How DeFi is reshaping the financial markets

Cryptocurrencies grew exponentially over the last decade, reaching a market capitalisation of over $2.2tn by the end of 2021. One of the biggest contributors to this exponential growth was the decentralised finance (DeFi) sector, which aims to provide permissionless and fully automated banking services.

Strong fundamental growth but mixed price action results
Total-value-locked (TVL) represents the sum of all assets deposited in DeFi protocols. According to data from Defillama, TVL grew from just over $18bn at the beginning of 2021 to $240bn by year end, a 1,200 per cent increase. Although TVL is a useful metric to gauge the overall DeFi market, it does not necessarily lead to outperformance. In the previous year, only Curve was able to outperform the price increase of Ether. Compared to the TVL of $24Obn, DeFi exposure represents only 0.016 per cent of global banks’ assets under management, indicating that global adoption is truly at its beginning.

Decentralised exchange trading volume surges
Decentralised exchanges (DEXs), one of the largest contributors to DeFi growth, reported more than $1 trillion in trade volume over the last year, an 858 per cent increase from 2020. Volume on DEXs jumped by a large percentage due to several factors: One of them is their unique and permissionless nature, allowing platforms to list a vast array of tokens utilising an automated market maker (AMM), a novel asset pricing algorithm. AMMs allow digital assets to be traded automatically by using liquidity pools instead of traditional orderbooks where buyers are matched with sellers. Although AMM algorithms are a breakthrough in digital asset pricing, trading against liquidity pools can present its challenges, as unscrupulous token issuers can drain liquidity pool funds, sending a token’s value to zero.

Another disadvantage comes with the transparent nature of public blockchains as anyone can view transactions to be confirmed, and users can suffer from being front run, adversely affecting their execution price.

As one of the few market makers for DEXs, iBloxx recently rolled out an algorithm to prevent frontrunning, allowing fair order execution for our clients. One of the biggest hurdles to achieving widespread institutional adoption is compliance. Initiatives like Aave Arc will likely open up DeFi access to institutional players by allowing them to participate in permissioned lending and borrowing with know your customer (or KYC) compliant counterparties. Such frameworks will cater to the need of a financial institution that has to meet higher regulatory standards.

DeFi projects in the UAE
Many DeFi projects look towards the Gulf countries as a decentralised finance hub. This is largely attributed to the focused attention that government officials give to innovation. Last year, DMCC announced its crypto centre to attract companies working within the industry. Crypto Oasis was established and over 500 organisations are already operating out of the region.

Ralf Glabischnig, founder of Crypto Oasis, says: “We have decided to bring our Crypto Valley experience to the Middle East because we believe in the potential of this region. Dubai is the heart of the Crypto Oasis, the local version of Crypto Valley.”

Abu Dhabi Global Market also made extensive moves since 2018 to accelerate global blockchain and crypto development while the UAE’s Securities and Commodities Authority issued far-reaching regulations on crypto assets in late 2020. Establishing a regulated environment will drive sustainability of DeFi protocols and enable institutional adoption as ambiguity and lack of clarity hold institutions back far more than established rules and regulations.

Domenik Maier is the CEO of iBLOXX Proprietary Trading DMCC, a company focused on artificial intelligence and algorithmic trading with offices in Dubai, Liechtenstein and Bulgaria. Apart from Proprietary Trading, iBLOXX provides market making services for token issuers to provide liquid- and orderly markets that are actively traded.