DeFi is a term that applies to an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies.

The report outlines the five most relevant types of DeFi protocols, highlighting that DeFi lending and DeFi trading have already seen impressive growth and are likely to continue developing more advanced functionality over time. DeFi asset management is a nascent, but promising, space, the report said.

DeFi's prospects are considered against a tough background. The 2022 selloff to tech stocks dragged down cryptoassets such as bitcoin, and the collapse of "stablecoin" Terra Luna, and later bankruptcy of cryptoexchange FTX, combined to put the the whole "digital assets" space under a dark cloud. While aspects of the sector, such as distributed ledger tech, or "blockchain", attract adherents, some of the earlier optimism and hype around the space has gone. The volatility has prompted global regulators and groups of industrialised nations to speak out.

The Corporate Insight report seeks to put recent troubles into context and cast an eye on where the sector is headed.  

Emerging promise
DeFi payments and stablecoins use is strongest in the emerging world, and the rate at which DeFi payments will grow in the developed world is difficult to predict.

DeFi insurance for on-chain crypto assets could succeed in the long term, but most DeFi insurance use cases that involve real-world assets, such as home or auto insurance, are unproven, the report said.  

Regardless of the exact growth rate, the author believes that DeFi and cryptocurrency are here to stay. “Financial services firms need to start the multiyear process of modernising their technology stack and considering how they will custody crypto to be competitive with DeFi,” the report said.

“While multiyear investments are undoubtedly a challenging prospect in the current macroeconomic environment, the winners of the 2020s will be those that can invest and improve during a down cycle,” it continued.  

The report said that DeFi lending for cryptocurrencies on a blockchain will only continue to grow, allowing individuals and institutions with existing assets to use DeFi lending protocols to lend or borrow crypto with a few clicks of a button from almost anywhere in the world. At this stage, the main question for the 2020s is how DeFi is a term that applies to an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies – and how fast – leading DeFi protocols will be able to lend and interact with the real world. 

Early movement in this space suggests that there is traction in crypto lending for relatively higher-value real-world assets such as home loans, small business loans and loans to a portfolio of assets or companies, the report said. Such loans can justify the complexities involved with combining DeFi protocols and real-world lending. 

As DeFi protocols seek to provide more real-world lending services. A separate question is whether these DeFi protocols will be able to maintain their decentralised nature while providing loans for real-world assets. The answer will probably vary by jurisdiction, it said. 

Some jurisdictions wanting to attract crypto assets and entrepreneurs will enable truly decentralised versions of lending involving real-world assets. Others will try to crack down on all things DeFi and cryptocurrency and prevent this kind of activity. Some jurisdictions will land somewhere in the middle, leading to what can best be described as “semi-DeFi” or centralised crypto lending activity. 

“Regardless of how it shakes out in terms of real-world assets and the regulatory framework in different jurisdictions, the overall DeFi lending ecosystem will only continue to grow throughout the 2020s. The established industry and traditional lenders need to prepare for the growth of new DeFi competition,” the report said. 

The reported highlighted how traditional retail brokerage firms will need to offer cryptocurrency trading services to compete with both decentralised exchanges and traditional rivals who roll out crypto features. If brokerage firms do not introduce crypto custody and trading services, they are likely to lose market share in the long term.  

Firms such as BlackRock, Charles Schwab and Fidelity are already ahead of the curve here, having made early moves in the crypto trading space, the report said. For example, Fidelity has rolled out a crypto trading service for retail clients, and BlackRock has partnered with Coinbase to offer institutional clients crypto trading services. Both Fidelity and Schwab have also invested in the crypto exchange EDX Markets.  

The report recommended that brokerage firms should ideally build crypto custody and trading services in house. Alternatively, firms can partner with third-party vendors and leverage external infrastructure to offer cryptocurrency services to their customers, it concluded.