Virtual markets readying to replace centralized exchanges

As more institutional investors become comfortable with decentralized finance (DeFi) the business of trading will become increasingly virtual, to the extent that centralised exchanges could be eclipsed within 10 years. 

“The way in which DeFi is going currently means that over the medium term you will see the replacement of all traditional centralised exchanges with virtual marketplaces which are regulated and have a tier-one markets licence,” says Jon Deane, CEO of Australian digital asset manager and technology firm Trovio Group. 

Deane points to Australia’s superannuation sector, which is currently sitting on assets worth $3.5trn (£2.6trn). At present, these funds earn extra returns on these assets via stock loans deals, which are managed by financial institutions such as Northern Trust and Citi. 

Supers looking at DeFi 

However, the CEO says the technology currently exists for large-scale fund managers to pledge their assets into liquidity pools via DeFi exchanges.

“The superannuation funds are sitting on billions of dollars of equities, and they could in theory be pledging those equities directly into a virtual marketplace, using smart contracts, and thereby earning all the transaction fees which are currently going to third parties,” Deane says.

The process is already well established in the crypto sector with users linking their digital wallets to DeFi exchanges. 

So far these volumes have been driven by individuals and lower profile institutional investors, but the Trovio CEO says the concept is equally valid for large-scale money managers. 

Regulated DeFi exchanges

Deane says an institution-focused DeFi exchange would operate as a decentralized app (dApp), with members of the exchange also included in the decentralized autonomous organisation (DAO) which runs it, thereby effectively owning the related token. 

Members would then be able to vote on how the exchange will operate. 

“So there isn’t a necessity for a centralised exchange apart from regulation. So while you need a tier-one market licence to operate an exchange it can be set-up as a decentralized, virtual marketplace,” Deane says.

“There are still issues to be addressed with DAOs, such as how do you define it as a company and what is the mechanism for levying tax on these structures. Overcoming these hurdles will probably take 5 to 10 years. But it’s definitely coming,” he adds.

Australia looks at DAO structures

These hurdles are being addressed, certainly in Australia. The chair of the Select Committee on Australia as a Technology and Financial Centre, Andrew Bragg, authored a report in October that specifically called for the establishment of a DAO company structure.

Following the report's issuance, Senator Bragg tweeted that, “DAOs are the future. And the now!”

Regulatory clarity is important for the future development of DeFi, but investor interest is critical to developing the crypto sector in the short term, and Deane says institutions are increasingly eyeing digital assets.

Digital Asset Income Fund

Trovio launched its Digital Asset Income Fund (DAIF) in October last year and Deane says the firm has secured investment from multi-billion dollar asset allocators, in addition to the family offices, which were the first institutions to move into crypto. 

“We’re also seeing interest from major superannuation funds to put assets into this area,” he says. 

The fund is essentially a new version of a traditional income product that is aiming to produce yields of 15–20%, not from investing in cryptos but by instead looking for returns from the digital ecosystem itself. 

Blockchains charge fees to make transactions, known colloquially as ‘gas costs’, and the DAIF is directed at monetising this aspect of the digital economy, rather than by taking directional bets on the value of tokens linked to those chains. 

Betting on DeFi ecosystems

“The DAIF is taking transactional value out of the ecosystem rather than saying, ‘we believe ethereum or solana is going to rise in value’. So you’re not betting on high prices but instead saying there will be more transactions occurring in the underlying marketplace,” says Deane.

This is done by pledging assets into DeFi exchanges using smart contracts and earning returns that have not been clipped by the fees that are charged by a traditional centralised exchange.  

“We are developing DAIF to be a lower risk, lower return product. We’re not targeting the 200–300 percent returns that a lot of other DeFi asset managers are. And it’s a way for investors to have a real money market solution that is a lot more attractive than zero rates,” says Deane. 

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