Is the encryption industry ready to welcome the influx of funds from Wall Street?

Is the encryption industry ready for Wall Street funds?

Author: Kevin De LianGuaitoul, Blockworks; Translation: Song Xue, LianGuai

Wall Street’s interest in cryptocurrencies is definitely growing.

Grayscale recently defeated the U.S. Securities and Exchange Commission, and the ongoing discussion surrounding a spot Bitcoin ETF by BlackRock has sparked a significant shift in market sentiment in the cryptocurrency field. Several companies, including Valkyrie, Bitwise, WisdomTree, and Invesco, have quickly followed suit and applied for their own ETFs.

Traditional financial participants have also made significant progress in the cryptocurrency field. Deutsche Bank, a $1.4 trillion asset management company, has applied for a license to provide cryptocurrency custody services, and EDX Markets, a new cryptocurrency exchange backed by Citadel, Fidelity, and Charles Schwab, has recently launched. LianGuai has also launched its own stablecoin project to continue participating in this field.

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However, many people wonder if cryptocurrencies are ready for the influx of institutional capital.

Indeed, they are.

How ready are they?

Determining whether the cryptocurrency field is ready depends on various factors, including regulatory clarity and the robustness of infrastructure providers and market makers. They play a crucial role in attracting institutional investors, as they need to ensure the maintenance of a healthy, fair, and integrated market.

Overall, centralized finance on Wall Street is ready. When we talk about CeFi, we are referring to well-known cryptocurrency platforms that closely resemble the service types familiar to traditional financial participants, such as Coinbase and Gemini.

By largely sticking to the use of Web2 infrastructure, these CeFi companies have been able to handle the scale of Wall Street business. They already have healthy market capacity and active market makers. Most jurisdictions are also becoming increasingly clear on the regulations for using these services.

Of course, there are still some details to be addressed, such as the lack of real bulk brokerage institutions and reliably scalable insurance. However, if given enough time and larger balance sheets, these will certainly be added to the system. They are not fundamental obstacles.

Bringing DeFi to the forefront

When we look at DeFi, we must recognize that the field can play two different roles in the cryptocurrency market. DeFi can be used as a settlement layer for non-custodial services that retain certain centralized features (referred to as “backend DeFi” here). But it can also be purely decentralized (“pure DeFi”).

The case of DeFi as a settlement layer (backend DeFi) is similar to CeFi. These types of operations still provide some centralized oversight, making them more compatible with traditional finance.

Some examples include over-the-counter trading services that settle automatically through Fireblocks, Copper, or other digital asset custody agencies. In addition, there are digital asset settlement platforms for derivative trading, such as LianGuaridigm for digital asset option settlement.

Backend DeFi is certainly equipped with the necessary infrastructure to act as a settlement layer. Many Layer2 DeFi platforms provide the speed and cost required for Wall Street operations, and enable market makers to provide healthy liquidity and absorb a large volume of transactions. Their supervisory capabilities also enable them to comply with local regulations.

When seeking approval from large institutions, a longer due diligence process may be required. However, institutional acceptance of backend DeFi also requires an understanding of the technology and security behind it.

Pure DeFi also has great potential. However, the situation here may be slightly different from alternative solutions with lower levels of decentralization. When we talk about pure DeFi, we are referring to protocols that operate in a mostly permissionless and decentralized manner, such as Uniswap or Curve Finance. This sector represents the largest paradigm shift, but on the other hand, it is still far from being ready for institutional adoption.

Pure DeFi protocols are still subject to too many black swan factors due to the experimental nature of their infrastructure. The recent vulnerability in Curve Finance is a famous example. For most institutional investors, this situation may be too risky, and they are not yet ready to trust software alone to ensure the security of their funds. Its permissionless nature also brings regulatory challenges.

This is not to say that pure DeFi does not represent an interesting exploration point for all market participants—it may even be the most interesting area of exploration. However, for now, it should be seen as a springboard for new financial instruments, which may eventually enter a more institution-friendly environment.

Being well-prepared

In summary, the most conservative position for the cryptocurrency industry’s ability to handle Wall Street capital inflows is that it is closer to being ready. Some industries are better prepared than others, but we only need to focus on the industries that are initially of interest.

As traditional financial institutions continue to experiment, the most likely scenario is that they will start with participating in CeFi—the industry that is already prepared for this attention. With the development of backend DeFi and pure DeFi, Wall Street’s attitude towards the cryptocurrency market will continue to heat up.

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