According to Morgan Stanley, the exponential growth seen in decentralised finance (DeFi) in recent years may be set to stall due to roadblocks such as legislation and overcollateralization. The central bank’s easing programmes compelled investors to seek new sources of return, boosting the total assets locked in DeFi to roughly around $200 billion in 2022 up from $600 million in 2020, according to the bank. It went on to say that DeFi initiatives offer significant rewards in order to recruit users, which increases the platform’s worth.
DeFi refers to lending, trading, and other financial transactions that take place on a blockchain without the use of traditional middlemen. While the idea of no middlemen may sound enticing, and proponents tout DeFi as a method to improve the present financial system, Morgan Stanley says it hasn’t seen much evidence that DeFi protocols are more efficient than the current system.
Rather, “Defi protocols appear to us as a mechanism to attract cash flow to enrich protocol operators,” according to the research. Because anonymity is a core component of DeFi, it is vulnerable to hacking and financial crime. According to the bank, institutional adoption will be limited because of a lack of know-your-client (KYC) and anti-money laundering (AML) information. The KYC/AML standards will “push DeFi to be more centralised,” according to the report.
KYC refers to the process of identifying and validating a client’s identification, which is used to prevent fraud and money laundering. According to the note, “Overcollateralization in lending/borrowing means DeFI lending doesn’t boost the money supply (for the same cryptocurrency), which means DeFi will be harder to recognise as an alternative to the present fractional reserve banking model without centralization.” As a result, the bank anticipates that DeFi will stay modest in the coming years.
Regulators have been slow to catch up with the DeFi boom because protocols aren’t centralised and don’t have to be registered, but monitoring will increase, according to the note.