How TradFi Bridges the Gap to DeFi and Web3

This article is part of The Assetizer, GenTwo's thought leadership platform.

On Tuesday’s podcast I spoke with Marco Morazzoni, the founder and CEO of Semoto, about how his company – which runs the largest B2B marketplace in the Web3 space – works with GenTwo to help crypto projects access traditional investors.

This got me thinking about the broader question of bridging the gap between DeFi/Web3 and traditional finance (TradFi).

It's a discussion that has been going on for a while now. But it's taken on new life lately with the more crypto-friendly regime in the US, the ongoing maturity and mainstreaming of blockchain generally, and slow but sure regulatory clarity around digital assets.

In this post, I want to take a look in more detail at how the two sides are coming together, and point out one area that I think gets overlooked somewhat, but may play a crucial role.

A Tale of Two Financial Worlds

Despite all the advances crypto has made in the past few years, the gap between DeFi and TradFi remains enormous. Crypto's USD 2.7 trillion market cap represents less than 3% of the global stock market. That's a stark reminder of how far there is to go.

We can think of these worlds as two distinct networks operating with different infrastructures and user bases:

• The crypto ecosystem. Here we have blockchain networks, decentralized protocols, digital assets, and a growing number of innovative projects seeking capital and users. This world moves quickly, operates 24/7, and has created remarkable technologies. But it remains somewhat isolated from the majority of the world's capital.
• The traditional financial system. This is where the vast majority of the world's wealth still resides – in banks, investment funds, wealth managers, and other traditional financial institutions. It's an established network with centuries of development behind it, enormous liquidity, and powerful network effects.

The original crypto/blockchain ethos was to replace the traditional financial system with fully decentralized technology. It remains to be seen if this will ever be the case.

But it’s certainly true that the sides seem to be slowly merging, advancing towards each other a bit like a bridge being built from two opposing shores. Here are some developments of note.

Tokenization of Real World Assets

From the crypto side, we're seeing significant momentum behind the tokenization of real world assets (RWAs).

The driver here is cost and efficiency. Traditional markets are hampered by inefficiencies like settlement delays, closing hours, and high operational costs. Blockchain technology offers potential solutions to these problems by (in theory) providing a decentralized, always on, global settlement layer.

No wonder that recently Blackrock’s Larry Fink urged the SEC to put stocks and bonds on chain.

Putting real financial and other assets on chain will certainly increase the size and value of the DeFi world (or some hybrid, CeDeFi, variant). This value will accrue not just to the underlying blockchain but to all the decentralized applications, exchanges, and protocols that handle these tokenized assets.

It will also bring them closer to the mainstream.

Traditional Financial Products for Digital Assets

From the other side we are seeing increasing use of traditional financial instruments to gain access to crypto and blockchain.

The most visible examples are the Bitcoin and Ethereum ETFs that have launched recently. These products have seen significant inflows and are providing traditional investors with exposure to digital assets through familiar, regulated vehicles.

But ETFs and similar products are complex, expensive to launch, and really only suitable for large-scale use cases around cryptocurrency investing (though there are ETFs geared towards investing in blockchain tech as well).

What gets less attention is the fact that the world of mainstream finance offers other instruments besides just ETFs and ETPs that can be used to bring non-crypto native investors into the world of digital assets.

These include financial wrappers like AMCs (Actively Managed Certificates), trackers, and CLNs (Credit-Linked Notes), which can for example be used to wrap digital assets or strategies, or easily create investment vehicles for fundraising, in a way that is accessible to traditional investors who might otherwise never directly purchase a token. This can open up a number of interesting use cases. Here’s a few:

• A tracker on a crypto fund – For investors who are curious about crypto but hesitant to engage directly, a tracker certificate that mirrors the performance of a single asset crypto fund provides exposure through a regulated, bankable security that fits into their existing portfolio.
• An AMC on an active crypto strategy – Say you've developed a sophisticated yield strategy involving staking, lending, or algorithmic trading of digital assets. An AMC lets you package this into a product that traditional investors can purchase through their bank, with an ISIN number and all the trappings of a conventional investment.
• A CLN to fund development – Instead of going through the complexities of token issuance or equity fundraising, a blockchain project could issue a credit-linked note to raise capital for development. This gives traditional investors debt exposure with defined terms, while providing the project with needed funding.

The Power of Network Effects

The power of these instruments is that they leverage the unfathomably large network effects of the traditional financial system.

This is precisely what Marco was talking about in our podcast conversation when he talked about the barriers many investors still face from their banks and brokers when they want to invest in crypto or blockchain.

Traditional financial products solve this problem by presenting crypto exposure in a form banks already understand and accept. As Marco colorfully put it, attaching a certificate to a crypto project "puts your reach on steroids" by making it accessible to a much broader pool of investors.

This is ultimately what assetization is all about – making all types of assets investible and accessible to more people, regardless of which financial world they primarily inhabit.

Tom Lyons
Head of Communications and Content, GenTwo