Financial institutions in the region need to keep their eye on this emerging game changer. Here are the why’s and how’s…

A recent whitepaper by Oliver Wyman, DBS, Onyx and SBI Digital Asset Holdings offers insights into use cases of ‘Institutional Decentralized Finance (DeFi)’ that financial institutions in the region.

According to the proponents, “building full-scale financial services with institutional decentralized finance (Institutional DeFi) can bring financial institutions substantial cost savings, if they have a participation strategy ready to capture its value.”

Apparently, existing DeFi protocols are “not designed for financial services, and thus need safeguards such as identity solutions to enable trust and compliance,” say the authors.

A safer alternative, defined as Institutional DeFi, combines the power and efficiency of DeFi protocols to tokenized real-world assets with a level of safeguards to meet regulatory and customer requirements.

Three whitepaper takeaways
While the concept of institutional DeFi is in its early days, the whitepaper has sought to lay the foundations for global institutional liquidity pools that “enable increased trading velocity, greater transparency, higher efficiencies, lower settlement risks, and economies of scale.

With bold thinking, commitment to innovation, and constructive partnerships, there will be a vast array of possibilities to reshape and reimagine the boundaries of financial market infrastructure, according to the authors.

Given the transformative potential of Institutional DeFi, financial institutions are advised to develop a playbook for getting the most value out of it. Keeping in mind that Institutional DeFi will likely vary by jurisdiction and market structure, the authors suggest three ways that financial institutions should start responding now:

    • Develop a house view on the DeFi implications across business portfolios

      Institutional DeFi efforts are already happening and starting to bring change to the finance industry. The road ahead remains unclear, and the degree of change is likely to vary by business and market segment.

      With all this uncertainty, it is important that industry participants take a scenario-based approach that enables them to examine multiple different potential futures while maintaining analytical discipline by requiring each scenario to use coherent and integrated assumptions.

      Based on these scenarios, firms could form a house view of the future and assess its implications for their business portfolios, profitability, funding costs, and the like. To get to that view, firms could consider three broad questions:

      • What are the future scenarios shaping the industry and key watch points or triggers?
      • What are the implications for clients and competitors?
      • What does this mean for our portfolio and financials?

      Once they form their view of the future, firms could perform an impact analysis to assess the specific implications on their current business and financials while agreeing on the key watch points to monitor to potentially accelerate or pivot their responses. Depending on the scenarios used, regulatory developments, and the firm’s current position, implications could take on varying degrees of scale and urgency. Scenario analyses should aid senior management to align on a view of the future and implications for the business. Based on this, firms can then determine if, where, and how to participate.

    • Decide on a participation strategy to adapt existing business and embrace new opportunities enabled by Institutional DeFi

      What role should a firm play in the Institutional DeFi space? Firms should look not only to transform existing end-to-end processes with new technology but also think about creating new businesses and new business models. As strategy is all about trade-offs, being clear on the right trade-offs is critical to aligning an institution and putting in place guardrails to ensure that where and how it participates is in line with its risk appetite and other internal considerations. To think through this, firms may want to consider several questions that can help them agree on a bespoke participation strategy.

      Formulating a firm’s participation strategy requires an understanding of clients’ starting points, including their DeFi IQ and willingness to use new technologies. Sell-side firms could guide clients through the adoption journey from a solution-driven perspective, which includes thoroughly understanding clients’ pain points, replicating traditional offerings in a new digital format, and building tooling to assist smooth adoption while also testing innovative new products, like intra-day liquidity, and new business models, such as automated market making

      The quality of the new offerings is critical to win the confidence from end-clients. Firms can consider taking gradual approaches to focus on products that are not overly complex and/or markets requiring efficiency improvement on day one, such as illiquid asset classes.

    • Get the organization ready to fulfil its ambitions by developing the required capabilities To facilitate this, three areas of capabilities need to be built.

      • Design organizational structure to deliver on the ambition
        The level of organizational support and engagement determines the feasibility of achieving such transformative opportunities. Possibilities including varying extents of centralization, such as focusing on one business unit only, or stretching across the entire business.
      • Choose the right delivery model given internal capabilities, risk appetite
        When determining the delivery approach, ensure that proofs of concept are done with scaling in mind; working with like-minded partners to build, test, and evolve the proposition based on lessons learned; and taking a co-creative approach with clients and regulators; being clear on what is needed from regulators to make pilots a scalable reality. External collaborations would require due diligence to ensure suitability of partners and alignment on new solution. Some notable delivery approaches depend on a firm’s level of belief and participation strategy — in-house builds; use of vendors; or leveraging industry consortiums.
      • Develop the right talent
        Build teams with professionals from a variety of backgrounds while at the same time working to right-skill their existing teams. To attract the right talent, firms need to complement talent strategies with branding efforts to ensure they have a compelling ‘digital brand’ aligned with their ambitions. At the same time, existing talent need to be refreshed with internal “mindset change” efforts, such as training and incentive programs.

        To help drive change, build specialist task forces that can play a role in driving proofs of concept and also act as a catalyst for reshaping the culture and right-skilling teams. These task forces can be complemented by other efforts depending on a firm’s starting point, including driving organization-wide education initiatives, running or supporting hackathons and other internal accelerators, and driving co-creation workshops to apply DeFi and identify challenges.

Strategizing now for an imminent trend

Two key factors of institutional DeFi play a crucial role in shaping how the framework will prove its relevance:

  1. Firstly, regulated institutions need to act as “trust anchors”, screening and verifying the credentials of participating entities to ensure transactions are executed in a compliant manner.
  2. Secondly, an agreed set of technical standards around business logic and token standards is needed for interoperability.

To unlock the full potential of Institutional DeFi, broader efforts and joint actions are needed from regulators, financial intermediaries, clients, and other third parties, including DeFi communities, to address legal and regulatory uncertainties, establish shared standards, and seek to forge a common vision of how the market should operate.