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Aave, one of the largest Defi protocols in terms of TVL, launches its permission pool Aave Arc, with 30 institutions set to join. It`s apparent that institutions are eyeing Defi. What’s the implication of it? Here’s my thought.

What’s Defi?

Defi is built on permissionless blockchain and thus KYC/AML is not mandatory. Historically, Defi market participants have been largely restricted to shrewd retail investors and crypto native institutions. If you`re new to Defi, this website is helpful to understand.

Since mid-2020, Defi summer has started and its TVL has markedly grown to USD 232b (750% y-y). Ethereum prinoeered Defi and other layer1s quikly followed the suit. Early adopters contributed Defi ecosystem growth and enjoyed juicy yield via various yield farming strategies (even >10,000% APY!!)

Defi is Infant Stage

Even if you have recently jumped on the Defi bandwagon, dont worry. You`re not late. Of note, only 1.8% of total Ethereum address has interacted with Defi protocols as of 2Q21, according to Consensys. Defi is still infant stage.

Defi Has Been Largely Untapped For Institutions

Meanwhile, traditional institutions are increasingly pouring money to crypto via BTC & ETH price linked products, LP of crypto VC and investment on crypto infrastructure equities. However, Defi has been largely untapped for traditional institutions due to absence of KYC/AML feature.

Stablecoin Yield Farming Is Their Target

Institutions should be primarily interested in stablecoin yield farming. Institutional-grade Defi protocols (AAVE, Compound, Uniswap, etc.) offer mid to low single digit APY (it`s not enough for crypto degen though. Risky Defi protocols generally offers double-digit, even triple-digit APY) and it`s still way better than traditional banks

Institutions will likely prefer USDC (or other pedigreed institutions backed stablecoins (such as JP Morgan and Paypal developed one) rather than USDT and other algorithmic stablecoins. In addition, they`ll likely choose insurance covered Defi protocols.

Web3 VC Backed Defi Protocols Will Embrace Regulation

I predict most web3 VC backed Defi protocols (particularly US based) will embrace regulation and implement KYC/AML in 3 yrs. Of note, SEC alredy investigated major Defi protocols such as Uniswap labs and Terraform labs) I think most of them will likely surrender.

More and more Defi protocols are embracing regulation, institutions will be able to enter Defi ecosystem, denting yield farming return significantly. We`ll miss mind-boggling Defi yield during 2020-21

Unregulated Defi Protocols Will Co-Exist

Still, I expect unregulated (hopefully decentralized) Defi protocols to co-exist. Crypto native developers and degen will support ecosystem. Retail investors and crypto savvy institutions will be able to continue their game, but they need to accept much lower yield.

Defi Derivatives And Arbitrage Are Next Alpha

I believe Defi derivatives and arbitrage will likely to remain in a sweet spot for a while. However, it`s only limited to crypto & quant savvy investors. A window of opportunity is closing down for normie. Enjoy yield farming and maximize your return when you can!

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