Decentralized finance sector’s explosive growth could slow down, says Morgan Stanley

While decentralized finance (DeFi) has seen explosive growth in recent years, Morgan Stanley believes that the sector will likely remain “fairly small.” The bank said that DeFi won’t be able to sustain its current momentum as regulation and over-collateralization will likely slow down its growth.

The total assets locked in DeFi, which was just $600 million in 2020, has ballooned to more than $200 billion, representing an increase of more than 33,000 percent in less than two years, according to Coindesk. This rapid growth is boosted in part by central bank easing projects which forced investors to scout for new investment opportunities elsewhere.

As its name suggests, DeFi offers various banking and financial services without traditional intermediaries using blockchain technology. Proponents say that removing the middleman in financial transactions can improve the efficiency of financial systems.

However, Morgan Stanley is a bit doubtful of this narrative and even pointed out some of the risks associated with decentralized platforms. “Rather DeFi protocols often seem to us as a way to attract cash flow to enrich the protocol operators,” Morgan Stanley said in a report published last week. “DeFi is hack-prone and at risk of financial crime given anonymity is a key feature.”

The bank also pointed out that there’s a lack of know-your-customer (KYC) and anti-money laundering (AML) in DeFi platforms. This could, in turn, limit institutional adoption of decentralized finance.

“Overcollateralization in lending/borrowing means DeFI lending doesn’t expand the money supply (for the same cryptocurrency), which means, without centralization, it will be harder for DeFi to be seen as an alternative to the current fractional reserve banking approach,” the bank added

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