There’s definitely been an increased interest from Wall Street firms in cryptocurrency.
Grayscale’s recent victory over the US Securities and Exchange Commission and the ongoing conversation around a spot bitcoin ETF by BlackRock have triggered a significant shift in market sentiment within the cryptocurrency space. Several companies, including Valkyrie, Bitwise, WisdomTree and Invesco, have swiftly followed suit and filed for their own ETFs.
Traditional financial players have also been making notable strides in the crypto arena. Deutsche Bank, a $1.4 trillion asset manager, has applied for a license to offer crypto custody services, while EDX Markets, a new crypto exchange backed by Citadel, Fidelity and Charles Schwab, recently launched. PayPal continued its involvement in the space by also launching its own stablecoin project.
However, many are wondering if crypto is ready to retain the massive inflow of institutional capital.
It certainly is.
How ready is it?
Determining whether crypto is ready depends on different factors, including regulatory clarity as well as the robustness of infrastructure providers and market makers. They all play a pivotal role in retaining institutional investors because they ensure the preservation of healthy, fair and integrated markets.
Big picture, centralized finance is ready for Wall Street. When we talk about CeFi, we’re talking about the well-known cryptocurrency platforms that already look a lot like the kind of services that are familiar to traditional finance players. These are platforms like Coinbase and Gemini.
By sticking to Web2 infrastructure for the most part, they’re already able to handle the scale of Wall Street operations. These CeFi firms already count with healthy market volumes and engaged market makers. There’s also increasing regulatory clarity in most jurisdictions around how to work with these services.
Of course, there are some details that need to be sorted out, such as a lack of true prime brokerage set-ups and solid insurance in size. However, given enough time and larger balance sheets, these will surely be added to the system. They’re not fundamental blockers.
Bringing DeFi to the table
When we look at DeFi, we have to see the space as being able to play two different roles in crypto markets. DeFi can be used as a settlement layer for non-custodial services that retain some aspects of centralization (referred to here as “Backend DeFi”). But it can also be purely decentralized (“Pure DeFi”).
The case for DeFi as a settlement layer, backend DeFi, is similar to CeFi. These types of operations still provide some centralized oversight, which makes them more compatible with the approach of traditional finance.
Some examples include OTC services with atomic settlement through Fireblocks, Copper or other digital asset custodians. Additionally, there are also digital asset settlement platforms for derivatives trading, such as Paradigm for the settlement of digital asset options.
Backend DeFi certainly comes with the necessary infrastructure to act as a settlement layer. Many layer-2 DeFi services provide the speed and cost level necessary for Wall Street operations, and have market makers providing healthy liquidity and the ability to absorb large volumes. Their capacity for oversight also enables them to comply with local regulations.
There might be a longer process of due diligence here when it comes to getting a green light by large institutions. However, having a full acceptance of Backend DeFi by institutions is just a matter of optics and understanding the technology and security behind it.
There’s definitely potential for pure DeFi as well. However, the situation here might be a little different than its less decentralized alternatives. When we talk about Pure DeFi, we’re talking about protocols that work in a mostly permissionless and decentralized manner like Uniswap or Curve Finance. This sector represents the greatest paradigm shift, but is conversely still the furthest from being ready for institutional adoption.
Pure DeFi protocols are still subject to too many black swan factors due to the experimental nature of its infrastructure. The Curve Finance exploit is a notable recent example. This presents a scenario that is likely too risky for the appetite of most institutional investors, who are not ready to trust software alone with the security of their funds. There are also regulatory challenges that come with their permissionless nature.
This is not to say that Pure DeFi doesn’t represent an interesting point of exploration for all market participants — it is perhaps even the most interesting field to explore. However, it should currently be seen as a springboard for new kinds of financial instruments that could eventually make it into more institutionally-friendly environments.
Altogether, the most conservative position to have around crypto’s ability to handle inflows of Wall Street money is that it’s closer to readiness than not. Some sectors are more ready than others, but we only have to focus on the sectors where initial interest is likely to go.
As traditional finance institutions continue to dip their toes, the most likely scenario is that they’ll start by participating in CeFi — a sector that is already prepared for this kind of attention. Wall Street’s attitudes towards cryptocurrency markets will then continue to warm up over time as Backend DeFi and Pure DeFi evolve.
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