Will DeFi and TradFi Ultimately Merge? a16z Challenges Mainstream Market Predictions

Authors: Christian, Pyrs Carvolth, a16z

Translation: Saoirse, Foresight News

There is a near-consensus future vision circulating in the crypto community: decentralized finance (DeFi) and traditional finance (TradFi) will converge, connecting permissionless liquidity with institutional-grade distribution channels, ultimately giving birth to a sophisticated hybrid system that combines the strengths of both, which will replace the old system.

This vision sounds appealing but is largely incorrect.

A more realistic truth is: Traditional finance will adopt blockchain technology as long as it can help optimize their existing operations. This is not because traditional finance embraces decentralization, but because blockchain offers compelling cost advantages—this technology happens to cut costs, optimize settlement processes, broaden business channels, and further solidify their control over customers.

This means various financial institutions will not merge with DeFi. On the contrary, they will selectively adopt DeFi technical components that fit their operational constraints, discard incompatible parts, and reshape DeFi around their own institutional needs. The final product will be neither traditional finance nor the current DeFi. We are witnessing the rise of a new category: programmable financial infrastructure built on blockchain foundations and optimized for institutional business constraints.

As regulatory frameworks mature, the industry landscape may change. Future bills like the CLARITY Act might lower the barrier for institutions to directly access permissionless systems. However, even if legal restrictions are lifted, traditional finance's risk appetite won't change overnight. Institutions evaluate technology based on four dimensions: cost, risk, control, and business fit, which means the crypto industry faces two major opportunities, not just one path forward.

The first opportunity: Helping institutions implement infrastructure they can adopt now. Each time an institution adopts a foundational component—atomic settlement, programmable money, tokenized collateral, etc.—it validates the technology's feasibility, builds a shared underlying network, and brings real capital and transaction volume on-chain.

The second opportunity: Continuously building an open, native crypto financial system, which institutions currently do not accept.

These two tracks are not mutually exclusive and can develop in parallel. Managed well, they can empower each other. Open networks and ecosystems continuously produce various foundational modules, market models, and innovations, which can later be adopted by institutions. If both tracks mature, convergence will occur naturally: not through one system completely replacing the other, but through both increasingly sharing the same underlying infrastructure.

The True Logic of Traditional Finance's Actions

Traditional finance will only adopt a technical component when two conditions are met simultaneously: it can optimize costs, risks, or business distribution; and it is compatible with control mechanisms and accountability systems. Those characteristics discarded by institutions—open access, anonymity, immutable execution—may satisfy the first criterion but fail the second. Therefore, institutions' technology choices follow a clear pattern, which developers can use as a litmus test for product design. In other words, if a feature can only create value by weakening institutional control, no matter how ingeniously designed, it will almost certainly be modified or outright rejected.

Let's test this standard with several foundational technologies. Atomic settlement eliminates the time gap between trade execution and final settlement, mitigating counterparty risk and freeing up collateral capital reserved for pending settlements. Shared ledgers address one of the largest hidden costs in back-office operations: reconciliation, making cumbersome reconciliations a thing of the past. Programmable money enables automatic execution of coupon payments, margin calls, and corporate actions via code, replacing a series of manual instructions. Automated Market Maker (AMM) curve algorithms, stripped of their permissionless shell, can be used as pricing engines for on-chain foreign exchange or tokenized money fund valuations.

Each of these technologies can improve P&L metrics, reduce operational risks and associated costs, without requiring institutions to embrace decentralization. Therefore, we should clearly recognize the nature of projects like JPMorgan building a permissioned blockchain for institutional deposits, or BlackRock and Franklin Templeton launching tokenized money market funds: these enterprises are not experimenting with DeFi. They are using blockchain to conduct the businesses they already operate—interbank settlement, fund subscriptions/redemptions, interest-bearing product distribution—simply upgrading the underlying technical architecture. These applications fully leverage blockchain characteristics (programmability, transparency, atomic settlement) while deliberately omitting the traits foundational to native DeFi: open access, anonymity, trustless execution.

This is not a compromise but an active architectural choice, indicating the industry's long-term direction.

Different Audiences, Different Rules

It is a mistake to view the institutional market merely as a larger sales channel for existing DeFi infrastructure. Institutions evaluate protocols from a perspective entirely different from native crypto users. When selecting software vendors or infrastructure partners, institutions heavily weigh operational risk, compliance controls, and long-term ownership of core systems, strictly adhering to internal standard processes. Therefore, a product's success in the DeFi ecosystem does not automatically translate to acceptance by institutional clients.

Corporations rarely purchase the "technologically best" product; they tend to choose the solution best adapted to existing business processes, risk models, and procurement procedures.

Any technology entering a highly regulated, risk-averse, liability-conscious institutional environment will be reshaped by it. This happened with the internet, giving rise to corporate firewalls and private intranets; it happened with cloud computing, spawning private clouds, virtual private clouds, and FedRAMP compliance systems; and it's currently happening with AI: on-premises deployment, data sovereignty requirements, model governance standards. Blockchain will be no exception.

Technology adaptation primarily progresses along two dimensions:

1. Compliance Layer: KYC, AML, sanctions screening, accredited investor verification, regulatory reporting—these are non-negotiable for most institutions. Permissionless systems are inherently incompatible with such rules. Institutions must have the authority to freeze assets, reverse transactions, and identify counterparties. DeFi was not initially designed around these needs, and compatibility often requires significant architectural changes. The future may improve, e.g., the CLARITY Act could help institutions access permissionless systems while meeting regulatory requirements. But for now, when evaluating blockchain infrastructure, most institutions prioritize control, accountability, and operational risk.
2. Enterprise Value Realization: This is often underestimated. Institutions adopt blockchain not to worship permissionlessness as a doctrine, but because blockchain can compress costs, reduce reconciliation friction, open new distribution channels, and deepen customer lock-in. Product value propositions must be anchored in such business metrics; otherwise, they will struggle to pass corporate procurement approvals.

Stablecoins are the most typical example. Banks, payment providers, and fintech companies increasingly view stablecoins as high-quality settlement infrastructure, facilitating rapid USD transfer across networks and regions. But almost no institution embraces the entire philosophy behind permissionless finance. They use programmable dollars because they are useful, with no intention of rebuilding the financial system according to DeFi principles.

Circle's development journey is an excellent case study. Its Arc product clearly demonstrates how blockchain infrastructure is being repackaged for institutions: highlighting compliance, operational control, trusted counterparties, and integration with traditional business systems, rather than permissionless access and composability. Its value proposition is not merely about permissionlessness, but about delivering capabilities institutions can adopt: faster clearing, global reach, higher capital efficiency.

Even SWIFT is starting to view blockchain through this lens. Its push for tokenized asset interoperability aims not to replace existing financial institutions but to optimize how institutions collaborate using the SWIFT network. The pattern repeatedly emerges: institutions deploy blockchain to reinforce established financial networks, not to replace them.

This is the path mature technologies often take when penetrating large, existing markets.

Two Opportunities for Developers

From an industry perspective, if everyone chases one track and abandons the other, a huge opportunity will be missed. From a startup perspective, trying to pursue both tracks simultaneously is also highly risky.

At the ecosystem level, the institutional business track and the open network track can empower each other. But for most teams, they are fundamentally different businesses. Developing for institutions requires understanding procurement processes, compliance systems, control solutions, channel partners, and long sales cycles. Developing for open networks requires continuous optimization around developer ecosystems, liquidity, composability, and network effects. The target customers, go-to-market models, product requirements, and success metrics for these two types of businesses are typically worlds apart.

This doesn't mean one track is superior to the other. Founders should clearly define which market they serve. The convergence point for the two paths lies in the underlying infrastructure: public blockchains as neutral settlement layers.

Working with institutions and building supporting financial systems are not contradictory. Well-executed, they can add value to each other: the permissioned track brings transaction volume, industry credibility, and capital; the open track continuously produces innovative components later adopted by the permissioned track. The true future convergence will occur at the underlying settlement network level, not through one system compromising for the other.

Even as upper-layer applications gradually become more permissioned, public blockchains will increasingly become the universal settlement substrate.

Two Paths to Building Programmable Financial Infrastructure

To build in this emerging category, developers have two paths: building entirely new systems from scratch, or adapting existing products. Take networks like Canton as an example: they didn't modify existing DeFi code but were designed from the ground up around institutional needs for privacy, compliance, and controlled interoperability. The goal is not to lure banks into the DeFi ecosystem, but to use blockchain for multi-party collaboration while preserving the governance rights, data confidentiality, and operational control institutions require.

Not all institutional business requires building from scratch. Morpho has chosen the opposite path: not discarding DeFi building blocks, but continuously optimizing their product to lower the barrier for institutions and asset issuers. For instance, Apollo's ACRED fund incorporated Morpho into its on-chain lending strategy, pairing native DeFi lending modules with institutional-grade distribution, compliance frameworks, and fund structures. The final form is neither pure DeFi nor a completely isolated institutional closed system. Institutions selectively adopt existing crypto infrastructure while repackaging it according to their own control, compliance, and distribution requirements.

This new category is built specifically for institutional constraints, borrowing DeFi technology but operating under stronger permissions and compliance frameworks, inherently distinct from current native DeFi.

Some teams, like Morpho, have successfully adapted native crypto products for institutional scenarios. But developers should not view this path as the standard answer. Institutions are a customer segment with entirely distinct needs. In most scenarios, designing products from the outset for institutional needs is far more efficient than adapting products originally built for open networks.

The Opportunity to Continue Building DeFi

The various innovations being adopted by institutions today were not initially born within banks, asset managers, or traditional financial infrastructure. They all originated from open networks—where developers could freely experiment with new market structures, collaboration mechanisms, and financial primitives.

This is crucial. Institutions are not the source of industry innovation; the permissioned track is often the downstream beneficiary of innovations from open networks.

This leads to a key strategic conclusion: If the entire industry becomes overly focused on selling products to banks and asset managers, it commits a cognitive error—equating one type of large customer with the entire market. Traditional finance is an important customer, but it is not the only market.

Building products for institutional needs is reasonable and offers tremendous value, but it is only one track, not the industry's only path forward. Teams that endure long-term will clearly identify whom they serve. The institutional business space is vast, but it cannot be simplistically viewed as an extension of DeFi. Success in one market does not guarantee replication in another.

If you choose to build for institutions, commit to it wholeheartedly. Don't assume that traction in the native crypto market automatically translates into enterprise customer orders. Deeply understand your clients, master the procurement process, and plan product development around institutional needs.

If you choose to focus on open networks, persist. Don't abandon your original vision just because institutions are currently the best-funded buyers.

Remember: The two tracks are complementary, not competitive. One track is responsible for adapting, commercializing, and scaling mature innovations; the other is responsible for continuous exploration and innovation. Blockchain technology is almost destined to become a foundational component of the existing traditional finance system, but that is not the only future taking shape. Open networks remain the industry's most important soil for experimentation and innovation, and many foundational modules supporting future institutional infrastructure will first emerge here.

Traditional finance will not embrace the complete DeFi system; it will only select the technical parts that fit its business model. The opportunity for developers is not to chase all markets simultaneously but to find their own lane and execute accordingly. The future financial infrastructure may be dominated by institutional systems, but many pivotal innovations will continue to emerge from open networks.