Institutional Investors Still Cautious Over DeFi—Report

Key Takeaways

• A new survey highlights the major challenges institutions face when adopting DeFi.
• High yield with tolerant risk factors is key to adoption.
• Institutions claim regulatory challenges are not a big issue, but they slow down innovation.

The scope and interest in the decentralized market are set to expand, as cryptocurrency continues gaining mainstream institutional adoption. However, despite the growing interest in decentralized finance (DeFi), institutional investors reportedly remain cautious over DeFi, due to regulatory and security risks.

According to a survey from blockchain infrastructure provider P2P, which manages over $6.8 billion in assets, the majority of institutions looking to enter the DeFi world struggle with technological challenges, added to security and regulatory risks.

High Yield Is Key to Institutional DeFi Adoption

Institutions seem to be primarily focused on finding high-yield products, with traditional financial products offering minimal returns over long periods.

Over 50% of respondents identified a broad range of yield solutions as a primary growth driver. A wide range of offerings is valuable for exchanges and investment funds that aim to support multiple yield strategies to enhance fund performance.

The report highlights that improving compliance regulatory frameworks, maximizing capital efficiency and spotting risk-adjusted high-yield opportunities drive the institutional DeFi rush.

It further suggests that institutions can improve their product offerings and operational efficiency. This is by investigating stablecoin yields linked to tokenized U.S. treasuries, utilizing yield solutions based on ETH and BTC staking and implementing liquid strategies, to lessen the impact of opportunities costs due to unbinding periods.

Furthermore, technologies, like restaking indices and risk management platforms, can offer opportunities to improve internal procedures and reduce exposure to hazards.

High Yield Comes With Several Risk Factors

Most institutions surveyed reiterated that they are looking for risk-adjusted yield solutions, i.e., products that offer higher-than-average market yield but manageable risks.

The risk was a recurring theme in the survey, with respondents highlighting different risk factors.

One respondent mentioned smart-contract risks as a key technological concern, affecting an organization’s security and reliability. Some of the key risk factors mentioned in the survey include:

• Technology Risk: Respondents highlighted the technological risks associated with smart contracts, which are the backbone of DeFi. Smart contract vulnerabilities have led to some of the largest exploits in the DeFi world.
• Operational Risks: Even if a product is built on a reputable smart contract standard with a proven track record, there is protocol operational risk, the combined risks of the operator and the technology. A number of respondents raised the operational risk involved in making sure that assets are constantly liquid and usable.
• Regulatory Risk: This refers to the external risk of regulatory uncertainty. Institutional investors need to assess whether the product they are investing in meets the regulatory standard.

About one-third of the respondents said that one of the most difficult tasks is locating a product that fits their organization’s risk tolerance while providing a greater yield than the market average. 

70% of the respondents reported lower regulatory uncertainty, but reiterated that compliance costs slow innovation.

In the meantime, the DeFi craze among institutions is booming, with Sony launching its mainnet based on Ethereum and Germany’s second-largest bank, Deutsche Bank, announcing  its own layer-2 protocol.