Future proofing the digital asset economy and the role of DeFi

Once viewed as a fringe asset class, digital assets have increasingly found their place in the financial mainstream, with Coinbase going public in the United States and some of the worlds largest institutional players such as Blackrock incorporating digital assets into investment products.

It is now 13 years since the publication of the bitcoin white paper. This period has seen incredible innovation, including the creation of a decentralised finance industry, and the development of secure and trusted infrastructure. This cycle of rapid growth has left digital assets ripe for adoption.

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As the digital asset industry has matured, the availability of trusted counterparties and institutional-grade infrastructure has removed the barriers to adoption for many institutional players. The volatility of the markets and the significant dip that crypto took in May has not stymied inflows to the sector, with institutional players understanding the need for mitigation and risk strategies.

Regulation is the final hurdle. Many of the worlds largest financial institutions, including Standard Chartered, State Street, and Citibank, have been quietly building digital assets divisions in anticipation of clear legislative frameworks on digital assets being finalised. This positive trend is evidenced globally, for example Switzerland and Singapore have already implemented comprehensive frameworks for distributed ledger technologies.The EUs Market in Crypto-assets (MiCA) framework is progressing at pace through the legislative process; and in North America, the Office of the Comptroller of the Currency (OCC) has provided guidance enabling federally chartered banks to provide crypto custody services.

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It is clear then that the calculus has changed among many institutions from whether we incorporate digital assets into operations to how can we maximise the success of digital assets in our operations? To date, investment in the crypto heavyweights of bitcoin and ethereum has dominated investor strategies. A July report by Fidelity Digital Assets showed that 37% of 1,100 institutional investors surveyed own bitcoin in their portfolio, while 20% own Ethereum. However, there is evidence that the appetite for digital assets beyond these staples is growing, with the areas of staking and decentralised finance (DeFi) of increasing interest.

DeFi, the sector of smart contract-based finance applications which exploded from little known use cases in 2020 to a $80bn industry in a little over a year, has particularly captured the attention of existing financial stakeholders, with questions of both how to invest in the industry, and capture the value of such applications within their own operations.

The breakneck pace of innovation demonstrated by the rise of DeFi over the past12 months indicates the challenge for institutions in managing their entry into the space. Unlike other more established areas of cryptocurrencies, the nascent nature of DeFi poses particular risks for institutional and large-cap investors. Data from crypto intelligence company Cipher Trace shows that losses from theft, hacks, and fraud in DeFi hit an all-time high in the first seven months of this year at $474m. The $600M Poly Network hack in August, widely regarded as one of the largest ever crypto hacks, brought this exact issue into the global spotlight.

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For institutional players looking to broaden their scope in digital assets, the question of how to balance such innovation alongside issues of security is a challenging one. Agile and customisable institutional-grade infrastructure will be critical for financial institutions to find the right blend of security versus agility to fit their specific needs.

One such means of achieving this can be blending key management technologies, such as Hardware Security Module (HSM) and Multi-Party Computation (MPC). While, traditionally, HSM has been the favoured custody solution for banks and institutions, incorporating flexible cryptography-based MPC technology into operations can ensure that firms retain high-grade security with the flexibility to stay apace with the latest development in the sector.

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The technology is clearly in place for institutions to securely integrate DeFiand other emerging digital asset use cases into their operations. However, questions remain as to how institutions will implement these technologies, with some incumbents choosing to acquire specialist providers in the space and others quietly building their native capabilities. Whatever path individual institutions take, it is clear that the race for supremacy in digital asset capabilities is well underway among institutions, with those not already moving likely to be left behind.

Adrien Treccaniis CEO and Founder ofMetaco.He lectures at the cole Polytechnique de Fdrale de Lausanne and University of Lausanne in cryptography and the financial applications of blockchain