The following article is a guest article by Vincent Maliepaard, Marketing Director of IntoTheBlock.
As Bitcoin surged past record highs earlier this year due to institutional interest, many expected a similar surge in the decentralized finance (DeFi) space. With more than $100 billion in DeFi Total Value Locked (TVL), it was a great time for institutions to jump in. However, the predicted flood of institutional capital to Defay Slower than expected. In this article, we will explore the key challenges hindering enterprise DeFi adoption.
regulatory barriers
Regulatory uncertainty is perhaps the most important obstacle for institutions. In large markets such as the United States and the European Union, the unclear classification of cryptoassets – especially stablecoins – complicates compliance. This ambiguity increases costs and prevents institutional interference. Some jurisdictions, viz Switzerland, Singaporeand United Arab Emirateshave adopted clearer regulatory frameworks, which have attracted early adopters. However, the lack of global regulatory uniformity complicates cross-border capital allocation and makes institutions hesitant to confidently enter the DeFi space.
In addition, regulatory frameworks such as Basel III impose strict capital requirements on financial institutions holding crypto assets, further discouraging direct participation. Many institutions choose to obtain indirect exposure through subsidiaries or specialized investment vehicles to circumvent these regulatory restrictions.
However, Trump's office is expected to prioritize innovation over restrictions and potentially change US DeFi regulations. Clearer guidelines could lower compliance barriers, attract institutional capital, and position the United States as a leader in the space.
Structural barriers beyond compliance
While regulatory issues often dominate the conversation, other structural barriers also prevent enterprise DeFi adoption.
One of the prominent issues is the lack of proper wallet infrastructure. Retail users with wallets like Metamaskbut institutions need secure and compliant solutions, e.g Fire blocksto ensure proper custody and governance. Additionally, the need for seamless on- and off-ramps between traditional finance and DeFi is critical to reduce friction in capital flows. Without a strong infrastructure, institutions struggle to move between these two financial ecosystems effectively.
DeFi infrastructure requires developers with very specific skills. The skill set required is often different from traditional financial software development and can also vary from blockchain to blockchain. Institutions looking to deploy cash-only strategies may need to deploy to multiple blockchains, which can increase overhead and complexity.
Fragmentation of liquidity
Liquidity is one of DeFi's most persistent issues. Fragmented liquidity in various decentralized exchanges (DEX) and lending platforms carries risks such as slippage and bad debt. It is critical for institutions to execute large trades without significantly affecting market prices, and shallow liquidity makes this difficult.
This can create situations where institutions are forced to transact on multiple blockchains to complete a transaction, which adds complexity and increases risk vectors to the strategy. To attract institutional capital, DeFi protocols must create deep and centralized liquidity pools that can support very large transactions.
A good example of liquidity fragmentation can be seen with the evolution of the Layer 2 (L2) blockchain landscape. As it becomes cheaper to build and transact on the L2 blockchain, liquidity has been removed from the Ethereum mainnet. This has reduced liquidity on the mainnet for certain assets and transactions, thus reducing the size of institutions' deployments.
While technologies and infrastructure improvements are being developed to solve many of the issues related to liquidity sharing, this has been a key barrier to institutional deployment. This is especially true for deployments in L2s where liquidity and infrastructure issues are greater than in the core network.
Risk management
Risk management is critical for institutions, especially when dealing with a nascent sector like DeFi. Beyond technical security, which mitigates hacks and exploits, institutions must understand the economic risks inherent in DeFi protocols. Protocol vulnerabilities, whether in the domain of governance or technonomics, can expose institutions to significant risks.
To compound these complexities, the lack of enterprise-sized insurance options to cover large loss events such as protocol abuse often means that only assets intended for high R/R are allocated to DeFi. This means that lower-risk funds that may be exposed to BTC are not deployed in DeFi. Additionally, liquidity constraints—such as the inability to exit positions without causing major market impacts—make effective exposure management challenging for institutions.
Institutions also need to be complex Liquidity risk assessment toolsincluding stress testing and modeling. Without these, DeFi will remain too risky for institutional portfolios that prioritize stability and the ability to deploy or unwind large capital positions with minimal exposure to volatility.
The Path Forward: Building Institutional-Grade DeFi
To attract institutional capital, DeFi must evolve to meet institutional standards. This means developing enterprise-class wallets, creating seamless capital ramps, offering structured incentive programs, and implementing comprehensive risk management solutions. Addressing these areas paves the way for DeFi to mature into a parallel financial system, one capable of supporting the scale and complexity required by large financial players.
By building the right infrastructure and aligning with organizational needs, DeFi has the potential to transform traditional finance. With these developments, DeFi will not only attract more institutional capital, but also establish itself as an essential component of the global financial ecosystem, ushering in a new era of financial innovation.
This article is based on IntoTheBlock's latest research article About the future of enterprise DeFi
