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Mainnet 2022

Insights Oct 6, 2022 3 min read

During Mainnet 2022, Bullish’s Denitza Vatchkova joined Chris Aruliah, Chief Commercial Officer, BCB Group, Aurora Schwarz, Director of Strategic Partnerships, Wintermute, and Riyad Carey, Research Analyst, Kaiko, in a panel discussion moderated by Joshua Frank, Founder and CEO, The TIE. The session titled, “Leveraging DeFi Innovation for Institutions: Automated Market Makers & Liquidity,” explored a range of topics through the lens of institutional market participants and services. To learn more about the discussion, read our session recap below.

Leveraging DeFi Innovation for Institutions: Automated Market Makers & Liquidity 

In this wide ranging discussion, experts from firms across the full spectrum of institutional market participants and services joined Bullish’s Denitza Vatchkova in covering how institutions are engaging with DeFi, the power of AMMs to solve market inefficiencies, and what comes next in this cycle. 

Institutions and DeFi

DeFi attracts a great deal of attention despite its relatively small market capitalization. During this correction, we’ve seen a contraction in DeFi valuations of approximately 70%, dropping from $90 billion earlier this year to $27 billion. Even still, market participants, particularly institutions, remain bullish on the technology. The DeFi space’s capacity to sustain innovation and long runway has continued to attract venture investors, placing the ecosystem in a strong position as it develops and grows in this cycle.

Blended structures of CeFi and DeFi highlight the next phase of the sector’s development. Institutions are keen to enter the space, but are wary of the ambiguity of counterparties and potential technology risks. To service them, providers are increasingly offering hybrid or “Permissioned DeFi” arrangements to ensure greater adherence to compliance and regulatory obligations. 

The benefits of Permissioned DeFi include its closed-loop structure, meaning that all participants have completed some form of KYC/AML vetting. This adds a layer of trust that eliminates some of the barriers to entry for institutions and opens up a range of possibilities for the sector. Seemingly oxymoronic, Permissioned DeFi may in fact offer a route to drive mass adoption of the innovations of decentralized technologies by adding a compliance layer which removes the possibility of engaging with bad actors. 

Liquidity Fragmentation

The rapid growth of the digital asset space led to the inundation of the market with exchanges and execution venues. Liquidity has become fragmented across these venues, creating market inefficiencies that are more acutely felt in a thinner bear market. 

While volumes are down, DEXs have fared better. Volumes have been more resilient as opposed to their centralized peers, suggesting that the automated market making (AMM) model provides certain benefits not found on central limit order books (CLOBs). Exponents of AMMs point to the reliability of liquidity. However, in principal, AMMs are agnostic to volatility and continue to provide liquidity during market turmoil, whereas CLOBs are reliant on a handful of market makers crowding around the same price point.  

Market Outlook

While there is some distance left to cover to reach true institutional adoption, significant progress has been made the past few years. Better depth and liquidity has made it easier for institutions to enter the space, although reliable solutions to access liquidity still need improvement. Nevertheless, this cycle has seen an uptick in institutional smart money on both the centralized and decentralized sides, pointing to greater overall comfort with the space and a willingness to take on some of the risks inherent to DeFi. 

DeFi remains in its nascent stages and it’s expected that the decrease in activity during the bear market will facilitate more flexibility to innovate and build. So too will the period serve as a time to educate and learn, helping developers iterate and institutions more clearly come to terms with the technology. 

Service providers are likely to expand blended offerings or “Permissioned DeFi” solutions as they become more attractive to customers. It’s likely we’ll also see traditional exchanges and brokers enter the space in the next few years, accompanying an expected wave of consolidation as institutional players look to acquire retail customers.

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