In the coming years, we may see traditional finance and decentralized finance transition from cautious engagement to deeper collaboration, with the pace of development determined by the interaction between innovation and regulation.
Written by: Insights4vc
Translated by: Shan Ouba, Golden Finance
Since 2020, major banks, asset management companies, and payment institutions in the United States have shifted from a cautious wait-and-see approach to actively investing, establishing partnerships, or launching crypto products. By early 2025, institutions are expected to hold about 15% of the Bitcoin supply, with nearly half of hedge funds allocating some capital to digital assets. Key factors driving this trend include the launch of regulated crypto investment tools (such as the first Bitcoin and Ethereum spot ETFs in the U.S. in January 2024), the tokenization of real-world assets (RWA) on the blockchain, and the increasing use of stablecoin settlements and liquidity by institutions. Institutions view blockchain as a tool to streamline traditional financial back-office systems, reduce costs, and enter new markets.
Many banks and asset management companies are piloting permissioned DeFi platforms that combine the efficiency of smart contracts with KYC/AML compliance, while also exploring permissionless public DeFi in a controlled environment. The automation and transparency of DeFi are expected to bring faster settlement speeds, round-the-clock markets, and new revenue opportunities, addressing long-standing inefficiencies in traditional finance. However, institutions still face significant challenges, primarily including regulatory uncertainty in the U.S., difficulties in technology integration, and market volatility, which somewhat limit the speed of adoption.
Overall, as of March 2025, the trend of institutional adoption of crypto assets is "cautious but accelerating." Traditional finance is no longer just a bystander but is carefully testing the waters in selected areas such as digital asset custody, on-chain lending, and tokenized bonds to gain tangible benefits. The next few years will be a critical period in determining how traditional finance and DeFi deeply integrate within the global financial system.
Paradigm Report — "The Future of Traditional Finance" (March 2025)
As a leading crypto venture capital fund, Paradigm surveyed 300 professionals from traditional financial institutions across multiple developed economies and released its latest report. Here are the key data points from the report.
Which areas contribute the most to the cost of financial services?
What cost-cutting strategies has your organization adopted in providing financial services?
Currently, about 76% of companies are involved in cryptocurrency.
About 66% of TradFi companies are collaborating with DeFi.
Currently, about 86% of companies are participating in blockchain and DLT.
Institutional Entry into the Crypto Market (2020–2024 Timeline)
2020 — Initial Attempts
Banks and financial institutions began to cautiously enter the crypto market. In mid-2020, the U.S. Office of the Comptroller of the Currency (OCC) clarified that banks could provide crypto asset custody services, opening the door for custodians like BNY Mellon (which announced digital asset custody services in 2021). The corporate treasury management sector also began to position itself, with MicroStrategy and Square making headlines by purchasing Bitcoin as a reserve asset, marking a boost in institutional confidence. Payment giant PayPal launched cryptocurrency buying and selling features for U.S. users at the end of 2020, bringing digital assets to millions of consumers. These initiatives marked the beginning of mainstream institutions viewing cryptocurrencies as a legitimate asset class.
2021 — Rapid Expansion
Driven by a bull market, the pace of institutional adoption of cryptocurrencies accelerated. Tesla invested $1.5 billion in Bitcoin, and Coinbase went public on Nasdaq in April 2021, becoming a key bridge between Wall Street and the crypto market. Investment banks responded to client demand, with Morgan Stanley beginning to offer Bitcoin funds to wealthy clients and JPMorgan restarting its crypto trading desk. In October, ProShares launched the first U.S. Bitcoin futures ETF (BITO), providing institutions with a regulated investment channel. Fidelity and BlackRock established dedicated digital asset departments. At the same time, Visa and Mastercard began using stablecoins for settlements (e.g., Visa piloting USDC settlements), demonstrating confidence in crypto payment systems.
2022 — Infrastructure Development in a Bear Market
Despite the downturn in the crypto market in 2022 (with the collapse of Terra and the bankruptcy of FTX), institutions continued to build infrastructure. BlackRock partnered with Coinbase in August 2022 to provide crypto trading services for institutional clients and launched a private Bitcoin trust fund, signaling a significant move from the world's largest asset management company. Traditional exchanges and custodians also expanded their digital asset services, with BNY Mellon beginning to offer crypto asset custody to select clients and Nasdaq launching a crypto custody platform. JPMorgan utilized blockchain for interbank transactions, with its Onyx division processing hundreds of billions of dollars in wholesale payments through JPM Coin. Meanwhile, the number of tokenization pilot projects increased, with companies like JPMorgan simulating DeFi transactions on public chains, including tokenized bonds and foreign exchange trading (Project Guardian). However, U.S. regulators reacted strongly to market volatility, leading some companies (like Nasdaq) to pause or slow down the launch of crypto products in late 2023, awaiting clearer regulations.
2023 — Institutions Return to the Market
At the beginning of 2023, institutional interest rebounded. By mid-2023, BlackRock applied for a Bitcoin spot ETF, followed by Fidelity, Invesco, and others, marking a significant turning point, especially after the SEC had previously rejected such applications multiple times. Traditional finance-supported crypto infrastructure was also officially launched, such as the EDX Markets digital asset exchange backed by Charles Schwab, Fidelity, and Citadel, aimed at providing a compliant trading venue for institutions. At the same time, a wave of tokenization of traditional assets emerged, with private equity giant KKR tokenizing part of its fund on the Avalanche chain, and Franklin Templeton migrating its tokenized money market fund based on U.S. Treasury bonds to a public blockchain. International regulators also began to provide clearer regulatory frameworks (the EU passed MiCA, and Hong Kong reopened crypto trading). By the end of 2023, the U.S. approved Ethereum futures ETFs, increasing market expectations for the approval of spot ETFs. The momentum for institutional adoption of crypto assets appeared more solid by the end of 2023, provided regulatory hurdles were cleared.
Early 2024 — Approval of Spot ETFs
In January 2024, the U.S. SEC approved the first Bitcoin spot ETFs (followed by the approval of Ethereum spot ETFs), ending years of delays. This approval became a watershed moment for the mainstreaming of crypto assets, allowing pension funds, registered investment advisors (RIAs), and conservative portfolios that previously could not hold crypto assets to enter the market. Within weeks, crypto ETFs saw a significant influx of funds, with investor participation notably increasing. During the same period, institutional crypto services continued to expand, including PayPal launching the PYUSD stablecoin and Deutsche Bank and Standard Chartered investing in digital asset custody startups. By March 2025, nearly all major U.S. banks, brokerages, and asset management companies had launched crypto-related products or established strategic partnerships in the field, marking a comprehensive entry of institutions into the crypto market since 2020.
TradFi's Perspective on DeFi (2023-2025)
The attitude of traditional finance (TradFi) towards decentralized finance (DeFi) gradually shifted between 2023 and 2025. From initial curiosity and caution to attempts to explore the efficiency advantages of DeFi in controlled environments, many institutions have recognized the importance of public blockchains. Although DeFi continued to operate normally during the market turmoil of 2022, showcasing its advantages of automation and transparency, compliance and risk issues led most institutions to prefer "permissioned DeFi" — that is, applying DeFi technology in closed or semi-closed environments. For example, JPMorgan's Onyx network launched JPM Coin to provide regulated stablecoin payment services for institutional clients, while Aave Arc introduced KYC certification mechanisms to allow qualified institutions to trade in decentralized liquidity pools. This strategy of "embracing technology but controlling participation" became the main approach for TradFi's response to DeFi before 2025.
Institutional DeFi Pilots
During the period from 2023 to 2025, several large financial institutions conducted DeFi pilots. JPMorgan's Onyx platform collaborated with the Monetary Authority of Singapore (MAS) on Project Guardian to conduct tokenized bond and foreign exchange trading on public blockchains, utilizing smart contracts for instant settlement. BlackRock launched the BUIDL fund at the end of 2023, tokenizing a U.S. Treasury money market fund and offering it to qualified investors through the Securitize platform, demonstrating how large institutions can leverage public blockchains within a compliance framework. Goldman Sachs' Digital Asset Platform (DAP) issued tokenized bonds and promoted digital repurchase transactions, while HSBC used the Finality blockchain platform for foreign exchange settlements. These pilots indicate that traditional financial institutions are exploring how to apply DeFi technology to core businesses such as payments, lending, and trading to enhance efficiency through a "learning by doing" approach.
VC-Supported Infrastructure
A batch of crypto infrastructure companies supported by venture capital and traditional financial firms is emerging, providing a bridge for institutions to enter DeFi. Custodians like Fireblocks, Anchorage, and Copper are building "institutional-grade" digital asset management platforms to help banks securely store and trade crypto assets while offering compliance tools for accessing DeFi protocols. Compliance technology companies such as Chainalysis and TRM Labs provide transaction monitoring and analysis, enabling banks to meet anti-money laundering (AML) requirements even when operating on public blockchains. Additionally, crypto brokers and fintech companies are reducing the complexity of DeFi; for example, crypto custodians offer "yield farming" or liquidity pool access services, allowing institutions to engage without directly managing on-chain operations. As wallets, APIs, identity verification, and risk management tools improve, the entry barriers for TradFi institutions into DeFi are gradually lowering. By 2025, decentralized exchanges (DEX) and lending platforms are expected to integrate institutional access to ensure that counterparties are verified. TradFi no longer views DeFi as the "untouchable Wild West," but rather as a financial innovation that can be cautiously utilized within a compliance framework. Large banks are becoming early adopters in controlled environments, recognizing that ignoring the growth of DeFi could leave them behind in financial development.
U.S. Regulatory Environment (and Global Comparison)
The ambiguity of U.S. regulation has hindered TradFi's advancement in the crypto space but has also created opportunities. In 2023, the U.S. Securities and Exchange Commission (SEC) took a hard stance, suing major exchanges for offering unregistered securities and proposing to classify many DeFi platforms as exchanges, making it difficult for institutions to operate in the DeFi space. Meanwhile, the U.S. Commodity Futures Trading Commission (CFTC) views Bitcoin and Ethereum as commodities and has fined DeFi protocol operators while advocating for a clearer regulatory framework. The U.S. Treasury Department is focusing on the anti-money laundering risks of DeFi, with a 2023 report indicating that the anonymity of DeFi could be exploited by illicit actors, potentially leading to future KYC requirements for DeFi platforms. In 2022, the U.S. Office of Foreign Assets Control (OFAC) sanctioned Tornado Cash, indicating that even decentralized code services cannot escape regulatory constraints. U.S. banking regulators (OCC, Federal Reserve, FDIC) issued guidance limiting banks' direct exposure to crypto assets, forcing institutions to participate in the crypto market more through regulated custodians and ETFs rather than directly using DeFi protocols.
As of March 2025, the U.S. has yet to pass comprehensive crypto regulations, but proposals regarding stablecoin regulation and the classification of securities versus commodities are in advanced discussions. In the future, U.S. regulation of stablecoins (e.g., whether to define them as new payment tools) and custody rules (such as the SEC's custody proposal) will determine the depth of TradFi institutions' involvement in DeFi. Due to regulatory uncertainty, U.S. TradFi institutions often limit their DeFi experiments to controlled "sandbox" environments or overseas subsidiaries, awaiting clearer regulations.
Europe — MiCA and Forward-Looking Rules
In contrast to the U.S., the European Union has established a comprehensive regulatory framework (MiCA - Markets in Crypto-Assets), which by 2024 will provide clear rules for the issuance of crypto assets, stablecoins, and service providers across member states. MiCA, along with the pilot regime for tokenized securities trading, offers greater innovation certainty for European banks and asset management companies. By early 2025, companies in Europe will know how to obtain licenses to operate cryptocurrency exchanges or wallet services, and guidelines for institutional stablecoins and even DeFi are being developed. This relatively clear regulatory environment has prompted TradFi's European branches to advance pilot projects for tokenized bonds and on-chain funds. For example, several EU commercial banks have issued digital bonds under regulatory sandbox programs and can legally handle tokenized deposits under supervision. The UK has also taken a similar approach: it has signaled a desire to become a "crypto hub" through tailored financial regulations — starting in 2025, the FCA is developing rules for cryptocurrency trading and stablecoins, and the Law Commission has recognized crypto assets and smart contracts in legal definitions. These initiatives may allow institutions based in London to deploy DeFi-based services more quickly than their U.S. counterparts (to a certain extent).
Asia — Regulatory Balance and Innovation
Singapore and Hong Kong provide a stark global contrast. The Monetary Authority of Singapore has implemented a strict licensing regime for cryptocurrency companies (in place since 2019) but is also actively experimenting with DeFi through public-private partnerships. Singapore's major bank, DBS Bank, launched a regulated cryptocurrency trading platform and even engaged in DeFi transactions (such as tokenized bond trading with JPMorgan). The approach of this city-state views licensed DeFi as a field to explore under supervision, reflecting the belief that controlled experiments can inform reasonable rule-making. After years of restrictions, Hong Kong reversed its stance in 2023, establishing a new framework to license virtual asset exchanges and allowing supervised retail cryptocurrency trading. With government support, this policy shift has attracted global cryptocurrency companies and encouraged banks in Hong Kong to consider offering digital asset services in a regulated environment. Other jurisdictions, such as Switzerland (where its DLT law allows for tokenized securities) and the UAE (where Dubai's VARA has established tailored crypto rules), further emphasize that the global regulatory attitude is shifting from cautious adaptation to actively promoting crypto finance.
Impact on DeFi Participation
For U.S. institutions, the fragmented regulatory landscape means that most direct participation in DeFi cannot be realized until compliant solutions emerge. We see U.S. banks insisting on using consortium blockchains or tokenized assets that comply with existing legal definitions. In contrast, in jurisdictions with clearer frameworks, institutions are increasingly willing to interact with DeFi-like platforms — for example, European asset management companies may provide liquidity to licensed lending pools, or Asian banks may use decentralized trading protocols for foreign exchange swaps internally, knowing that regulators are aware of the situation. The lack of unified global rules also presents challenges: an institution operating globally must coordinate strict rules in one region with opportunities in another. Many are calling for the establishment of international standards or safe harbors for decentralized finance to leverage its advantages (such as efficiency and transparency) without compromising financial integrity. In summary, regulation remains the biggest factor determining the pace of TradFi's participation in DeFi. By March 2025, progress is evident — the U.S. has approved ETFs, and global regulators are issuing tailored licenses — but much work remains to establish legal clarity that enables institutions to fully and widely embrace permissionless DeFi.
Key DeFi Protocols and Infrastructure Bridging TradFi
Many leading DeFi protocols and infrastructure projects are directly addressing the needs of traditional finance, creating entry points for institutional use:
Aave Arc (Institutional Lending Market): Aave Arc is a permissioned version of the popular Aave liquidity protocol, launched in 2022-2023 to meet institutional needs. It provides a private pool where only whitelisted participants verified through KYC can lend and borrow digital assets. By enforcing AML/KYC compliance (through whitelisted agents like Fireblocks) and only allowing pre-approved collateral, Aave Arc addresses a key requirement for TradFi — counterparty trust and regulatory compliance — while still offering the lending efficiency of DeFi based on smart contracts. This helps banks and fintech lenders utilize DeFi liquidity for secured loans without exposing themselves to the anonymity of public pools.
Maple Finance (On-Chain Capital Markets): Maple is an on-chain low-collateral institutional lending market, akin to a syndicate loan market on the blockchain. Through Maple, approved institutional borrowers (such as trading companies or mid-sized enterprises) can obtain liquidity from global lenders under agreed terms, assisted by "pool representatives" conducting due diligence. This addresses a gap in TradFi: low-collateral credit is often relationship-based and opaque, but Maple brings transparency and 24/7 settlement to such loans. Since its launch in 2021, Maple has issued hundreds of millions of dollars in loans, demonstrating how reputable companies can raise funds more effectively on-chain. For TradFi lenders, Maple's platform provides a way to earn stablecoin yields by lending to vetted borrowers, effectively mirroring the private debt market but with lower management fees. It showcases how DeFi can streamline loan issuance and servicing (such as interest payments) through smart contracts, thereby reducing management costs.
Centrifuge (Tokenization of Real-World Assets): Centrifuge is a decentralized platform focused on bringing real-world assets (RWA) as collateral into DeFi. It allows originators (such as trade finance, invoice factoring, and real estate lenders) to tokenize assets like invoices or loan portfolios into fungible ERC-20 tokens, which investors can finance through DeFi liquidity pools (Centrifuge's Tinlake). This mechanism essentially links TradFi assets with DeFi liquidity — for example, an invoice from a small business can be aggregated and funded by global stablecoin lenders. For institutions, Centrifuge provides a template to transform illiquid assets into investable on-chain instruments with transparent risk grading. By leveraging a global investor base on the blockchain, it addresses a core inefficiency in TradFi: limited access to credit for certain industries. By 2025, even large protocols like MakerDAO may use Centrifuge to join collateral, while TradFi companies are observing how this technology can lower capital costs and open new funding sources.
Ondo Finance (Tokenized Yield Products): Ondo Finance offers tokenized funds that allow cryptocurrency investors to access traditional fixed-income yields. Notably, Ondo has launched products like OUSG (Ondo Short-Term U.S. Government Bond Fund), which is fully backed by short-term Treasury bond ETFs, while USDY represents tokenized shares of a high-yield money market fund. These tokens are offered to qualified purchasers under Regulation D and can be traded on-chain around the clock. Ondo effectively serves as a bridge, packaging real-world bonds into DeFi-compatible tokens, allowing, for example, stablecoin holders to swap for OUSG and earn about 5% from Treasury bills, then seamlessly exit back to stablecoins. This innovation addresses an urgent issue faced by both TradFi and cryptocurrency: it brings the security and yield of traditional assets into the digital asset space and provides traditional fund managers with a new distribution channel through DeFi. The success of Ondo's tokenized Treasury bonds (with issuance reaching hundreds of millions of dollars) has prompted competitors and even existing firms to consider launching similar products, blurring the lines between money market funds and stablecoins.
EigenLayer (Re-staking and Decentralized Infrastructure): EigenLayer is a new protocol based on Ethereum (launched in 2023) that supports re-staking — reusing the security of staked ETH to secure new networks or services. Although still in its early stages, its significance for institutions lies in the scalability of infrastructure. EigenLayer allows new decentralized services (such as oracle networks, data availability layers, and even institutional settlement networks) to inherit Ethereum's security without a separate set of validators. For TradFi, this could mean that future decentralized trading or clearing systems can be built on existing trust networks (Ethereum) rather than starting from scratch. Institutional stakeholders are viewing EigenLayer as a potential solution to scale blockchain use cases with high security and lower capital costs. From a practical perspective, banks could one day deploy smart contract services (e.g., for interbank loans or foreign exchange) and use re-staking to ensure billions of dollars in staked ETH are protected, achieving levels of security and decentralization that are not possible on permissioned ledgers. EigenLayer represents the forefront of decentralized infrastructure; while TradFi has not yet used it directly, it may become the foundation for the next generation of institutional DeFi applications by 2025-2027.
These examples illustrate a broader point: the DeFi ecosystem is actively developing solutions to integrate the needs of TradFi — whether it be compliance (Aave Arc), credit analysis (Maple), exposure to real assets (Centrifuge/Ondo), or robust infrastructure (EigenLayer). This integration is bidirectional: TradFi is learning to use DeFi tools, while DeFi projects are adapting to meet the requirements of TradFi, forming a more mature and interoperable financial system.
Tokenization and RWA Outlook
One of the most direct intersections between traditional finance and the crypto world is the tokenization of real-world assets — bringing traditional financial instruments (such as securities, bonds, and funds) on-chain. As of March 2025, institutional participation in tokenization has moved beyond the proof-of-concept stage into actual product applications:
Tokenized Funds and Deposits
Several large asset management firms have launched tokenized funds. BlackRock's aforementioned BUIDL fund and Franklin Templeton's OnChain U.S. Government Money Fund (which records shares on a public blockchain) allow qualified investors to trade fund shares in the form of digital tokens. WisdomTree has launched a suite of blockchain-based funds (providing exposure to Treasury bills, gold, etc.) with the vision of enabling 24/7 trading and simplifying investor access. These initiatives are typically built under existing regulations (e.g., issuing private securities under exemptions), but they mark a significant shift — traditional assets are being traded on blockchain infrastructure. Some banks are even exploring tokenized deposits (regulated liability tokens) that represent bank deposits but can move on-chain, aiming to combine bank-level security with cryptocurrency-like speed. Each of these projects indicates that institutions view tokenization as a way to enhance liquidity and reduce settlement times for traditional financial products.
Tokenized Bonds and Debt
The bond market has seen early victories in tokenization. In 2021-2022, entities like the European Investment Bank issued digital bonds on Ethereum, with participants settling and custodizing bonds via blockchain rather than traditional clearing systems. By 2024, banks like Goldman Sachs and Santander facilitated bond issuances on their private blockchain platforms or public networks, indicating that even large debt issuances can be completed via DLT. Tokenized bonds promise near-instant settlement (T+0 instead of the typical T+2), programmable interest payments, and easier fractional ownership. For issuers, this can lower issuance and management costs; for investors, it can expand access and provide real-time transparency. Even government treasuries are beginning to explore using blockchain for bonds — for example, the Hong Kong government issued tokenized green bonds in 2023. The market size remains small (with on-chain outstanding bonds amounting to hundreds of millions), but growth is accelerating as legal and technical frameworks improve.
Private Market Securities
Private equity and venture capital firms are partially tokenizing traditionally illiquid assets (such as private equity funds or pre-IPO stocks) to provide liquidity to investors. Companies like KKR and Hamilton Lane are collaborating with fintech firms (Securitize, ADDX) to offer tokenized access to portions of their funds, allowing qualified investors to purchase tokens representing economic interests in these alternative assets. While the scope remains limited, these experiments point to a future where secondary markets for private equity or real estate could operate on the blockchain, potentially reducing investors' liquidity premium demands for such assets. From an institutional perspective, tokenization here is about expanding distribution and unlocking capital by allowing traditionally locked assets to be traded in smaller units.
Crucially, the tokenization trend is not limited to TradFi-led initiatives — DeFi-native RWA platforms are addressing the same issues from another angle. Protocols like Goldfinch and Clearpool (along with the previously mentioned Maple and Centrifuge) are enabling on-chain financing of real-world economic activities without waiting for large banks to take action. For example, Goldfinch funds real-world loans (such as those from emerging market fintech lenders) through liquidity provided by cryptocurrency holders, essentially acting as a decentralized global credit fund. Clearpool provides a market for institutions to launch unsecured lending pools under pseudonyms (with credit scores), allowing the market to price and finance their debt. These platforms often collaborate with traditional companies — for instance, the financial health of fintech borrowers in Goldfinch pools may be audited by third parties — creating a hybrid model of DeFi transparency and TradFi trust mechanisms.
Currently, the outlook for RWA tokenization is promising. With rising interest rates, the crypto market's demand for real-world asset yields is strong, further driving the tokenization of bonds and credit (as seen in Ondo's success). Institutions are attracted by the improved trading efficiency: tokenized markets can settle in seconds, operate around the clock, and reduce reliance on intermediaries like clearinghouses.
Industry predictions suggest that tens of trillions of real assets could be tokenized over the next decade, provided regulatory issues are resolved. By 2025, we have already seen initial network effects — for example, tokenized government bonds can serve as collateral in DeFi lending protocols, meaning an institutional trader can use tokenized bonds to borrow stablecoins for short-term liquidity management, which would be impossible in traditional markets. This composability of on-chain assets will fundamentally change how financial institutions manage collateral and liquidity.
Overall, tokenization is narrowing the gap between TradFi and DeFi, potentially more directly than any other trend. It allows traditional assets to enter the DeFi ecosystem (providing stable on-chain collateral and cash flow) while also offering TradFi institutions a secure experimental environment (through permissioned blockchains or known legal structures). In the coming years, we may see larger-scale pilots — for example, major stock exchanges launching tokenized trading platforms, and central banks exploring wholesale CBDCs (central bank digital currencies) compatible with tokenized assets, further solidifying the future role of tokenization in the financial industry.
Challenges and Strategic Risks of TradFi Entering DeFi
Despite the immense opportunities, traditional financial institutions face a range of challenges and risks when integrating DeFi and crypto assets:
Regulatory Uncertainty: The lack of clear and consistent regulations is the biggest risk. If banks use DeFi protocols that are later deemed illegal securities exchanges or involve unregistered asset trading, they may face enforcement risks. Regulatory differences across countries further complicate the cross-border use of crypto networks.
Compliance and KYC/AML: DeFi platforms on public blockchains often allow for anonymous transactions, which conflicts with banks' KYC/AML (anti-money laundering) obligations. How to implement compliance on the blockchain (e.g., whitelist mechanisms, on-chain identity verification, compliance oracles) is still being explored, and compliance risks make TradFi more inclined toward permissioned or regulated DeFi solutions.
Custody and Security: Private key management is a significant risk (loss or theft can lead to irretrievable assets). Vulnerabilities in DeFi smart contracts or hacking incidents also raise concerns for institutions, many of which rely on third-party custodians or self-built cold storage solutions, but these still lack comprehensive insurance.
Market Volatility and Liquidity Risks: The cryptocurrency market is known for its extreme volatility. Institutions providing liquidity to DeFi pools or holding cryptocurrencies on their balance sheets must endure significant price fluctuations that could impact earnings or regulatory capital. Additionally, DeFi market liquidity can evaporate quickly during crises; if users of a protocol default (e.g., due to under-collateralized loan failures), institutions may struggle to unwind large positions without slippage and could even face counterparty risks. This unpredictability starkly contrasts with the more controlled volatility and central bank support found in traditional markets.
Integration and Technical Complexity: Integrating blockchain systems with traditional IT infrastructure is both complex and costly. Banks must upgrade systems to interact with smart contracts and manage 24/7 real-time data, which is a daunting task. Moreover, there is a talent gap — assessing DeFi code and risks requires expertise, meaning institutions need to hire or train specialists in a competitive talent market. These factors lead to high initial entry costs.
Reputational Risks: Financial institutions must consider public and client perceptions. Engaging in cryptocurrency can be a double-edged sword: while innovative, it may raise concerns among conservative clients or board members, especially following events like exchange collapses or institutions being involved in DeFi hacks or scandals. Many institutions proceed cautiously, participating in behind-the-scenes pilots until they are confident in their risk management. Reputational risks also extend to unpredictable regulatory narratives — negative comments from officials about DeFi could cast a shadow over related institutions.
Legal and Accounting Challenges: There are unresolved legal issues regarding the ownership and enforceability of digital assets. If a bank holds tokens representing loans, is it legally recognized as owning those loans? The lack of established legal precedents for smart contract-based agreements increases uncertainty. Additionally, the accounting treatment of digital assets (though improved, with new standards allowing fair value accounting before 2025) has historical legacy issues (e.g., impairment rules) and higher capital requirements for cryptocurrencies from regulators (Basel proposals classify unsecured cryptocurrencies as high risk). From a capital perspective, these factors may make holding or using cryptocurrencies economically unattractive.
In the face of these challenges, many institutions have adopted strategic risk management approaches: starting with small-scale pilot investments, using subsidiaries or partners to test the waters, and proactively collaborating with regulators to achieve favorable outcomes. They are also contributing to industry alliances to establish compliance DeFi standards (for example, proposals for embedding identity tokens or "DeFi passports" for institutions). Overcoming these barriers is crucial for broader adoption; the timeline will largely depend on regulatory transparency and whether crypto infrastructure continues to mature to meet institutional standards.
2025-2027 Outlook: Scenarios for the Integration of TradFi and DeFi
Looking ahead, the degree of integration between traditional finance and decentralized finance over the next 2-3 years may take various trajectories. We outline bullish, bearish, and base case scenarios:
Bullish Scenario (Rapid Integration): In this optimistic scenario, by 2026, regulatory clarity will significantly improve. The U.S. may enact a federal law that delineates categories of crypto assets and establishes a regulatory framework for stablecoins and even DeFi protocols (perhaps creating new charters or licenses for compliant DeFi platforms). With clear rules, major banks and asset management firms will accelerate their crypto strategies — directly offering crypto trading and yield products to clients and using DeFi protocols for certain backend functions (such as overnight financing markets using stablecoins). Regulation of stablecoins could particularly serve as a catalyst: if USD-backed stablecoins receive official approval and insurance, banks could begin to use them on a large scale for cross-border settlements and liquidity, embedding stablecoins into traditional payment networks. Improved technological infrastructure will also play a role in the bullish scenario: Ethereum's planned upgrades and Layer 2 scaling will make transactions faster and cheaper, with robust custody/insurance solutions becoming standard. This will enable institutions to deploy into DeFi with lower operational risks. By 2027, we could see a significant portion of interbank lending, trade financing, and securities settlement occurring on hybrid decentralized platforms. In a bullish scenario, even ETH staking integration would become common — for example, corporate finance departments might treat staked ETH as a yield-generating asset (almost like digital bonds), adding a new asset class to institutional portfolios. The bullish scenario suggests integration: traditional financial companies not only invest in crypto assets but also actively participate in DeFi governance and infrastructure, contributing to the shaping of a regulated, interoperable DeFi ecosystem to complement traditional markets.
Bearish Scenario (Stagnation or Contraction): In a bearish scenario, regulatory crackdowns and adverse events severely hinder integration. Perhaps the SEC and other regulators will double down on enforcement without providing new pathways — effectively prohibiting banks from engaging with open DeFi and limiting crypto exposure to a few approved assets. In this case, by 2025/2026, institutions will largely remain on the sidelines: they will stick to using ETFs and a few licensed networks, but will avoid public DeFi due to legal concerns. Additionally, one or two high-profile failures could undermine sentiment — for example, a major stablecoin collapse or a systemic DeFi protocol hack leading to losses for institutional participants, reinforcing the narrative that the space is too risky. In a bearish scenario, global fragmentation intensifies: markets like the EU and Asia continue to integrate crypto, while the U.S. lags behind, causing American companies to lose competitiveness or lobby against crypto to create a level playing field. If TradFi perceives DeFi as a threat and lacks viable regulation, they may even actively push back against DeFi, potentially slowing innovation (for instance, banks might only promote private DLT solutions and prevent clients from engaging in on-chain finance). Essentially, the bearish scenario represents a stagnation of the TradFi-DeFi synergy, with cryptocurrencies remaining a niche market or secondary field for institutions until 2027.
Base Case (Gradual, Steady Integration): The most likely scenario lies between these two extremes — ongoing gradual integration with steady but incremental progress. In this base case outlook, regulators will continue to issue guidance and some narrow rules (for example, stablecoin legislation may pass in 2025, the SEC may refine its stance, or perhaps exempt certain institutional DeFi activities or approve more crypto products on a case-by-case basis). There will be no comprehensive reforms, but some clarity will emerge each year. In turn, traditional financial institutions will cautiously expand their crypto operations: more banks will offer custody and execution services, more asset management firms will launch crypto or blockchain-themed funds, and more pilot projects will go live, connecting bank infrastructure to public chains (especially in areas like trade finance documentation, supply chain payments, and secondary market trading of tokenized assets). We may see consortium-led networks selectively interconnect with public networks — for example, a group of banks could operate a permissioned lending protocol that connects to public DeFi protocols for additional liquidity when needed, all under agreed-upon rules. In this scenario, stablecoins may be widely used as a settlement medium by fintech companies and some banks, but may not yet replace major payment networks. ETH staking and crypto yield products will begin to appear on a small scale in institutional portfolios (for example, pension funds allocating a few basis points to yield-generating digital asset funds). By 2027, in the base case, the integration of TradFi x DeFi will be significantly deeper than today — measured by 5-10% of trading volume or loans occurring on-chain in certain markets — but it will still operate in parallel with traditional systems rather than completely replacing them. Importantly, the trend is upward: the success of early adopters will persuade more conservative peers to test the waters, especially in the face of increasing competitive pressure and client interest.
Key Drivers
In all scenarios, several key factors will influence the outcomes. Regulatory developments are crucial — any initiative that provides legal clarity (or conversely, new restrictions) will immediately alter institutional behavior. The development of stablecoin policy is particularly critical: safe, regulated stablecoins could become the backbone of institutional decentralized finance transactions. Technological maturity is also a driving factor — ongoing improvements in blockchain scalability (through Ethereum Layer 2 networks, alternative high-performance chains, or interoperability protocols) and tools (better compliance integration, private trading options, etc.) will make institutions more comfortable. Additionally, macroeconomic factors may play a role: if traditional yields remain high, the urgency to seek decentralized finance yields may be lower (reducing interest), but if yields decline, the additional yield points of decentralized finance may again become attractive. Finally, market education and historical records will also play a role — each year that decentralized finance protocols demonstrate resilience, every successful pilot (for example, a major bank smoothly settling $100 million via blockchain) will build trust. By 2027, we expect discussions to shift from "whether" to use decentralized finance to "how" to use decentralized finance, much like how cloud computing was gradually adopted after initial skepticism in banking. Overall, in the coming years, we may see traditional finance and decentralized finance move from cautious engagement to deeper collaboration, with the pace of development determined by the interaction between innovation and regulation.
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