IInstitutional participation in decentralized financing (DeFi) has increased dramatically in recent months. With the Total Value (TVL) set in DeFi at $ 50 billion (and 40 of that 50 have come in since early November last year), it’s obvious that the market has moved beyond hobbyists and early adopters.
Decentralized Finance (DeFi) uses smart contracts that automatically execute code that is on blockchains, mostly on Ethereum. In most cases, this code repeats common traditional financial market measures such as lending or trading, but without facing a traditional financial market intermediary. This disintermediation is intended to lessen the financial burden placed on middlemen, and while there is much debate about where DeFi stands on such a cost optimization, the takeover is increasingly undeniable.
Participation in these protocols is often marketed as risk-free “yield farming,” which is far from given the harshness of the systems in play, the difficulty of maintaining low-bug code, and the community’s cultural aversion to heavy use of Ethereum’s testnets is risk-free. There are many ways of losing all of the money invested in these income farms, and it is the market expectation to occasionally lose a significant percentage of a platform’s stake – becoming “robust”.
Be that as it may, the rewards (the returns) so far have been sufficient compensation for taking the risk. With the significant rise in the price of cryptocurrencies, there has been a similar appreciation of the tokens recorded in these income farms, which has led to high double-digit returns.
Savvy players have vastly improved their technical skills. Most serious gamblers can quickly review new contracts for anomalies with adequate automation and monitoring.
The scale has changed
While the metrics for individual wallets continue to improve across the board and new money continues to pour into the DeFi brand around the world, funds, trading companies and centralized return platforms are increasingly providing most of the liquidity.
In recent months, some institutional wallets for whales such as those from Alameda, Three Arrows, 0XB1 and Celsius have dominated the capital pools of many of these platforms. The Big Data Protocol, an extremely low risk fringe farm, attracted over $ 7 billion in 24 hours of launch. It is expected that a popular project, if the code can be easily verified, will attract more than a billion people – see Float, FEI, Ellipsis, etc.
This notion of low risk farms is mainly driven by the repeated copying and pasting of familiar smart contracts like Sushi’s MasterChef or Synthetix Rewards contracts. Often times, the code changes from these “safe” reference implementations are minor (although this does not mean risk free) and a high level of confidence can quickly be established that one’s money is not at high risk.
Safe or “low risk” should be taken with a relatively large handful of grains of salt in this context. Often times, assets get stuck due to incorrect, minor changes to the reference implementations. Many of the old guard or blue-chip DeFi platforms had critical vulnerabilities that were not exploited, but certainly could have been. However, with tight risk controls, diversification (where possible) and an improvement in the skills to review smart contract codes, institutions are well positioned to participate.
For the most part, gas charges are a red herring for institutions
Despite repeated portrayals of how expensive transactions have become on Ethereum – with fees skyrocketing hundreds of dollars in February for complex transactions – the impact mainly affects individual users who do transactions on the order of under $ 100,000 want to perform. With the institutional sizing, where most attendees move large sizes, the fees are an annoying but minor drag on performance.
After all, the Ethereum fees are fixed and cannot be scaled with the transaction size. A $ 50 million swap on Curve incurs the same fees as $ 200. Ultimately, the perceived value of the settlement on Ethereum is currently high and much of that premium is the perception that there is a lot of value to capture.
The returns in the room vary widely. To some extent it is relative to risk pricing; New platforms with untested, complex code often generate the highest returns, but the risk of total loss is significant. Different institutions have different size and price risks. Many funds have returns north of 100%, but there are also many with more conservative risk books with an emphasis on generating returns on established, well-reviewed platforms – those returns were still north of 20%.
With traditional market returns of 0 to 2%, a small amount of capital working in DeFi on DeFi return search types can produce significant outperformance.
What is ahead of us?
Ethereum as the master settlement layer is starting to feel a bit inevitable. There is a lot to be gained and a lot of market share to be gained in introducing various Layer 2 solutions. It’s starting to feel like a lot of the finances are being shifted to wholesale after Ethereum.
Joshua Greenwald runs Digital Asset Alpha LP, a fund managed by Sustained Asset Management Ltd. Josh leads asset management on the Uphold platform, a digital money platform that serves over 6 million clients in more than 150 countries.
The views and opinions expressed are those of the author and do not necessarily reflect those of Nasdaq, Inc.