Why Institutional Investors Are Defying the Banks and Leaning Into DeFi

Between negative-yielding bonds, the frothy equity market and looming inflation, institutional asset allocators have been forced to look for alternative means of generating yield. 

Over the last year or so, a growing list of institutional players have started to accrue massive sums of Bitcoin and Ethereum, not only as a means of combating lingering inflation fears but as a way of generating steady, tangible and fixed income streams.

In fact, according to the core personal consumption expenditure index — the Federal Reserve’s preferred inflation reading — projected inflation rates are currently at their highest level in almost three decades. Speaking to Bloomberg at the Qatar Economic Forum, Bridgewater Founder Ray Dalio and former Treasury Secretary Larry Summers shared the sentiment that inflation in financial assets is a concern, mostly because there is a significant amount of liquidity in the market making it difficult for returns to be justified. As a result, corporations have more incentive to hedge their treasuries in favour of crypto.

The decentralized finance (DeFi) market has afforded many forward-thinking institutional investors the opportunity to go beyond Bitcoin and explore crypto lending, borrowing, liquidity mining, and staking. This has facilitated ways to generate steady yields that are often much larger than they would traditionally garner. 

Why DeFi?

“Yield farming” has become synonymous with the DeFi sector. In its most basic sense, Yield farming allows users to deposit digital assets and be rewarded with other digital assets in return. For example, deposit ethereum and earn a 3rd party token in return. 

One of the most popular methods, known as liquidity mining, requires investors to provide liquidity to a decentralized exchange (DEXs) in return for rewards. The process involves funds placing multiple digital assets, typically a trading pair, into a liquidity pool and gaining a percentage of the trading fees as a reward. 

Another avenue favored by fixed income style funds playing with DeFi is staking, where users agree to deposit their crypto in smart contracts on a specific network (Ethereum, Algorand, Cardano etc.,) to secure the platform and validate transactions. In return for this service, the individual is provided with incentives, primarily in the form of token rewards.

Tokens harvested via staking from these ventures can then be compounded via similar DeFi protocols, creating a cyclical chain of rewards that can quickly add up. For example, the best performing investment fund in Australia, Apollo Capital, generated nearly 700% YTD in April 2021 by staking on behalf of its liquidity providers.

The DeFi market is becoming flatter, allowing users to farm for yield across disparate DeFi ecosystems. So called ‘bridge’ products, such as Yieldly’s Algorand-Ethereum bridge, are allowing users to easily transfer their assets to other ecosystems to leverage and compound their digital assets across various DeFi product offerings. 

As for yield potential, staking ventures such as Yiedly’s YLDY-ALGO pool enables users to gain upward of a 100% Annual Percentage Rate (APR) on their assets. This differs dramatically from traditional lending and borrowing, which nets out at 1%-5% at best. Moreover, through compounding returns via yield farming, it is even possible to lock in an APR ranging anywhere between 500%-1000%.

The tides of institutional involvement are turning

The continued growth of the DeFi sector has not gone unnoticed by many big-name players. In fact, per a survey of 100 hedge fund chief financial officers globally, an overwhelming majority of today’s biggest fund managers believe that by 2026, at least 7.2% of their holdings will consist of cryptocurrencies — working out to a whopping $312 billion. 

Not surprisingly, a recent PwC study recently revealed that 31% of crypto-based hedge funds have already started making use of DEXs (like Uniswap, 1inch and SushiSwap) as well as DeFi-specific tokens in order to help maximize the earning potential of their clients. 

For 57% of hedge fund managers the principal reason for adding digital assets to their portfolio was “general diversification.” 29% cited “exposure to a new value-creation ecosystem” as the chief reason for getting involved and 14% suggested that it made for a good hedge against inflation. The large amount of liquidity in the market paired with negative real interest rates means that for many investors, it pays not to hang onto cash in an environment where there is no interest rate but potentially significant inflation rates. 

Another source of appeal for institutional investors to utilize things like yield farming, staking is that unlike before, there are now many holistic, end-to-end institutional trading solutions that can help facilitate such activities in a seamless yet regulated manner.

Further, even though there might have been a degree of hesitancy from traditional players in the past — primarily due to a lack of clear-cut regulations — this problem has been largely mitigated in the past year. There now exists ample institutional custody platforms implementing stringent KYC/AML practices (as well as utilizing other confidence-inspiring measures such as third party audits). 

As such, It stands to reason that as we move into an increasingly decentralized and digital future, investors all over the globe will start to put increasing pressure on their fund managers to gain exposure to the best-performing asset class of the last 12 months.

Previously, some people argued that Ethereum, the ecosystem that currently houses a large number of all DeFi platforms in existence today, may actually prevent the growth of this burgeoning sector due to various high transaction fees and low network throughput related issues. Institutional investors have historically also had a lot of concerns about the environmental impact of crypto. However, this criticism does not hold entirely true since there are now many more efficient and green alternative cryptos that users can avail of.

Yieldly, for example, enables institutional investors to participate in various DeFi activities using the Algorand network for a secure, speedy, scalable, low cost and sustainable base of operations — essentially enabling them to mitigate the aforementioned problems almost entirely. Moreover, with interoperability becoming a focal point of DeFi useability, institutional investors no longer have to concern themselves with cherry-picking ecosystems and instead concentrate on generating the greatest yield. 

About The Author
Sebastian Quinn, co-founder of Yieldly, and a veteran in developing blockchain and emerging technologies.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.