DeFi degens and finance bros: Let’s be friends

Crypto and traditional finance have more in common than they might think, and both would benefit by taking each other more seriously

OPINION
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Olha Povozniuk/Shutterstock modified by Blockworks

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Traditional banks and crypto have not had the most stellar years. 

After a tumultuous wave of collapses and centralized downfalls, crypto projects now face intense and seemingly unreasonably harsh regulatory scrutiny. And as the US Federal Reserve seizes and sells off yet another bank in an ongoing wave of bank failures, legacy institutions now find their risk assessment mechanisms placed under the microscope.

So what do these industries have to learn from each other, if anything at all? 

If you ask investors in either sector, they would likely tell you that this industry-wide turbulence stems from risk assessment and a lack of diversification. That much is certainly true. 

But they’d also likely tell you that the scenarios unfolding in crypto and traditional finance are totally unrelated.

And they would be right, to an extent. Each sector certainly has its own inherent risk factors simply based on how they operate and broadly handle investments and finances. But crypto and traditional finance both adopting a “do as I say, not as I do” mentality toward diversification as a key risk mitigator means they can’t effectively practice it themselves.

That closed dialogue on risk creates a real silo between TradFi and crypto communities, isolating themselves from each other based on their own presumptions. 

Not every risk in traditional investing and crypto investing is mutually exclusive, and hubris from investors and banks can create ignorance toward the nuances in each sector that only stepping out of their risk echo chambers can solve.

The key disconnects

By and large, traditional institutions still view crypto as an unruly, unwieldy industry largely run by con artists. And many projects haven’t done themselves any favors in rectifying that. But because institutions don’t necessarily want to miss out on crypto’s potential, they still often enter the space, just in the most basic way possible.

A bank deliberating adopting crypto, for instance, might think it’s sufficiently diverse to add bitcoin to its balance sheet and call it a day. Conversely, it might offer crypto investments to its clientele through only one source and as an afterthought to its other investment services. That’s not a sufficient amount of diversification.

In crypto, younger and technically-savvy investors generally tend to dismiss the virtues of traditional finance, naively assuming that, in understanding the crypto ecosystem, they must be experts on the broader financial market too. Because of how crypto and DeFi operate, investors often think that the industry is not beholden to the same rules of gravity as traditional markets, and therefore don’t take them as seriously.

This lack of understanding on both sides occurs in the middle of many crypto and DeFi platforms’ plans to woo legacy institutions and large-scale liquidity providers to give the industry a certified seal of approval. But for that to happen, DeFi can no longer be a fly-by-night market — it does actually require some forethought and long-term strategy, which it can and should learn from traditional finance itself.

Fostering real collaboration

That unwillingness of actors in both sectors to step out of their respective risk echo chambers is part of the reason why constant calls for “bridging” between these two industries come across as hollow. Both sides are not usually referring to meaningful collaboration, they simply want one industry to acquiesce to the rules and operations of another.

Consolidating the disconnects between these sectors requires both to understand the blind spots of investors and institutions in both sectors. That is non-negotiable.

For example, DeFi investors can have a hard time grasping the amount of specialization and custodial aspects in traditional institutions, given the relative self-reliance required to participate in decentralized markets. Crypto companies champion doing your own research when it comes to  technical and financial aspects, but they don’t really hold your hand through this research.

DeFi as a whole also typically moves at a much faster pace than traditional markets, and this price action volatility can sideswipe investors and institutions more accustomed to the relatively predictable pace of traditional finance. Simply put, decentralized markets don’t close on the weekend or holidays. And while it would be useful to have an on-chain 24-hour market on real-world assets, that’s unlikely to happen at this point.

Read more from our opinion section: The death of free money won’t stop crypto

Institutions and experienced financial investors adopted long-term risk management strategies that have stood the test of time. Yet when it comes to DeFi, they view purchasing crypto as a substantial move into decentralized, and therefore unknown, territory. Here, institutional actors must learn from DeFi natives how to properly diversify their portfolios, and treat digital assets with the same sophistication and nuance given to traditional markets instead of a singular stock option.

DeFi natives, then, should step out of their comfort zone by taking a page out of finance’s handbook on tried-and-true risk management. While still only in its infancy, investors native to the new financial ecosystem have yet to fully maximize its potential, and they can only do that by going beyond the scope of what is applicable to only decentralized ecosystems.

On the regulatory front, DeFi has much less to adhere to in terms of rules and best practices, at least for the time being. But with more regulations in the pipeline, using the traditional financial sector as an example of adjusting an industry to new mandates would be helpful.

Contending both ends of these dynamic markets requires a deep dive into seeing what they have to offer each other in terms of investment knowledge. Reworking skills and strategies to suit the unique purposes of DeFi and traditional finance can maximize diversification and, in turn, concretely impact risk management capabilities. 

Encouraging knowledge sharing is just the first step — but it’s perhaps the most critical one to take.



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