The next few years will be a critical period to determine whether TradFi and DeFi can deeply integrate into the global financial system.

Author: insights4.vc

Translation: Deep Tide TechFlow

Since 2020, major banks, asset management companies, and payment institutions in the United States have gradually shifted from a cautious wait-and-see approach to actively investing, collaborating, or launching related products in the cryptocurrency space.

By early 2025, institutional investors are expected to hold about 15% of the Bitcoin supply, with nearly half of hedge funds beginning to allocate digital assets.

Key trends driving this integration include: the launch of regulated crypto investment tools (such as the first U.S. spot Bitcoin and Ethereum ETFs in January 2024), the rise of tokenization of real-world assets (RWA) on the blockchain, and the increasing use of stablecoins by institutions for settlement and liquidity management.

Institutions generally view blockchain networks as effective tools to simplify traditional back-end systems, reduce costs, and enter new markets.

Many banks and asset management companies are piloting permissioned decentralized finance (DeFi) platforms that combine the efficiency of smart contracts with KYC (Know Your Customer) and AML (Anti-Money Laundering) compliance.

At the same time, they are also exploring permissionless public DeFi in a controlled manner. The strategic logic is clear: DeFi's automated and transparent protocols can achieve faster settlements, round-the-clock market operations, and new revenue opportunities, thereby addressing the long-standing inefficiencies in traditional finance (TradFi).

However, significant resistance still hinders this process, including regulatory uncertainty in the U.S., challenges in technological integration, and market volatility, which suppress the speed of adoption.

Overall, as of March 2025, the interaction between traditional finance and the crypto space shows a cautious but gradually accelerating trend. Traditional finance is no longer merely a bystander in the crypto space but is beginning to cautiously engage in some use cases with tangible advantages (such as digital asset custody, on-chain lending, and tokenized bonds). The next few years will be crucial in determining whether TradFi and DeFi can deeply integrate into the global financial system.

Paradigm Report - "The Future of Traditional Finance" (March 2025)

As a leading crypto venture capital fund, Paradigm investigated 300 traditional finance (TradFi) practitioners from multiple developed economies in its latest report. Here are some of the most interesting statistics and insights from the report.

Which areas contribute the most to the cost of providing financial services?

What cost-cutting strategies has your organization employed in providing financial services?

Currently, about 76% of companies are involved in cryptocurrency.

About 66% of traditional finance companies are associated with decentralized finance (DeFi).

Approximately 86% of companies are currently involved in blockchain and distributed ledger technology (DLT).

Timeline of Institutional Entry into Crypto (2020-2024)

2020 - Initial Exploration:

Banks and traditional financial institutions began tentatively entering the crypto market. In mid-2020, the Office of the Comptroller of the Currency (OCC) in the U.S. clarified that banks could custody crypto assets, opening the door for custodians like BNY Mellon.

BNY Mellon subsequently announced in 2021 that it would offer digital asset custody services. That same year, corporate finance departments also began to venture into the crypto space: MicroStrategy and Square made headlines with their Bitcoin purchases, positioning it as a reserve asset, marking a boost in institutional confidence.

Payment giants also began to take action—PayPal launched cryptocurrency buying and selling services for U.S. customers at the end of 2020, bringing digital assets to millions of users. These initiatives marked the beginning of mainstream institutions viewing cryptocurrencies as a legitimate asset class.

2021 - Rapid Expansion:

As the bull market fully unfolded, 2021 witnessed an acceleration of integration between traditional finance and the crypto space. Tesla's purchase of $1.5 billion in Bitcoin and Coinbase's listing on Nasdaq in April 2021 became significant bridges connecting Wall Street and the crypto realm.

Investment banks also responded to client demand: Goldman Sachs revived its crypto trading desk, and Morgan Stanley began offering access to Bitcoin funds for wealthy clients. In October of the same year, the first Bitcoin futures ETF in the U.S. (ProShares BITO) officially launched, providing institutions with regulated crypto investment tools.

Major asset management firms like Fidelity and BlackRock also began to establish dedicated digital asset divisions. Additionally, Visa and Mastercard formed partnerships with stablecoins (such as Visa's USDC pilot project), demonstrating confidence in crypto payment networks.

The report clearly outlines how traditional finance transitioned from initial exploration to rapid expansion, laying the groundwork for further integration of crypto and traditional finance in the coming years.

2022 - Bear Market and Infrastructure Development:

Despite the downturn in the crypto market in 2022 (marked by events such as the collapse of Terra and the bankruptcy of FTX), institutions continued to build infrastructure. In August of that year, the world's largest asset management company, BlackRock, partnered with Coinbase to provide crypto trading services for institutional clients and launched a private Bitcoin trust for investors, which released strong market confidence.

Traditional exchanges and custodians also expanded their digital asset services. For example, BNY Mellon launched crypto asset custody services for some clients, while Nasdaq developed a custody platform. Meanwhile, JPMorgan utilized blockchain for interbank transactions through its Onyx division, with JPM Coin processing hundreds of billions of dollars in wholesale payments.

Tokenization pilot projects also gradually emerged: institutions like JPMorgan simulated DeFi trading of tokenized bonds and foreign exchange in the "Project Guardian" initiative using public blockchains.

However, U.S. regulators took a stricter stance on market volatility, leading some companies (such as Nasdaq at the end of 2023) to pause or slow down the launch of crypto products while awaiting clearer rules.

2023 - Renewed Institutional Interest:

2023 saw a cautious resurgence of institutional interest. By mid-year, BlackRock submitted an application for a spot Bitcoin ETF, followed by Fidelity, Invesco, and others. This wave of applications marked a significant turning point, especially considering the U.S. Securities and Exchange Commission (SEC) had previously rejected similar proposals multiple times. That same year, crypto infrastructure supported by traditional finance began to go live: the digital asset exchange EDX Markets, backed by Charles Schwab, Fidelity, and Citadel, officially launched in 2023, providing a compliant trading platform for institutions.

At the same time, the tokenization wave of traditional assets accelerated—for example, private equity giant KKR tokenized part of its fund on the Avalanche blockchain, while Franklin Templeton migrated its tokenized money market fund holding U.S. Treasury bonds to a public blockchain.

The international regulatory environment also improved (the EU passed the Markets in Crypto-Assets Regulation (MiCA), and Hong Kong reopened crypto trading under new regulations), further encouraging U.S. institutions to prepare for the global competitive landscape.

By the end of 2023, the approval of Ethereum futures ETFs generated anticipation for the approval of spot ETFs. By year-end, institutional adoption of crypto assets showed a trend that would accelerate if regulatory barriers were removed.

Early 2024 - Approval of Spot ETFs:

In January 2024, the U.S. Securities and Exchange Commission (SEC) finally approved the first U.S. spot Bitcoin ETFs (followed by Ethereum ETFs), marking a milestone event that signified the mainstreaming of crypto assets on U.S. exchanges and unlocked billions of dollars for pension funds, registered investment advisors (RIAs), and previously conservative portfolios that could not hold crypto assets.

Within weeks, crypto ETFs attracted significant inflows, greatly expanding the range of investor participation. During this period, institutional crypto products continued to expand—from stablecoin initiatives (such as PayPal's PYUSD stablecoin) to banks (like Deutsche Bank and Standard Chartered) investing in digital asset custody startups. By March 2025, nearly every major U.S. bank, brokerage, and asset management company had launched crypto-related products or formed strategic partnerships within the crypto ecosystem, reflecting a comprehensive entry of institutions into the crypto space since 2020.

2023-2025 Traditional Finance's View on DeFi

Traditional finance (TradFi) holds a curious yet cautious attitude towards decentralized finance (DeFi).

On one hand, many institutions recognize the innovative potential of permissionless DeFi—public liquidity pools and automated markets have performed well during crises (for example, decentralized exchanges continued to operate smoothly even during the market turmoil of 2022). In fact, industry surveys show that most TradFi practitioners foresee public blockchain networks gradually becoming an important part of their business in the future.

On the other hand, concerns about compliance and risk management have led most institutions to prefer "permissioned DeFi" environments in the short term. These platforms are typically private or semi-private blockchains that retain the efficiency advantages of DeFi while limiting participants to vetted entities.

A typical case is JPMorgan's Onyx network, which operates a proprietary stablecoin (JPM Coin) and payment channels to serve institutional clients—essentially a "walled garden" version of DeFi. Similarly, Aave Arc launched a permissioned liquidity pool in 2023, requiring all participants to undergo KYC certification through the whitelisted entity Fireblocks, combining DeFi technology with TradFi compliance requirements.

This dual-track perspective—embracing automation and transparency while imposing controls on participants—has become a defining feature of traditional finance's exploration of DeFi before 2025.

Institutional DeFi Pilot Projects

Between 2023 and 2025, several well-known institutions explored the potential of decentralized finance (DeFi) through a series of high-profile pilot projects. JPMorgan's Onyx platform collaborated with other banks and regulators to participate in the "Project Guardian" led by the Monetary Authority of Singapore (MAS), completing tokenized bond transactions and foreign exchange swaps on a public blockchain, achieving instant atomic settlement through smart contracts.

These experiments demonstrate that even permissionless protocols (like Aave and Uniswap, modified for KYC compliance) can be utilized by regulated entities under appropriate security measures. Asset management giant BlackRock launched the BlackRock USD Digital Liquidity Fund (BUIDL) at the end of 2023, tokenizing a U.S. Treasury money market fund.

Distributed to qualified investors via the Securitize platform, BUIDL provides institutions with a compliant way to hold tokenized yield-bearing assets on the Ethereum network, indicating that traditional finance's acceptance of public blockchains is increasing, provided that intermediaries ensure compliance.

Other examples include Goldman Sachs' Digital Asset Platform (DAP), which issued tokenized bonds and facilitated digital repurchase transactions, and HSBC's use of the Finality blockchain platform for foreign exchange settlements.

These initiatives reflect a "learning by doing" strategy—large institutions are assessing the potential advantages of DeFi technology in speed and efficiency through limited scope experiments in core activities such as payments, lending, and trading.

Venture Capital-Backed Infrastructure Development

A robust ecosystem of crypto infrastructure is forming, with these companies often receiving venture capital and support from traditional financial institutions to connect TradFi with DeFi. Custody and security service providers like Fireblocks, Anchorage, and Copper have raised significant funds to develop "institutional-grade" platforms for storing and trading digital assets (including tools for secure access to DeFi protocols).

Compliance technology companies like Chainalysis and TRM Labs provide transaction monitoring and analysis, enabling banks to meet anti-money laundering (AML) requirements when interacting with public blockchains. Additionally, brokers and fintech startups are simplifying the complexities of DeFi, providing user-friendly interfaces for institutions.

For example, crypto prime brokers can now offer access to yield farming or liquidity pools while handling the technical operations off-chain. This venture-driven development of wallets, APIs, identity solutions, and risk management layers is gradually addressing the operational barriers for traditional finance to enter DeFi, paving the way for deeper integration in the future.

By 2025, decentralized exchanges (DEXs) and lending platforms have begun integrating institutional portals to ensure that counterparty identities are verified.

Overall, traditional finance's view of DeFi has undergone a profound change: DeFi is no longer seen as the "wild west" to be avoided but rather as a collection of financial innovations that can be cautiously utilized within a compliance framework. Large banks are becoming early adopters of DeFi in a controlled manner, recognizing that ignoring the growth of DeFi could mean falling behind in the next financial transformation.

The U.S. Regulatory Environment and Global Comparisons

In the crypto space, the clarity of U.S. regulations has lagged behind the pace of technological innovation, creating friction for traditional finance's entry into crypto while also creating opportunities. The U.S. Securities and Exchange Commission (SEC) has taken a hardline stance: in 2023, the SEC filed several high-profile lawsuits against major exchanges, accusing them of offering unregistered securities and proposing rules that could classify many DeFi platforms as securities exchanges. This regulatory environment has made U.S. institutions more cautious in participating in DeFi, as most DeFi tokens lack clear legal status.

However, by the end of 2024 and early 2025, significant changes in the regulatory environment began to emerge. Under pressure from various parties, the SEC approved spot crypto ETFs, marking a pragmatic shift in its stance. At the same time, court rulings such as the Grayscale case in 2024 began to clarify the SEC's regulatory authority. The Commodity Futures Trading Commission (CFTC) is also playing a role, maintaining a clear position that Bitcoin and Ethereum are commodities. Nevertheless, the CFTC penalized some DeFi protocol operators in 2023 for non-compliance while advocating for a clearer framework to support innovation.

Meanwhile, the U.S. Treasury has turned its attention to DeFi from an anti-money laundering (AML) perspective. In 2023, the Treasury released a risk assessment report on illegal financial risks in DeFi, indicating that the anonymity of DeFi could be exploited by criminals, laying the groundwork for potential future KYC (Know Your Customer) obligations on decentralized platforms. Similar to the sanctions against Tornado Cash in 2022, it shows that even code-based services cannot escape legal scrutiny if associated with illicit financial flows.

For banks, U.S. banking regulators (OCC, Federal Reserve, FDIC) have issued guidance limiting direct contact with crypto assets, effectively steering institutional participation toward regulated custody services and ETFs rather than direct use of DeFi protocols. As of March 2025, the U.S. Congress has yet to pass comprehensive cryptocurrency legislation, but several proposals (such as stablecoin regulation and clarification of the distinction between securities and commodities) are in advanced discussion stages. This means that traditional financial institutions in the U.S. need to be particularly cautious when participating in DeFi: they typically restrict DeFi activities to sandbox experiments or offshore subsidiaries while awaiting clearer regulatory guidance. Clarity in areas such as stablecoins (which federal law may designate as a new payment tool) and custody rules (like the SEC's custody proposal) will significantly impact the depth of institutional participation in DeFi protocols within the U.S.

Europe: MiCA and Forward-Looking Regulations

In stark contrast to the U.S., the European Union has passed a comprehensive regulatory framework for crypto—the Markets in Crypto-Assets Regulation (MiCA). By 2024, MiCA provides clear rules for the issuance of crypto assets, stablecoins, and the operation of service providers across member states. Combined with pilot programs for tokenized securities trading, MiCA offers innovative certainty for European banks and asset management companies. By early 2025, European firms will clearly understand how to apply for operating licenses for crypto exchanges or wallet services, while guidelines for institutional stablecoins and even DeFi are also being developed. This relatively clear regulatory environment has driven pilot projects in tokenized bonds and on-chain funds by traditional financial institutions in Europe.

For example, several EU commercial banks have issued digital bonds through regulatory sandbox programs and legally processed tokenized deposits under regulatory supervision. The UK has taken a similar path, explicitly expressing its desire to become a "crypto hub." By 2025, the UK's Financial Conduct Authority (FCA) is developing rules for crypto trading and stablecoins, while the Law Commission has included crypto assets and smart contracts in legal definitions. These initiatives may enable institutions in London to launch DeFi-based services earlier than their U.S. counterparts (within certain limits).

Asia: Regulatory Balance and Innovation-Driven

Singapore and Hong Kong provide striking contrasting cases for global regulation. The Monetary Authority of Singapore (MAS) has implemented a strict licensing regime for crypto companies since 2019, while actively exploring DeFi innovations through public-private partnerships.

For instance, Singapore's major bank DBS launched a regulated crypto trading platform and participated in DeFi transactions (such as tokenized bond trades completed in collaboration with JPMorgan). Singapore's approach views permissioned DeFi as a controllable exploration area, reflecting the idea of formulating reasonable rules through regulated experimentation.

Hong Kong, after years of restrictions, changed its policy direction in 2023, introducing a new framework to issue licenses for virtual asset exchanges and allowing retail crypto trading under regulation. This policy shift has received government support, attracting global crypto firms and encouraging banks in Hong Kong to consider providing digital asset services within a regulated environment.

Additionally, Switzerland has promoted the development of tokenized securities through the Distributed Ledger Technology Act (DLT Act), while the UAE has established specific crypto regulations through the Dubai Virtual Assets Regulatory Authority (VARA). These examples further illustrate the diversity and potential of crypto finance development globally, with regulatory attitudes ranging from cautious acceptance to proactive promotion.

The Impact and Differences of DeFi Participation

For financial institutions in the U.S., the fragmented regulatory rules still limit most direct participation in DeFi until compliance solutions emerge. Currently, U.S. banks are more focused on consortium blockchains or trading tokenized assets that comply with existing legal definitions. In contrast, institutions in jurisdictions with clearer regulatory frameworks appear more at ease in interacting with similar DeFi platforms.

For example, asset management companies in Europe may provide liquidity for a permissioned lending pool, while banks in Asia might use decentralized trading protocols for foreign exchange swap transactions internally, ensuring that regulators are informed. However, the lack of unified rules globally also presents challenges: a multinational institution needs to find a balance between strict rules in one region and opportunities in another. Many are calling for the establishment of international standards or a dedicated "safe harbor" policy for decentralized finance to unleash DeFi's potential (such as efficiency and transparency) without compromising financial integrity.

In summary, regulation remains the biggest determinant of the speed at which traditional finance (TradFi) participates in DeFi. As of March 2025, despite some progress—such as the U.S. approving spot crypto ETFs and global regulators beginning to issue customized licenses—more effort is needed to establish sufficient legal clarity for institutions to fully embrace permissionless DeFi on a large scale.

Key DeFi Protocols and Infrastructure: Bridges to Traditional Finance

Many leading DeFi protocols and infrastructure projects are directly addressing the needs of traditional finance, creating entry points for institutional use:

Aave Arc (Institutional Lending Market)

Aave Arc is a permissioned version of the popular Aave liquidity protocol, launched between 2022 and 2023, specifically designed for institutional users. It offers a private lending pool that only allows participants who have been whitelisted and completed KYC (Know Your Customer) verification to engage in digital asset lending operations. By introducing anti-money laundering (AML) and KYC compliance mechanisms (supported by whitelisted agents like Fireblocks) and only accepting pre-approved collateral, Aave Arc addresses a key need of traditional financial institutions (TradFi)—trust in counterparties and regulatory compliance. At the same time, it retains the efficiency of DeFi smart contract-driven lending. This design enables banks and fintech lending institutions to leverage DeFi liquidity to obtain secured loans without exposing themselves to the anonymity risks of public liquidity pools.

Maple Finance (On-Chain Capital Markets)

Maple is an on-chain institutional low-collateral lending market, comparable to a syndicated loan market on the blockchain. Through Maple, certified institutional borrowers (such as trading firms or mid-sized enterprises) can obtain liquidity from lenders globally, with the terms of the transactions being handled by "Pool Delegates" responsible for due diligence and facilitation. This model fills a gap in traditional finance: low-collateral loans often rely on relationship networks and lack transparency, while Maple brings transparency and around-the-clock settlement capabilities to such lending. Since its launch in 2021, Maple has facilitated hundreds of millions of dollars in loans, demonstrating how creditworthy enterprises can more efficiently raise funds on-chain. For lenders in traditional finance, the Maple platform provides a way to earn stablecoin yields by lending to vetted borrowers, effectively simulating a private debt market while reducing operational costs. Maple showcases how DeFi can simplify loan issuance and servicing (such as interest payments) through smart contracts, significantly reducing administrative costs. This innovation offers traditional financial institutions an efficient and compliant on-chain capital market solution.

Centrifuge (Tokenization of Real-World Assets)

Centrifuge is a decentralized platform focused on bringing real-world assets (RWAs) into DeFi as collateral. It allows asset originators (such as trade finance, accounts receivable factoring, or real estate lenders) to tokenize assets like invoices or loan portfolios into interchangeable ERC-20 tokens. These tokens can then be financed through DeFi liquidity pools (Centrifuge's Tinlake platform). This mechanism effectively connects traditional financial assets with DeFi liquidity— for example, invoices from small businesses can be pooled together and funded by stablecoin lenders globally. For institutions, Centrifuge provides a template for converting illiquid assets into investable on-chain instruments while reducing investment risks through a transparent risk layering mechanism. It addresses one of the core pain points in traditional finance: certain industries struggle to access credit. By leveraging blockchain technology, Centrifuge can tap into a global pool of investors, and by 2025, even large protocols like MakerDAO are expected to introduce collateral through Centrifuge, while traditional financial institutions observe how this technology can lower capital costs and unlock new sources of financing.

Ondo Finance (Tokenized Yield Products)

Ondo Finance offers tokenized funds, bringing traditional fixed-income opportunities to crypto investors. Notably, Ondo has launched products such as OUSG (Ondo Short-Term U.S. Treasury Fund)—which is fully backed by short-term U.S. Treasury ETFs—and USDY, a tokenized share of a high-yield money market fund. These tokens are offered to qualified investors under Regulation D and can be traded on-chain around the clock. Ondo effectively acts as a bridge, packaging real-world bonds into DeFi-compatible tokens.

For instance, stablecoin holders can exchange their assets for OUSG, earning about 5% from short-term Treasury bonds, and then seamlessly exit back to stablecoins. This innovation addresses a common challenge in both traditional finance and the crypto space: it brings the security and yield of traditional assets into the digital asset realm while opening new distribution channels for traditional fund managers through DeFi. The tokenized Treasury products launched by Ondo (with issuance sizes reaching hundreds of millions) have sparked imitation from competitors and traditional financial institutions, blurring the lines between money market funds and stablecoins. This model not only provides investors with more options but also further promotes the integration of traditional finance and DeFi.

EigenLayer (Restaking and Decentralized Infrastructure)

EigenLayer is a new Ethereum-based protocol launched in 2023 that supports "restaking" functionality, allowing the security of already staked ETH to be reused to secure new networks or services. Although this technology is still in its infancy, it holds significant implications for institutions in terms of infrastructure scalability. EigenLayer allows new decentralized services (such as oracle networks, data availability layers, and even institutional settlement networks) to inherit the security of Ethereum without needing to establish separate validator networks. For traditional financial institutions (TradFi), this means that future decentralized trading or clearing systems can operate based on existing trust networks (Ethereum) without having to build from scratch. In practical applications, banks may deploy a smart contract service (for example, for interbank loans or foreign exchange transactions) and ensure that the service is secured by billions of staked ETH through restaking—this level of security and decentralization is nearly impossible to achieve on permissioned ledgers. EigenLayer represents cutting-edge technology in decentralized infrastructure, and while it has not yet been directly utilized by TradFi, it may become a foundational pillar for next-generation institutional DeFi applications by 2025 to 2027.

These examples illustrate that the DeFi ecosystem is actively developing solutions that align with the needs of TradFi—whether it be compliance (Aave Arc), credit analysis (Maple), access to real assets (Centrifuge/Ondo), or robust infrastructure (EigenLayer). This integration is a two-way street: TradFi is learning how to use DeFi tools, while DeFi projects are continuously adapting to meet the requirements of TradFi. This interaction will ultimately foster a more mature and interconnected financial system, paving the way for future financial innovations.

The Prospects of Tokenizing Real-World Assets

One of the most substantive intersections between traditional finance (TradFi) and the cryptocurrency space is the tokenization of real-world assets (RWA)—that is, migrating traditional financial instruments (such as securities, bonds, and funds) onto the blockchain. As of March 2025, institutional participation in the tokenization space has moved from proof-of-concept stages to the realization of actual products:

Tokenized Funds and Deposits

Several large asset management companies have launched tokenized versions of funds. For example, BlackRock's BUIDL fund and Franklin Templeton's OnChain U.S. Government Money Fund (which records shares on a public blockchain) allow qualified investors to trade fund shares in the form of digital tokens. WisdomTree has introduced a series of blockchain-based fund products (covering government bonds, gold, etc.) aimed at achieving 24/7 trading and simplifying investor participation. These initiatives typically operate under existing regulatory frameworks (such as issuing private securities through exemption clauses), but they mark a significant step forward in trading traditional assets on blockchain infrastructure.

Additionally, some banks are exploring tokenized deposits (i.e., regulated liability tokens) that represent bank deposits but can circulate on the blockchain, attempting to combine bank-level security with the transaction speed of cryptocurrencies. These projects indicate that institutions view tokenization as an effective way to enhance liquidity and shorten settlement times for traditional financial products.

Tokenized Bonds and Debt

The bond market is one of the early success stories of tokenization. Between 2021 and 2022, institutions like the European Investment Bank issued digital bonds on Ethereum, with participants completing bond settlements and custody via the blockchain rather than relying on traditional clearing systems. By 2024, institutions like Goldman Sachs and Santander facilitated bond issuances through their private blockchain platforms or public networks, indicating that even large-scale debt issuances can be accomplished using distributed ledger technology (DLT).

Tokenized bonds offer instant settlement (T+0, compared to the traditional T+2), programmable interest payments, and more convenient fractional ownership. This not only reduces issuance and management costs for issuers but also provides investors with broader market access and real-time transparency. Even some government treasuries have begun exploring blockchain applications in bonds; for example, the Hong Kong government issued a tokenized green bond in 2023.

Although the current market size for on-chain bonds remains relatively small (around several hundred million), growth in this area is accelerating as legal and technical frameworks continue to improve.

Tokenization of Private Market Securities

Private equity and venture capital firms are partially transforming traditionally illiquid assets (such as private fund shares or pre-IPO stocks) into tradable forms through tokenization, providing liquidity to investors. For instance, KKR and Hamilton Lane have partnered with fintech companies (like Securitize and ADDX) to launch tokenized fund shares, allowing qualified investors to purchase tokens representing economic rights to these alternative assets. Although currently limited in scale, these attempts suggest that future secondary markets for private equity or real estate may operate on the blockchain, thereby reducing the liquidity premium that investors demand for these assets.

From an institutional perspective, the core of tokenization lies in expanding asset distribution channels and unlocking capital potential by converting traditionally locked assets into tradable smaller units. This innovation not only enhances asset accessibility but also injects new vitality into traditional finance.

The Rise of DeFi-Native Platforms

Notably, the trend of tokenization is not limited to the dominance of traditional financial institutions—DeFi-native platforms for real-world assets are also addressing the same issues from a different angle. Protocols like Goldfinch and Clearpool (as well as the previously mentioned Maple and Centrifuge) are driving on-chain financing to support real economic activities without waiting for the actions of large banks.

For example, Goldfinch acts as a decentralized global credit fund by providing liquidity from cryptocurrency holders to finance real-world loans (such as fintech lending institutions in emerging markets). Clearpool, on the other hand, offers a market for institutions to launch unsecured loan pools anonymously (combined with credit scoring), with pricing and funding determined by the market.

These platforms often collaborate with traditional institutions, forming a hybrid model that combines DeFi transparency with TradFi trust mechanisms. For instance, fintech borrowers in Goldfinch's lending pools may undergo financial audits through third parties. This collaborative model ensures transparency in on-chain operations while introducing the prudent trust systems of traditional finance, providing a solid foundation for the further development of tokenization.

The future of tokenization of real-world assets (RWA) is promising. In the current high-interest rate environment, there is strong demand in the crypto market for yields from real assets, further driving the tokenization of bonds and credit (the success of Ondo is a typical case). For institutions, the efficiency gains brought by the tokenization market are highly attractive: transactions can settle in seconds, markets can operate around the clock, and reliance on intermediaries like clearinghouses is reduced. Industry estimates suggest that if regulatory barriers are resolved, tens of trillions of dollars in real assets could be tokenized over the next decade. By 2025, we have already seen early network effects of tokenization. For example, a tokenized government bond can serve as collateral in DeFi lending protocols, meaning institutional traders can use tokenized bonds as collateral to borrow stablecoins for short-term liquidity, something that is not achievable in traditional finance. This unique composability supported by blockchain is expected to revolutionize collateral management and liquidity management for financial institutions.

In summary, tokenization is bridging the gap between traditional finance (TradFi) and decentralized finance (DeFi) more directly than any other trend. It not only brings traditional assets into the DeFi ecosystem (providing stable collateral and real cash flows on-chain) but also offers traditional financial institutions a testing ground (as tokenization tools can often be restricted to operate in a permissioned environment or issued under known legal structures). In the coming years, we may see larger-scale pilot projects—such as major stock exchanges launching tokenization platforms and central banks exploring wholesale central bank digital currencies (CBDCs) that interoperate with tokenized assets—further solidifying the core position of tokenization in the future of the financial industry.

Challenges and Strategic Risks of Traditional Finance in Decentralized Finance

Regulatory Uncertainty

Despite the enormous opportunities, traditional financial institutions face numerous challenges and risks when integrating into DeFi and the crypto space. Among these, regulatory uncertainty is the primary concern. Due to the lack of clear and consistent regulations, banks worry that collaborating with DeFi protocols may be deemed illegal securities trading or unregistered asset trading by regulators, leading to enforcement actions. Until the legal framework is improved, institutions face potential regulatory backlash or penalties, making legal and compliance teams cautious about approving DeFi-related initiatives. This uncertainty is global, and the differences in rules across jurisdictions further complicate the cross-border use of crypto networks.

Compliance and KYC/AML

Public DeFi platforms often allow anonymous or pseudonymous participation, which conflicts with banks' Know Your Customer (KYC) and Anti-Money Laundering (AML) obligations. Institutions must ensure that counterparties are not sanctioned or involved in money laundering activities. Although technologies for achieving on-chain compliance through whitelisting, on-chain identity verification, or dedicated compliance oracles are still developing, this area is not yet mature. The operational risk of inadvertently facilitating illegal fund flows in DeFi poses significant reputational and legal threats, compelling traditional financial institutions to prefer permissioned or heavily regulated environments.

Custody and Security

Secure custody of crypto assets requires new solutions. The custody risks associated with private key management are particularly pronounced—once a private key is lost or stolen, the consequences can be catastrophic. Institutions typically rely on third-party custodians or internal cold wallet storage, but the frequent high-profile hacking incidents in the crypto space raise concerns about security among executives. Additionally, smart contract risks are also a significant factor—funds locked in DeFi smart contracts may be lost due to vulnerabilities or attacks. These security issues often lead institutions to limit their exposure to crypto assets or require strong insurance, while digital asset insurance is still in its infancy.

Market Volatility and Liquidity Risks

The crypto market is known for its high volatility. Institutions providing liquidity to DeFi pools or holding crypto assets on their balance sheets must endure severe price fluctuations, which can directly impact returns or regulatory capital. Moreover, during times of crisis, liquidity in DeFi markets may dry up quickly, and institutions may face slippage risks when attempting to close large positions, potentially encountering counterparty risks due to defaults by protocol users (such as low-collateral loan defaults). This unpredictability sharply contrasts with the more controllable volatility in traditional markets and the safety nets provided by central banks.

Integration and Technical Complexity

Integrating blockchain systems with traditional IT infrastructure is a complex and costly process. Banks must upgrade systems to interact with smart contracts and manage real-time data around the clock, which is a daunting task. Additionally, the shortage of specialized talent is a significant challenge—assessing DeFi code and risks requires specialized knowledge and skills, meaning institutions need to recruit or train experts in a competitive talent market. These factors lead to high initial entry costs.

Reputational Risks

Financial institutions must also consider public and client perceptions. Engaging in the crypto space is a double-edged sword: while it demonstrates innovation, it may raise concerns among conservative clients or board members, especially after events like exchange collapses. If institutions become embroiled in DeFi hacking incidents or scandals, their reputations may suffer. Many institutions are therefore cautious, opting to conduct pilot projects behind the scenes until they have sufficient confidence in risk management. Furthermore, reputational risks extend to unpredictable regulatory sentiment—negative comments from officials about DeFi could cast a shadow over related institutions.

Legal and Accounting Challenges

Unresolved legal issues regarding the ownership and enforceability of digital assets remain. For example, if a bank holds a token representing a loan, is this legally recognized as owning that loan? Protocols based on smart contracts lack mature legal precedents, further increasing uncertainty. Additionally, while accounting treatment is improving (expected to allow fair value measurement by 2025), there have historically been many issues with the accounting treatment of digital assets (such as impairment rules), and regulatory capital requirements for crypto assets are high (e.g., Basel accords classify unsecured crypto assets as high-risk). These factors significantly diminish the economic attractiveness of holding or using crypto assets from a capital perspective.

In response to these challenges, many institutions are adopting strategic risk management approaches: starting with small-scale pilot investments, testing through subsidiaries or partners, and proactively communicating with regulators to seek favorable outcomes. Additionally, institutions are actively participating in industry alliances to promote the establishment of compliance standards for DeFi (such as identity-embedded tokens or proposals for "DeFi passports" designed for institutions). Overcoming these obstacles is crucial for achieving broader adoption, and the timeline will largely depend on the clarity of regulatory frameworks and the continued maturation of crypto infrastructure to institutional standards.

Looking Ahead to 2025-2027: Scenario Analysis of the Integration of Traditional Finance and DeFi

Looking ahead, the degree of integration between traditional finance and decentralized finance may develop along various paths over the next 2-3 years. Below is an overview of optimistic, pessimistic, and neutral scenarios:

Optimistic Scenario (Rapid Integration)

In this positive scenario, by 2026, regulatory clarity significantly improves.

For instance, the U.S. may pass a federal law that clearly defines categories of crypto assets and establishes a regulatory framework for stablecoins and even DeFi protocols (perhaps creating new charters or licenses for compliant DeFi platforms). With clearer rules, large banks and asset management companies accelerate their crypto strategies—directly offering crypto trading and yield products to clients and utilizing DeFi protocols for certain backend functions (such as using stablecoins for overnight funding markets).

In particular, regulation of stablecoins could become a key catalyst: if dollar-backed stablecoins receive official approval and insurance, banks may begin to use them on a large scale for cross-border settlements and liquidity management, embedding stablecoins into traditional payment networks.

Improvements in technological infrastructure also play a crucial role in the optimistic scenario: planned upgrades to Ethereum and Layer-2 scaling technologies enable faster transactions at lower costs, while robust custody and insurance solutions become industry standards. This allows institutions to enter the DeFi space with lower operational risks.

By 2027, we may see most interbank lending, trade financing, and securities settlements conducted on hybrid decentralized platforms. In the optimistic scenario, even Ethereum staking integration becomes commonplace.

For example, corporate finance departments may treat staked ETH as a yield-generating asset (similar to digital bonds), adding a new asset class to institutional portfolios. This scenario envisions a deep integration of traditional finance and DeFi: traditional financial institutions not only invest in crypto assets but also actively participate in DeFi governance and infrastructure development, fostering a regulated, interoperable DeFi ecosystem that complements traditional markets.

Pessimistic Scenario (Stagnation or Retreat)

In the pessimistic scenario, regulatory crackdowns and adverse events severely hinder the integration of traditional finance and DeFi. A possible situation is that the U.S. Securities and Exchange Commission (SEC) and other regulators intensify enforcement without providing new compliance pathways—effectively prohibiting banks from engaging with open DeFi, allowing only limited access to a few approved crypto assets. In this case, by 2025/2026, most institutions would still choose to wait and see, limiting themselves to investing in ETFs (exchange-traded funds) and a few permissioned networks, while staying away from public DeFi due to legal risks.

Moreover, one or two high-profile failures could further dampen market sentiment. For example, a major stablecoin collapse or a systemic DeFi protocol being hacked, resulting in losses for institutional participants, could deepen the impression that "the crypto space is too risky." In this scenario, the global market fragmentation intensifies: the EU and Asia may continue to advance crypto integration, while the U.S. lags behind, potentially causing American firms to lose competitiveness and even lobby against crypto to maintain fair competition in the market. Traditional financial institutions may even adopt a resistant stance toward DeFi, especially when they view it as a threat without viable regulatory support. This could lead to innovation stagnation (for instance, banks only promoting private distributed ledger technology (DLT) solutions and discouraging clients from participating in on-chain finance). Essentially, the pessimistic scenario depicts a situation where the promise of collaborative development between traditional finance and DeFi fails to materialize, leaving the crypto space as a niche or secondary area for institutional investment before 2027.

Neutral Scenario (Gradual and Steady Integration)

The most likely scenario lies in between the two—an ongoing gradual integration, although slow but steady. In this baseline expectation, regulators will continue to issue guidance and some narrow rules (for example, stablecoin legislation may pass before 2025, the SEC may adjust its stance, possibly exempting certain institutional DeFi activities or approving more crypto products on a case-by-case basis). While there will not be comprehensive regulatory reform, some new clarity will emerge each year.

Traditional financial institutions will cautiously expand their participation in the crypto space: more banks will offer custody and execution services, more asset management companies will launch crypto or blockchain-themed funds, and more pilot projects will be initiated to connect banking infrastructure with public blockchains (especially in the areas of trade finance documentation, supply chain payments, and secondary market trading of tokenized assets). We may see networks led by alliances selectively interconnect with public networks—for example, a group of banks may operate a permissioned lending protocol and bridge to public DeFi protocols when additional liquidity is needed, all under agreed-upon rules.

In this scenario, stablecoins may be widely used as settlement tools by fintech companies and some banks, but they have not yet replaced major payment networks. Ethereum staking and crypto yield products begin to enter institutional portfolios on a small scale (for example, certain pension funds allocate a small portion of their funds into yield-generating digital asset funds). By 2027, in the neutral scenario, the integration of traditional finance and DeFi will be noticeably deeper than today—such as 5-10% of trading volume or loans occurring on-chain in certain markets, but it will still be a parallel track to the traditional system rather than a complete replacement. More importantly, this trend line is upward: successful cases from early adopters will persuade more conservative peers to participate, especially in the face of increasing competitive pressure and client interest.

Key Drivers to Watch

In all scenarios, several key drivers will determine the ultimate outcome of the integration between traditional finance (TradFi) and decentralized finance (DeFi).

First and foremost is regulatory dynamics—any initiative that can provide legal clarity (or conversely, new restrictive policies) will directly impact the shift in institutional behavior.

Among these, the evolution of stablecoin policy is particularly critical: safe and regulated stablecoins may become the cornerstone of institutional-level DeFi trading. The maturity of technology is another important driver—the ongoing improvement of blockchain scalability (through Ethereum Layer 2 networks, alternative high-performance chains, or interoperability protocols) and enhancements in tools (such as better compliance integration, privacy trading options, etc.) will increase institutional acceptance of DeFi.

Additionally, macroeconomic factors may also play a role: if traditional yields remain high, the urgency of institutions for DeFi yields may weaken, reducing interest; but if traditional yields decline, the appeal of DeFi's additional yields may rise again.

Finally, market education and industry performance are also crucial—each year that DeFi protocols demonstrate resilience, and every successful pilot project (for example, a major bank successfully settling $100 million via blockchain) will increase market trust.

By 2027, we expect the debate over "whether traditional finance should adopt DeFi" to shift to "how traditional finance can better leverage DeFi," similar to the gradual widespread adoption of cloud computing in banking after initial skepticism. Overall, the next few years may witness traditional finance and DeFi moving from cautious exploration to deeper collaboration, with the pace determined by the interaction of technological innovation and regulatory frameworks.

Highly Recommended:

“The Future of TradFi: The Rise of DeFi and Scalable Finance”

Risk Disclaimer:

insights4.vc and its newsletters provide research and information for educational purposes only and should not be considered as any form of professional advice. We do not advocate any investment actions, including the purchase, sale, or holding of digital assets.

The content of this article represents the author's personal views and is not financial advice. Please conduct your own due diligence before participating in cryptocurrency, DeFi, NFTs, Web3, or related technologies, as these areas carry high risks and significant value volatility.

Note: This research report has not received sponsorship from any mentioned companies.

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