Building for Institutions: DeFi's Next Steps

Key Takeaways

• Regulatory clarity has catalyzed a structural shift: Regulatory changes made in 2025 have moved crypto from speculation-driven growth to institutional-led momentum, with a large number of institutional investors moving on-chain and increasing holdings.
• Institutions demand infrastructure upgrades for scale: Strong appetite exists for DeFi (engagement projected to triple to 75% in the next two years), and tokenized assets (57% interested for diversification), but meaningful participation hinges on three pillars: privacy to safeguard information and strategies, embedded compliance to meet regulatory standards, and composability to enable programmable, capital-efficient use of RWAs
• Protocols are rising to the challenge: Both emerging and established projects are delivering solutions - privacy layers with selective disclosure, markets that merge permissioned assets and permissionless liquidity, and unique use cases for tokenized assets - that bridge TradFi expectations with the blockchain, creating a flywheel for sustained institutional inflows and deeper on-chain integration.

Turning of the Tides

Following transformative regulatory changes in 2025 setting clearer frameworks and guidelines around cryptocurrencies, the industry has begun undergoing a pivotal shift. Growth once heavily driven by speculative assets and products has taken a backseat for that driven by growing institutional interest, adoption, and capital inflows.

With Coinbase and EY-Parthenon’s 2025 Institutional Investor Digital Assets Survey citing regulatory clarity as one of the key issues for investors looking into cryptocurrencies and digital assets, it is no surprise that institutional interest has greatly increased alongside last year’s regulatory developments. The survey states multiple takeaways that are promising for the upcoming year, citing strong interest in DeFi participation, and investing into tokenized assets. However, institutions still require much improvement to underlying infrastructure to comfortably do so - particularly in the realms of privacy, compliance, and composability.

In light of this changing landscape, both existing and emerging infrastructure and applications have started to adapt, introducing features and products that serve the building institutional momentum. This report explores the various needs of institutions, teams working to address them, and more.

Privacy & Confidentiality in Operations

Blockchain technology and cryptocurrencies are built on the core belief of transparency, where every transaction is publicly verifiable on an immutable ledger. While this has driven innovation in areas like trustless systems, it has paradoxically emerged as a significant limitation to institutional adoption in DeFi. Institutions accustomed to the confidentiality and information asymmetry of TradFi, are reluctant to expose their trading strategies, portfolio compositions, or balance sheets to public scrutiny. Such visibility allows competitors and malicious parties to front-run trades, analyze market positions in real-time, or even replicate proprietary strategies - eroding competitive advantages and introducing operational risks. Targeted attacks, such as liquidation sniping on visible positions become a threat as well. In essence, privacy becomes a prerequisite for meaningful institutional capital inflows into any DeFi protocol.

In an effort to create a more institution-friendly DeFi environment, protocols have started to introduce privacy-preserving mechanisms and infrastructure, bridging the gap between public blockchains and institutional needs. Zk-proofs enable obfuscated transactions, proving validity without disclosing amounts, addresses or details. Off-chain order matching combined with on-chain settlement allows for the encryption of orders, revealing only the final execution on-chain for auditability and verification. This mirrors dark pools, which conceal limit orders and positions to protect investors against front-running and other attacks. Fully Homomorphic Encryption (FHE) enables computation on encrypted data without decryption, allowing for private participation into DeFi and yield farming, often with selective disclosure for regulators.

Case Studies (Zama & Keeta)

Zama is one such example, utilizing FHE to deliver programmable privacy on existing public blockchains like Ethereum and Solana. By allowing smart contracts to perform computations on encrypted data, it ensures that sensitive information like trade amounts, asset types, or user identities remain hidden in the process. Through this modular confidentiality layer, existing DeFi protocols are able to integrate end-to-end privacy features like confidential token swaps, lending, yield farming, stablecoin payments, and even RWA tokenization.

Unlike Zama that introduces privacy to existing blockchains, Keeta is building an L1 with native privacy features, and is designed as a unifying settlement layer for TradFi - DeFi interactions. While its main network remains public and auditable for broad transparency and interoperability, Keeta introduces Private Sub-Networks that operate identically to the main chain but keep transactions fully private and invisible to participants on the public network. These come with a degree of customizability, allowing for tailored solutions with specific privacy or operational needs. Institutions can conduct sensitive operations, such as large-value transfers, proprietary trading, or compliant RWA handling, in these closed environments to prevent exposure of strategies, positions, or balances. Accounts and balances can be seamlessly transferred between the public main network and any private sub-network using the same universal key pair, preserving compatibility without silos or fragmentation.

Additionally, its use of verifiable certificates issued by trusted KYC providers further enhances institutional privacy, allowing selective disclosure of attributes via cryptographic proofs, without storing or revealing sensitive information on-chain.

Compliance as the Default

Institutions entering the crypto and DeFi space have been aware of the regulatory minefield that has historically plagued the industry. Non- compliance is often viewed as a prohibitive risk that could lead to severe penalties, enforcement actions, or outright exclusion from markets. With global regulators ramping up oversight - evidenced by frameworks like the U.S. GENIUS Act for stablecoins, the EU's MiCA regime, and Hong Kong's Stablecoin Ordinance - protocols and solutions that embed compliance from the ground up to mitigate regulatory uncertainties are likely to be preferred. Surveys and reports underscore this: EY-Parthenon's 2025 findings rank regulatory uncertainty as the top barrier for institutional investors, while PwC's 2026 Global Crypto Regulation Report notes a shift toward operational regimes with licensing and disclosure, encouraging institutions to demand "same risk, same rule" enforcement.

In response to the shifting trends and institutional demands, DeFi protocols and infrastructure providers have shifted from reactive compliance to embedding it by design. They have pursued targeted licensing where required, adopted industry-standard frameworks, and integrated on-chain mechanisms such as verifiable credentials, automated policy enforcement, and real-time audit trails.

Case Studies (Aave & Railgun)

A leading example is Aave Horizon, the lending giant’s dedicated institutional market for tokenized RWAs. Launched as a licensed, separate instance (forking Aave v3.3), Horizon is purpose-built for regulated capital where institutions can supply permissioned RWAs - such as tokenized treasuries or money-market funds - as collateral and borrow permissionless stablecoins like GHO. Compliance is enforced natively at the asset level through the RWA token’s smart contracts, restricting interactions to approved participants only. Horizon further integrates Chainlink’s Automated Compliance Engine (ACE) to handle identity verification, asset-source screening, transaction eligibility, and risk-bounded NAV validation in real time. This design delivers “permissioned collateral + permissionless liquidity” while fully aligning with regulatory expectations around custody, sanctions, and investor protection.

Railgun is a zk-based privacy middleware that integrates seamlessly with existing DeFi protocols. On top of enabling the shielding of balances and transactions, and private interactions with protocols via zkSNARKs, it also offers two key compliance-related tools to developers and existing applications. These include shareable viewing keys and Private Proofs of Innocence (PPOIs).

Shareable viewing keys grant selective, read-only access to transaction histories (scoped by time, blocks, or specific interactions) without compromising spending control or revealing the full privacy set. Institutions can provide these keys to auditors, tax authorities, regulators, or internal compliance teams for verification of fund origins, tax reporting, or due diligence, ensuring transparency and compliance where needed while keeping everyday operations confidential.

PPOIs are a zk-based mechanism that allows users to cryptographically prove that their shielded funds are not linked to known illicit sources - such as sanctioned addresses, hacks, exploits, or blacklisted transactions - without disclosing any other details about balances, transaction history, or identities. While directly for institutions, PPOIs ensure that bad actors are kept out of DeFi protocols, ensuring that institutions are interacting with honest and safe environments.

Composability & Utility of RWAs

While institutional interest in on-chain exposure to traditional assets has grown over 5x within the past two years, static tokenization alone is not enough. Institutions are seeking composability - the ability for tokenized real-world assets (RWAs) to function as programmable building blocks within DeFi, serving as collateral for borrowing, integration into yield strategies, derivatives trading, or liquidity provision while preserving regulatory compliance and legal ownership. While various protocols have already taken steps towards this, DeFi composability for RWAs is still far from what institutions are familiar with in TradFi, where a Treasury bill can be pledged as collateral, repo’d, or even used in structured products.

Case Studies (Falcon Finance & Pendle)

Building the first universal collateralization infrastructure protocol, Falcon Finance is one team working on integrating a wide variety of tokenized RWAs. Their partnership with Backed Finance has already supported the integration of various xStocks, on top of assets like Tether’s XAYT, Superstate’s USTB, and other tokenized assets. This allows depositors to mint their native stablecoin - USDf, and turn tokenized RWAs into productive, yield-bearing assets, while still maintaining exposure to traditional companies like Tesla or Nvidia.

Though still in the works, Pendle has also already indicated future plans to onboard more tokenized RWAs, allowing for the stripping and trading of their yield components via the PT and YT token design. As mentioned by Dan Wong, Growth Lead at Pendle, this could serve as a granular hedging and speculative instrument that would be otherwise difficult to execute in traditional markets, increasing the utility of the tokenized assets on-chain. Furthermore, this opens up increased potential for the acceptance of tokenized RWAs as collateral on other DeFi protocols, via its PT variation.

Conclusion

The increase in regulatory clarity in 2025 did more than remove uncertainty, it unleashed a structural realignment within the crypto industry and DeFi sector. Speculative retail flows, while still present, no longer defines the market. Instead, DeFi is being reshaped around the requirements of large institutional allocators who move capital in size and required infrastructure that matches the standards of traditional finance, all while still leveraging blockchains’ core strengths.

The three pillars outlined in this report - privacy that protects information asymmetry, compliance embedded at the protocol level, and composability that turns tokenized assets into composable and active financial tools — represent the minimum viable environment for meaningful institutional participation. The industry is already seeing early signs of the effects of these pillars becoming more apparent. Privacy features enable secure treasury management and execution of proprietary strategies. Native compliance tooling builds counterparty trust and satisfies institutional legal teams. RWA composability unlocks new yield surfaces, hedging instruments, and leveraged exposures that were previously inaccessible for on-chain RWAs.

It is no longer a question of “if” institutions will allocate meaningfully to digital assets and participate in DeFi, but of how quickly the remaining gaps close. Protocols and infrastructure providers that have prioritized these institutional-grade features will define the success and extent of the next growth cycle of on-chain finance. The institutional era is no longer on the horizon, the tide has turned.