning to have conversations around DeFi.

I don’t think anyone’s highlighted how fast it’s happening”, Aya says. While it’s not clear if that will be the case tomorrow, it is certainly the case today, according to Aya. From Konstantin’s perspective, the longest-term interest in DeFi is on the investment side. Blockdaemon has received investment from top 10 to top 100 banks. Goldman Sachs, for example, is a traditional financial institution that has invested in Blockdaemon. This type of investment is the first of its kind for the bank. Given that Blockdaemon receives a portion of its revenues from tokens, it’s a good indicator that larger institutions are diving into this sector more and more.

How can I get ‘this’ level of yield?” is the number one call Aya Kantorovich gets from financial institutions.

DeFi Adoption: where will it come from?

Where will DeFi adoption flow from? Legacy institutions or crypto-native apps?

Konstantin believes that the biggest mass adoption of crypto will come from the legacy financial rails. Everyday people will earn yield on tokens not knowing what the underlying assets are. However, that must be balanced with crypto-native services. Brian Norton (COO of MyEtherWallet), agrees that both legacy institutions and crypto-native infrastructure is important for DeFi, “I think that you absolutely do need both …

We do not see a future for sustainable institutional projects unless we go backwards from consumer facing, because the blockchain is immutable and it can be scary … being able to create a user experience that can co-exist in both worlds doesn't have to be fundamentally contradictory.

For Konstantin, institutions provide liability and insurance for DeFi services. Non-crypto investors could fall victim to a bug without these guard-rails, for example. Imran’s DeFi Alliance works closely with trading firms and market makers. He sees two trains of thought from institutions towards DeFi.

Firstly, they believe there’ll be a looming regulatory landscape. This means companies have to be careful about how they provide liquidity and how they use the platforms. The second top-of-mind is how they guarantee security.

This is particularly important given how much money is lost due through faulty security across DeFi offerings.

Most Popular DeFi platforms

The panel called-out a number of great DeFi platforms. Imran sees Solana in particular as a key platform for DeFi. “A lot of the innovation is still happening on Ethereum”, Imran says, “a lot of the institutional sandbox tests and protocol development is happening on Solana.

Aya sees Luna as a great layer-1 blockchain for DeFi. Avalanche and Polkadot have gained a lot of ground as well, according to Aya. Imran sees a lot of product-market-fit playing out, as web2 services look for suitable blockchains to build on. Incentives are also important for building on a DeFi platform.

From Imran’s perspective, “incentives are a great way to bootstrap a community early on, but the goal is how do you retain these customers after the incentives are gone?” We’re starting to see this question play-out in real-time with DeFi projects. “When Polygon’s incentives tapered, for example, we started to see a lot of the founders who stayed kept building.

Winning DeFi platforms of the future

Konstantin opened this side of the panel discussion with a look at what the key ingredients are in winning DeFi platforms. He commented, “you need really heavy pockets, technical feasibility (although that’s not a must, we’ve seen protocols scale with terrible technology), yet the sad reality is that the money that’s pumped into the system is a really important factor to incentivize certain behaviours.

Some of the best technical projects don’t get the traction they deserve just because they lack the ability to market-make and build a community on that side.” That being said, Konstantin believes Ethereum 2.0 will be the largest opportunity for DeFi to-date. However, Solana has proven to have the technical chops to compete with Ethereum 2.0.  

Aya believes it’s not a “one size fits all model.” In this vein, Aya continued “you’ll see different protocols win specific niches.” Imran offered a more blockchain-agnostic perspective:

What do people care about? Do they just want to use a product and call it a day? Are they going to worry about if it comes from Solana or Ethereum? In my high-level thought process...people are probably not going to care where it comes from.”Brain Norton sees the Ethereum network’s established developer community as a key advantage for innovation.

Putting it in terms of losing market share or being overtaken is not the way to look at it...when you take a step back from DeFi, the new internet is being built.

We’re going to see the use-cases on these chains evolve as we settle in. I do anticipate that Ethereum and EVM compatible chains will be the innovation center for the near-term, just because there is no developer community like this.


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