Aave is the largest DeFi lending protocol with over $ 16 billion in locked cryptocurrency assets. He plans to launch Aave Pro, which will operate separate authorized user pools of âwhitelistedâ users who have passed Know Your Customer (KYC) protocols. This removes one of the main obstacles to regulated institutions participating in decentralized finance (DeFi).
Why would institutions be interested? Because they can earn 2.1% (3.2% including Aave token rewards) on US dollars with relatively low risk, although it is not without risk. Returns are possible because cryptocurrency investors don’t want to sell their Bitcoin. Using a smart contract-based protocol, they borrow up to 85% of the value of their assets and pay 3.1% for the secured loan. For depositors, competitor Compound offers a 1.6% lower return for lower risk, as up to 70% is loaned against the secure cryptocurrency. If the price of the cryptocurrency falls too low, the asset used as collateral is automatically liquidated.
The recent sharp drop in prices has been a good test for the industry. Although it has gone well, it is still not without risk. It is possible that if a drop in the price of the cryptocurrency is strong enough, the asset used as security cannot be sold quickly enough. Or a smart contract bug could be discovered. For the main protocol, the bugs should now have been fixed as there has been a lot of money stuck for some time.
News that Aave was testing authorized private liquidity pools first emerged in May when someone noticed a pool that was inaccessible. The news was confirmed by Aave during a Blockworks webinar last week.
Aave CEO Stani Kulechov said he offered “accessibility to institutions without knowing their counterparties and mitigating their compliance risk.”
In the initial phase, the guard and security company Fireblocks implements the KYC on the basis of rules that have been agreed with the legal advisers of several institutions that participated in the pilot projects. But other child care providers will also provide solutions in the future.
The regulated DeFi approach
Mike Novogratz, the founder of cryptocurrency asset manager Galaxy Digital, said there are three approaches institutions could take to participate in DeFi. The first is to assume that the US Department of Justice will not be interested in DeFi. As a regulated institution, it was not something he was comfortable with. A regulated approach would either be a separate pool, as in this case, or rely on an organization like Chainalysis to analyze blockchains to reassure you about the origin of transactions with a high degree of probability.
âI think both are going to work to protect, to give prophylaxis to the user,â Novogratz said. “You’re going to see an increase in the number of users because someone like us, we’re going to be more comfortable participating in DeFi more aggressively.”
However, Novogratz is concerned about regulators’ interest in the sector and whether this will make it inconvenient for Aave and force them to choose between without permission and with permission. âWill companies like Aave have to say that we are not going to be open and without permission like we were. We’re going to have some form of KYC, however it looks, to let regulators continue to allow them to exist, âNovogratz asked. âIt’s an existential question. I do not know the answer. I just know it’s going to be asked.
Aave’s general counsel, Rebecca Rettig, said: “This has already been requested.” But she wanted to distinguish Aave, the company, from the decentralized protocol. She also said the company is very committed to training regulators.
A threat to banks
Novogratz was asked what could create FOMO (fear of missing out) for DeFi with institutions. His response was that the big participating institutional names will attract others, as happened with Bitcoin.
The irony with many players in the DeFi and cryptocurrency industries is the simultaneous courtesy and contempt for institutions. Rettig was slightly more diplomatic when she said, “It (DeFi) is superior in many ways to the traditional financial system and banks must be a little nervous about that.”
A colleague from Aave was more direct:
And someone who isn’t directly associated with Aave thought the idea of ââinstitutions participating in a DeFi-authorized liquidity pool was meme-worthy.