Three challenges to institutional crypto adoption that have not been resolved by the merger

by Arthur · October 4, 2022

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Crypto market players, as well as analysts at Bank of America and Bernstein, expect the merger to boost institutional adoption for Ethereum (ETH) and the digital asset industry. Although their arguments are true to some extent – especially how a greener ETH could attract ESG investments – the event did not tackle all the industry’s challenges at once.

The post-merger crypto industry still needs to overcome several challenges that hinder its institutional adoption. These include the lack of an adequate infrastructure connecting TradFi (traditional finance) and DeFi (decentralized finance) and regulatory and security concerns, as well as risks of centralization.

The lack of a TradFi-DeFi bridge

No matter how green or scalable a blockchain network becomes, institutional adoption will only increase significantly when TradFi solutions can be seamlessly integrated with DeFi protocols. We have yet to see a DeFi solution that supports SWIFT, FIX or other messaging protocols TradFi platforms typically use for stock exchanges, trading systems and operational processes.

Of course, DeFi players may decide to roll out support for established messaging protocols. TradFi companies can also build new front and back office platforms from scratch.

But while the prior may go against the very idea of decentralization, the latter is a resource-heavy solution. And we cannot expect TradFi players to replace their proven and time-tested procedures and mechanisms with cryptonative solutions just to connect these two ecosystems.

For these reasons, the most effective solution to bridge the gap between TradFi and DeFi is through partnerships between the two industry participants. In addition to revealing competitive advantages to leverage, collaborative initiatives will establish the infrastructure that seamlessly bridges the DeFi and TradFi ecosystems.

Security considerations

While distributed ledger technology and cryptography provide increased security for blockchain networks, cybercrime targeting crypto users remains a major problem.

According to a Chainalysis report, the crypto winter reduced digital asset-related illicit volume by 15%, but still claimed an impressive $1.9 billion in hacks in July 2022 alone – an increase of 60 percent since 2021.

While the technology is promising, security concerns and the lack of a decent regulatory framework make crypto a high-risk market for newcomers. And this prevents many institutional investors from adopting digital assets.

Fortunately, we can observe a positive development in this field. In particular, Dubai’s digital asset regulation earlier this year attracted many established industrial companies with the potential for the emirate to become a regional crypto hub.

There are also ongoing efforts in the United States. First, the bipartisan Lummis-Gillibrand Encryption Act aims to clarify the classification of digital assets.

The proposed legislation could promote TradFi’s digital asset activity by enabling depository institutions to issue stablecoins. It would potentially eliminate a caveat in an existing law that presented challenges for custodians of digital assets and facilitate the creation of financial regulatory sandboxes.

The Stabenow-Boozman bill also seeks to regulate the crypto industry through CFTC oversight, increased transparency, and investor protection.

While we have to wait several months for senators to cast their votes, the proposal for more US crypto legislation is a step in the right direction.

Reservations about decentralized governance

Ethereum’s move to proof-of-stake (PoS) will actually green the blockchain network while reducing the energy needed to maintain the project’s ecosystem by 99.5%.

Alas, there is a chance that some level of decentralization will have to be sacrificed for the green narrative and future scalability improvements.

While the proof-of-work (PoW) algorithm enabled anyone with a mid- to high-end GPU to become a validator, the move to the stake-based PoS mechanism could give increased authority over the network to those with the highest ETH balances. It could lead to a small group of wealthy validators or ecosystem participants deciding the fate of blockchain protocols.

At worst, a centralization of power within the Ethereum ecosystem or a DAO (decentralized autonomous organization) could create more vulnerabilities waiting to be exploited by malicious parties.

For DAOs, this problem can be minimized by replacing the current token-based voting model with a governance model that allows everyone to vote – bout it will weigh their voting power based on their contribution to the ecosystem.

In Ethereum’s case, fairness among validators can be ensured by changing the validator selection process to limit the authority of wealthy participants.

Solution first – adoption later

The merger provides crypto participants with a solution to address the challenges of increased energy consumption and limited scalability. But it fails to address longstanding barriers to institutional adoption.

As TradFi players struggle to integrate with DeFi services, security and power concerns, as well as a lack of regulations, can easily discourage institutional investors from joining the industry.

As long as these challenges are not addressed, it is too early to talk about institutional crypto adoption.

Dmitry Ivanov is the Head of Marketing at CoinsPaid, an ecosystem of cryptocurrency products that aims to satisfy the world’s daily needs by leveraging blockchain technology and crypto payments.

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