Fidelity's new report suggests that as yields begin to rise, institutions may eventually enter the DeFi space in 2024.

The report covers the asset management company's outlook for the crypto industry in 2024, focusing on several key areas of development, including Bitcoin mining, stablecoins, and DeFi. The report states, "If DeFi yields become more attractive than TradFi yields again and more advanced infrastructure emerges, people may reignite their interest by 2024."

Large investors once couldn't make money in DeFi, RWA becomes the savior

This prediction was made when DeFi investors were earning yields by lending stablecoins that exceeded the yields of US Treasury bonds. Previously, Fidelity also predicted that institutional investors would start meaningfully participating in DeFi in 2023, but this prediction did not materialize.

Fundamentally, large investors couldn't make money in DeFi.

While decentralization and security are important for DeFi, both traditional finance and decentralized finance rely on a core point, which is the ability to make money, especially for wealthy individuals and institutions. Allowing these people to make money is the most realistic problem facing DeFi.

After the collapse of LUNA, liquidity issues began to spread throughout the entire crypto market. Subsequently, Three Arrows Capital also failed to generate target returns due to reduced market activity, leading to large clients withdrawing funds and ultimately collapsing. According to some former internal employees of 3AC who spoke to BlockBeats, in the later stages of the company's operation, the team managed large-scale assets and could hardly find any scenarios that could generate expected returns. The year-end FTX collapse further exacerbated the market situation.

According to FRED data, as of August last year, the yields of US one-year, two-year, and ten-year Treasury bonds were 5.37%, 4.88%, and 3.97% respectively. Regardless of the yield curve, whether it's short-term or long-term bonds, yields have been steadily rising since the end of 2021. Compared to mainstream DeFi protocols such as Curve and Aave, even the yield of the ten-year Treasury bond is significantly higher than their average yield.

In contrast, the yield levels of DeFi have gradually declined. According to DeFi Llama data, from early 2022 to July 2023, the median DeFi yield has dropped from 6% to 2%, which is almost unprofitable for large investors.

In response, Fidelity's latest report stated that last year, "In a generally risk-averse environment, institutions found that the mid-single-digit returns provided by DeFi yields were too low for the associated risks." And the Fed's decision to raise interest rates in 2023 provided institutions with better, or at least perceived as safer, options, further exacerbating the liquidity squeeze in the cryptocurrency market.

When it's not possible to generate sufficient returns on-chain, bringing real-world returns into DeFi is a viable solution, namely Real World Assets (RWA). In June last year, after the market entered a deep bear market, the tokens of Compound and MakerDAO, two veteran DeFi projects, began to rise with the RWA narrative and reached new highs within the year.

Previously, the founder of MakerDAO published a proposal article titled "Endgame" after the Tornado Cash incident, which sparked a discussion about RWA. There were also rumors in the market that MakerDAO significantly increased its income in the past few months by using treasury funds to purchase US Treasury bonds. The founder of Compound also announced the establishment of a new company called Superstate at the end of June, specifically dedicated to bringing bonds and other assets onto the chain to provide potential clients with returns comparable to the real world. Under the wave of compliance in Hong Kong, the popularity of RWA reached a new high.

Based on the premise that government bond yields exceed DeFi yields, the demand for tokenized government bonds among cryptocurrency investors continues to grow. People not only hope to achieve better on-chain returns through this narrative but also aim to attract more traditional funds, creating a new wave of the cryptocurrency cycle.

One of the key parts of MakerDAO's construction of decentralized stablecoins is to use RWA as collateral. RWA, as one of the most important topics for MakerDAO, is constantly being discussed and verified by the community and is considered an important solution.

DeFi yields rise above government bonds

According to a report by DLNews, DeFi lending protocols like Aave are the largest in their class, with over $83 billion in deposits, providing investors with a simple way to use their cryptocurrency assets. However, to do this, other investors must deposit stablecoins for them to borrow. In recent months, the yield earned by Aave users by lending stablecoins has exceeded the 10-year US Treasury bond rate.

According to FRED data, the current US 10-year yield is approximately 4.25%. For the largest stablecoin pegged to the US dollar, USDT, investors can earn up to 14% in returns. The circulation of USDT has exceeded $97 billion, which is an increase from around 5% in August.

The yields of other stablecoins are also higher. Dai, the third-largest stablecoin with a circulation of approximately $4.8 billion, offers a return of about 8.5% to Aave depositors, while the second-largest stablecoin, Circle's USDC, has a slightly lower yield of less than 5%. DeFi investors typically view the lending rates of stablecoins provided by protocols like Aave as the industry's own risk-free rate. This is because it represents the benchmark return for evaluating all other DeFi positions.

The interest rate provided to borrowers on Aave is determined by the protocol's algorithm, and the yield increases as the assets become more popular with borrowers. If US Treasury bond yields decline, such high yields may attract institutions to enter DeFi. As long as the preference for risk continues, the attractive returns that DeFi investors can obtain through stablecoin lending are unlikely to diminish in the near future.

Although throughout 2023, as DeFi investors turned to US Treasury bonds to earn higher yields, stablecoins pegged to the US dollar were affected. However, if the Fed lowers rates by 0.75% as predicted by the end of 2024, institutions may start looking for more profitable ways to make more money, namely investing in DeFi.

Can the RWA narrative continue?

Bringing RWA onto the chain is to bring the value that real-world assets can create into the crypto world, catering to the preferences of users and investors in the crypto world. The reason these two worlds exist independently, apart from blockchain technology, is fundamentally due to the difference in strong regulation. This fundamental difference is what has created the crazy wealth effect in the crypto world, and the wealth effect is the reason why most people are drawn into the crypto world. Traditional assets, due to their asset and compliance attributes, are actually contrary to the crypto world.

However, bringing RWA onto the chain is not easy and involves challenges in designing new product architectures, financial, legal compliance, and technical risks, as well as unknown unknowns.

The reason why RWA has sparked a wave of attention is also because, under the baptism of the bear market, some whales who have made money are beginning to crave stable fixed income in the real world. Based on the current development of RWA, it is mainly limited to exposure to government bonds, especially US Treasury bonds. On the one hand, this reduces the regulatory resistance of DeFi, and on the other hand, it also means that once the Fed reverses, RWA protocols relying on US bonds will fail again, entering an irreversible trend of declining returns. And in the eyes of many, the Fed's reversal is not far away.

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