Traditional Finance Leverage CeFi Infrastructure for DeFi Profit
The relationship between traditional finance and the crypto markets had previously been upheld by a few banks allowing customers to use their fiat to convert into cryptocurrency in the safe knowledge that they could cash out at any time. The number of retail banks letting their customers use their accounts with crypto exchanges has become smaller at a time when many are seeking alternative investments. Gold has lost its shine as a hedge against inflation while Bitcoin has outperformed all other major asset classes making the crypto market a target for portfolio diversification with recent reports showing that most institutions are planning to invest in cryptocurrency.
How Does the CeFi Infrastructure Benefit Institutions?
Centralised finance infrastructure has been built to create a secure gateway to fill the gap left by traditional banks unable to provide their customers with reliable access to crypto. Exchanges such as Kraken and Coinbase have worked with banks and regulators introducing centralised controls such as KYC and AML compliant integration. Nevertheless, the crypto market has been largely developed around retail investment and with some banks unexpectedly blocking or freezing accounts connected to crypto exchanges the choice of banking and payment services needs to be considered by institutions who are looking to diversify into digital assets.
CeFi crypto exchanges have consolidated the first wave of bridges required to connect traditional finance to the crypto markets though it has taken the work of a new generation of specialist CeFi players to establish an improved infrastructure of banking and payments for professional investors to securely buy, hold and exchange digital assets. This is paving the way for some of the more complex opportunities that are evolving on blockchain protocols that support unique DeFi (decentralised finance) instruments. Exchanges like SushiSwap and Pancakeswap have no centralised authority which has made way for greater efficiency and innovation that has fuelled rapid growth with the total value locked (TVL) in DeFi protocols soaring from $1bn at the beginning of 2020 to over $200bn in 2022.
A catalyst for this unprecedented growth is the profit investors are earning by adding liquidity to DeFi exchanges. Lenders can add their funds to liquidity pools to meet the huge demand for borrowing that has developed from crypto market players wanting to trade on DeFi platforms. This peer to peer lending and borrowing environment is fully automated with smart contracts. Experienced investors can switch between liquidity pools for the maximum yield for their funds. Liquidity is also needed to swap coins and tokens with transaction fees shared between those who have funds locked into the protocols enabling this activity. The returns on offer in the DeFi lending market are far exceeding those found in traditional finance with CeFi infrastructure now set to provide a secure route for institutional investors to safely access these opportunities.
DeFi Brings Freedom, Control, and Creativity to the Financial Investment Sector
The regulatory framework of traditional finance has provided the building blocks for compliant access using the values of centralised finance to embed innovations such as KYC on and off ramps helping to solidify the mainstream adoption of digital assets. The freedoms of decentralised finance have enabled a space for unlimited creativity, launching financial instruments that can’t be found anywhere else. While KYC and AML compliant ramps can go some way to regulating participants as they use fiat to enter and cash out from a centralised exchange it’s more of a challenge to account for DeFi counterparties who may have arrived from unregulated platforms. The liquidity that institutional investment is bringing to DeFi is making it possible to seamlessly install centralised controls so that liquidity pools can be monitored while smart contracts automate the entire lending process. Institutional investment is leveraging the best of CeFi infrastructure to access and use the incredible efficiency of DeFi smart contracts which are now a proven source of revenue.
Written by Ashley Pope, Product Manager – Crypto. Ashley is a Mayor of London’s Business Growth Programme alumni. A creator, builder and executor of globally impactful technology products.