The Trading Tools Institutions Need to Enter DeFi

This
post
is
part
of


Consensus
Magazine’s
Trading
Week,
sponsored
by
CME.


Antoni
Zolciak

is
the
co-founder
of


Aleph
Zero.

There’s
good
reason
for
institutions
to
shy
away
from
DeFi
—
regulatory
uncertainty.

While
ultimately
desirable,
many
features
native
to
decentralized
finance
(DeFi)
—
permissionless
markets,
pseudonymity,
censorship-resistance
—
can
also
be
considered
gray
areas
for
institutions
who
want
to
stay
on
the
right
side
of
the
law
(or
preemptively
clear
future
regulations).

For
DeFi
to
thrive
and
attract
a
wider
pool
of
capital
it
needs
to
strike
the
right
balance
between
privacy
and
transparency
through
a
proactive
approach
to
compliance.

Certain
crypto
verticals
downplay
or
disregard
the
importance
of
regulatory
compliance,
including
standard
regulatory
disclosures
meant
to
increase
transparency.
This
view
is
rooted
in
the
industry’s
philosophical
origins
(including
a
commitment
to
privacy)
and
technical
foundations
(blockchains
are
transparent
by
default).
For
the
most
part,
DeFi
has
leaned
towards
this
viewpoint.

However,
crypto
and
privacy
are
not
synonymous.
They
never
have
been.
But
privacy
and
transparency
are
also
not
mutually
exclusive
—
a
mistaken
view
that
comes
from
a
binary
understanding
of
what
privacy
is.
Instead,
privacy
has
always
existed
on
a
spectrum.

DeFi
and
Web3
create
new
ways
to
navigate
this
spectrum.
This
has
big
implications
for
individual
traders
and
entire
industries,
can
help
return
privacy
to
its
rightful
place
as
an
actual
business
prerogative,
and
ultimately
something
to
be
negotiated
under
flexible
terms.

A
lot
of
the
research
that
is
happening
in
zero
knowledge
technology,
secure
multi-party
computation
and
other
areas
in
advanced
cryptography
are
creating
a
world
where
traders
can
maintain
their
privacy
and
businesses
(or
protocols)
can
deploy
compliant
fraud-prevention
mechanisms.

Many
of
the
solutions
that
would
soothe
the
valid
institutional
and
regulatory
concerns
with
crypto
are
demanding.
On-chain
intellectual
property
protection
and
anti-money
laundering
(AML)
analytics
are
not
simple
implementations,
but
require
tools
that
work
in
real-time.

DeFi
needs
to
be
more
usable
than
simple
swaps.
Let’s
introduce
blazing-fast
order
book
exchanges
that
remain
decentralized
but
also
protect
the
strategies
of
large
players
and
ensure
that
no
bad
actors
get
involved
with
the
ecosystem.

No
institutional
investor
will
ever
get
meaningfully
involved
in
DeFi
if
all
their
intellectual
property
is
plain
to
see
for
competitors
on
any
block
explorer,
or
even
in
the
exchange
itself

DeFi
protocols
can
have
all
the
benefits
of
having
programmable
money,
permissionless
markets
and
certain
degrees
of
transparency
while
offering
protections
for
intellectual
property
that
are
similar
to
what
exist
in
traditional
finance
settings.

Another
problem
to
solve
is
the
incompatibility
that
exists
between
DeFi
infrastructure
and
compliant
infrastructure.
Regulations
are
inevitably
coming
for
crypto
and
Web3
as
a
whole
and
an
end-to-end
compliant
approach
should
be
available
to
users
and
institutions
alike.

If
we’re
introducing
know-your-customer
(KYC)
and
know-your-business
(KYB)
tools
to
DeFi,
let’s
make
it
as
user-friendly
as
possible.
Ideally,
these
implementations
would
be
interoperable
within
an
entire
blookchain
ecosystem
like
Ethereum,
including
all
of
its
layer
2s.

We
need
good
identity
infrastructure
that
makes
things
easier
for
users
and
developers
alike
by
being
compliant
from
the
ground
up.
DeFi
would
benefit
from
having
a
cross-chain
decentralized
identity
layer
that
manages
user
data
and
privacy
but
makes
the
necessary
concessions
for
law
enforcement
when
necessary.

Identity
verification
goes
hand
in
hand
with
anti-money
laundering
(AML)
regulations
as
well.
On-chain
AML
analytics
are
certainly
possible,
and
maybe
even
preferable
to
existing
traditional
AML
analytics
software.
Analytics
need
reliable
data
sources
and
on-chain
tools
ensure
that’s
the
case
in
ways
that
traditional
software
would
not
be
able
to.

See
also:


The
Perverse
Impacts
of
the
Anti-Money-Laundering
System

|
Opinion

The
advantages
of
these
analytics
solutions
go
even
further
than
compliance.
Institutional
players
would
also
benefit
from
having
on-chain
risk
management
solutions
as
well
as
help
with
their
due
diligence
processes.

Exchange-traded
funds
(ETF)
conversations,
the
newfound
focus
on
the

tokenization
of
real-world
assets
and
even
recent
Web3
product
launches
by
major
fintech
brands
(looking
at
you

PayPal
and

VISA)
are
signaling
an
inflow
of
new
institutional
capital
into
crypto
markets.
Will
DeFi
also
benefit?

The
necessary
technology
is
falling
into
place,
and
the
industry
has
the
right
intentions
—
and
so,
hopeful,
an
influx
of
capital
will
soon
follow.
However,
this
time
we
must
ensure
is
that
DeFi’s
growth
remains
sustainable,
and
this
can
only
happen
if
it
stays
on
the
right
side
of
the
law
and
if
institutions
meet
the
obligations
of
their
stakeholders.

Striking
the
right
balance
between
privacy
and
transparency
—
where
traders
and
institutions
benefit
alike
—
is
what
will
help
soothe
institutions’
valid
concerns
over
participating
in
DeFi
markets.

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