Decentralized finance—DeFi—refers to the shift from traditional, centralized financial systems to peer-to-peer finance enabled by the Ethereum blockchain. In 2021, the DeFi ecosystem grew by over 20x. It has attracted millions of users and many of the world’s leading financial institutions, funds, exchanges, and family offices, with yields that far outweigh those in traditional finance.
This year we've seen significant traction from decentralized versions of lending and borrowing platforms, prediction markets, margin trading, payments products, insurance, and more. Notable traction has also been evident across entirely new forms of investment, such as staking and yield farming. The DeFi ecosystem now represents an expansive network of integrated protocols and financial instruments worth more than $60B.
Based on ecosystem developments in the first half of 2021, it’s not hyperbole to claim that the entire financial system is being rebuilt from first principles with more security, transparency, and composability across protocols.
Here are a few of the most promising opportunities for institutional investments in DeFi.
Digital Asset Trading
Decentralized exchanges (DEXs), automated market makers, and token swapping aggregators are the types of cryptocurrency exchanges that operate without a central authority, allowing users to transact peer-to-peer and maintain control of their funds. DEXs, like Uniswap, Sushiswap, 0x, ParaSwap, and many others are solving the issue of being able to access crypto assets from anywhere in the world as long as you have an internet connection and a wallet like MetaMask. They are also increasingly giving centralized exchanges a run for their money.
Coinbase, the popular cryptocurrency exchange that went public in Q2, identified decentralized exchanges as one of the key threats to their business in their S-1. It’s no wonder: in Q2 2021, DEXs saw the highest ever volume, with May alone witnessing a whopping $173B in volume, and Q2 total of $343B. This surpassed Coinbase’s total trading volume of $335B in Q1 2021. This is notable because DEXs enable trading only for EVM-compatible assets, whereas 58% of Coinbase’s trading is Bitcoin.
Compound and Aave are non-custodial, decentralized peer-to-peer lending platforms. Both platforms offer users opportunities to (1) borrow funds while putting up their crypto assets as collateral, and to (2) lend their cryptocurrency for interest rates that are exponentially higher than those offered in traditional finance. Aave is known for popularizing flash loans, which are instant loans that users can borrow without collateral as long as the loan is repaid in full before the block is completed.
Providing USDC liquidity on Aave currently yields 6.27% APR, yielding 7.22% on average since inception. As protocols chase liquidity, attractive yields like 32.5% for providing sUSD liquidity on Aave are increasingly the norm.
In July 2021, Aave launched Aave Pro, which uses KYC’d pools to provide institutional investors with direct access to decentralised lending markets. These pools will be separate from existing liquidity pools on Aave in order to comply with institutional compliance and regulatory requirements.
Another institution-focused decentralized liquidity network, Alkemi, reached over $16m liquidity last May. Similar to Aave, Alkemi offers KYC’d lending pools for institutional investors.
Check out our tool Codefi Compare, to see how these yields compare with traditional finance.
Unique to DeFi, yield farming allows users to stake their crypto assets in various non-custodial, DeFi protocols to earn high fixed or variable interest rates. Yearn, Idle Finance, Enzyme, and Vesper are some of the top yield farming protocols.
In the absence of yield farming platforms, users must manually search for protocols with the highest returns, and move their crypto assets onto that platform to earn higher rewards. Think of it like crop rotation, with the seeds representing idle crypto assets and the fields as the protocols offering the highest returns. Yearn Finance automates this process by finding, and switching to, the highest yielding opportunities for yield farmers and liquidity providers. The price of YFI, the Yearn token, has hovered around $35,000 for most of Q2, 2021. With over $4B worth of crypto assets staked in its protocol, Yearn Finance is highly valued by DeFi users who want to put their idle crypto assets to work.
Here is a snapshot of the high returns users can expect by staking or lending their YFI tokens:
Idle Finance is a decentralized rebalancing protocol that allows users to automatically and algorithmically manage their digital asset allocation among different third-party DeFi protocols. Investors can choose to maximize their interest rate returns through their MaxYield strategy or minimize risk exposure through their RiskAdjusted allocation strategy.
Enzyme Finance (MLN, ~$100), formerly Melon Protocol, facilitates on-chain management of pooled funds and allows users to create their own tokenized, financial instruments.
Touted as the “401K of Crypto”, Vesper offers a service where users can “store and forget” their assets with the promise that they will generate the highest possible returns.
Before engaging in any of these activites, institutional investors have heightened risk and operational requirements to consider. Last week, we listed 5 things institutions need to participate in DeFi. Among which, institutions need a secure and efficient gateway and wallet to properly transact.
MetaMask is the most used and trusted Web3 wallet. It serves over 10M monthly active users and is integrated with almost every DeFi dapp, offering access to tens of thousands of venues for trading, staking, lending, borrowing, derivatives, asset management and more.
MetaMask's institutional arm helps address the unique needs of institutions so that they can safely and efficiently access DeFi. Only MetaMask Institutional provides unrivaled access to DeFi without compromising on institution-required security, operational efficiency, or compliance requirements.
DeFi for Institutions
Institutional opportunities within DeFi don’t stop here. This is a chapter from Consensys’ ‘DeFi for Institutions’ report. Download the full report to learn more about…
The surge in institutional adoption of blockchain and digital assets
The challenges of institutional engagement in DeFi
Different ways institutions can get started accessing, investing, and participating in DeFi
DeFi solutions by Consensys
Need a recap of the basics of the DeFi ecosystem? Watch our “Introduction to DeFi" Webinar.