DeFi’s Next Frontier: The Untapped Potential of On-chain Structured Products

Globally, asset management is a huge industry, with a large percentage of assets in each nation being held in ETFs, index funds and other passive vehicles. In Europe, €28.4 trillion of assets are managed by the industry, of which 20% are held in passive strategies, about half in exchange traded products and half in index funds. All told, passively-held assets under management have doubled since 2015, with around one fifth of European retail investors holding such products. Analysts predict that by 2027 ETFs will account for 24% of total assets in Europe, up from 12% in 2022. In the world of decentralized finance and digital assets, some commentators see the on-chain structured product market as analogous, but this sector has yet to capture much market share. on-chain structured products make up 0.07% of the crypto market overall currently, with a combined TVL of $2.46 billion across protocols. In comparison, the DeFi market is $48.29 billion and the total crypto market is $1.18 trillion.

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Nevertheless, over the last several years, on-chain structured products — that is, index tokens and strategy tokens — have shown the kind of promise that led to these types of products’ dominance in traditional markets. In 2020, the on-chain structured product market saw 20 projects launching (including nine projects that launched during what would come to be known as DeFi Summer). Yearn, Compound and the Index Coop all started offering such products during this period. At the height of the 2021 bull market, Index Coop’s on-chain structured products captured over $550 million in TVL.

In total, 47 projects have launched in the on-chain structured product space since 2016, with the majority of projects offering index or yield-earning products. Of those, 37 are still operational. At the Index Coop, we’re bullish on the long term promise of on-chain structured products because of their advantages in transparency, security, accessibility, automation and liquidity. Regrettably, the sector has been hampered by regulatory ambiguity, as well as nascent technology and market infrastructure. That said, some encouraging signs have emerged recently. If, as seems likely, BlackRock’s spot Bitcoin ETF and Grayscale’s spot Ethereum ETFs are approved in the U.S. that would represent a major step forward for the on-chain structured product sector.

As digital asset markets mature, we expect to see more growth on the on-chain structured product market, especially as correlations reduce across digital assets. Currently high correlation across digital assets means that different assets move together, reducing the value of a diversification strategy. As digital assets become less correlated, diversification will become more attractive proposition. Additionally improvements in UX and cross chain infrastructure could contribute to growth in our space. Long-term, we expect on-chain products to prevail because of their unique advantages, enabling underlying tokens to reach wider audiences.

You can learn more about the on-chain structured product space in our annual report on the state of the industry.