TradFi/DeFi collaboration: squaring the circle

World-first traditional finance and digital natives collaborations are now a daily occurrence. Etay Katz and Simon Williams analyse the issues.

Key takeaways:

• TradFi/ DeFi partnerships are now a question of 'how' and 'when', not 'if'.
• New regulation and an updated regulator mindset are key enablers, but some regulations are also blockers.
• A paradigm digital cash leg continues to be a material challenge (and opportunity).
• There will be growing pains as digital natives adapt to a regulated culture.
• Lack of standardisation remains a key issue.
• The pace of change continues to accelerate.

Structuring

The huge potential of distributed ledger technology (DLT) for the financial services sector is now widely recognised. As is the value that digital natives bring to traditional finance, and vice versa.
The value-adds manifest in many different ways. Each collaboration will have its own ambitions and targets and be structured accordingly. For example from mergers, acquisitions and joint ventures, to services provision, outsourcing and white-labelling.

Each manner of collaboration will present different economics, integration risk, cultural challenges, and reputational hot spots; and needs to be managed accordingly.

So far, material M&A activity has largely been confined to digital natives with digital natives. TradFi and DeFi partnerships have taken the more prudent services provision and outsource route. As happened back in the day between internet service providers and traditional media, with some DeFi market capitalisations now rivalling major banks, and further use-case rollouts, DLT collaboration will encompass material TradFi/ DeFi M&A activity in the short to medium-term.

Use-case example: custodial services

Global assets under management are projected to reach USD171 trillion by 2028. Custody services are therefore an obvious DLT collaboration use-case. At present, traditional finance and digital natives each play to their respective strengths by providing services.

For example Ripple, leveraging its on-chain technology, infrastructure and know how, is providing digital asset custody to support BBVA's cryptoasset services. Traditional finance institutions are providing support services to digital natives. For example to mitigate the perceived digital native counterparty risk, BBVA is reported to be providing custodial services for clients' US Treasuries, which Binance accepts as margin for trading.

Use-case example: digital assets as financial collateral

As digital and traditional financial markets converge, the rise of fiat-backed stablecoins continues, and adoption of tokenised real world assets and securities broadens, demand will rise for the use of digital securities and native cryptoassets as financial collateral. A key blocker is legislation.

Internationally, the Basel Committee on Banking Supervision's (BCBS) cryptoasset exposures standard (SCO60) comes into force on 1 January 2026. Some jurisdictions will implement on time, for example Hong Kong and Canada. The UK will be late, and the USA will not implement SCO60 in its current form at all. In addition a coalition of leading global financial trade associations have called for a pause and recalibration of the standard, to better reflect actual cryptoasset risk profiles and to support responsible innovation within the regulatory perimeter.
Domestic regulation has also not kept up with the technology. For example, the UK's Financial Collateral Regulations were written in 2003 without digital ledger technology in mind. As a result, some digital assets (arguably) might qualify as UK financial collateral, whereas – for no good regulatory policy reason – others do not.

Regulation

Traditional finance is one of the most highly regulated sectors in the world. In contrast, digital natives have usually been lightly or un-regulated. Cryptoasset regulation is fast changing, and regulation will be a big culture shift for digital natives.

Cryptoasset firms are becoming part of the highly regulated financial services mainstream. For example under the UK's proposed regime, cryptoasset activities in the UK will generally be subject to the same standards as traditional financial services. Firms wishing to carry out regulated cryptoasset activities will be required to obtain UK Financial Conduct Authority (FCA) authorisation (see our update).

Digital natives collaborating with traditional finance (and vice versa) may be subject to an additional regulatory hurdle. For example, the provision of cryptoasset custody services, or white-labelling a blockchain, could be regulated outsources. A joint venture or an acquisition may require joint regulatory business plans, change in control consent, and key personnel approvals.
Traditional finance and digital natives culturally start from very different regulatory places. The regulation of collaboration brings them closely together and will be a big culture jump for both, likely more so than direct regulation alone.

Regulation is a game changer for digital natives. For some, it has brought the cryptoasset sector's perceived reputation in from the cold. At the same time, it has enabled regulators now to contemplate TradFi/ DeFi collaboration.

Regulation: the international dimension

Each major financial centre aspires to be the digital assets jurisdiction of choice. All are at different stages of implementing regulatory regimes. There is commonality of approach in some respects, but naturally there are many differences too.

Regulatory variances can offer jurisdictions a competitive advantage. However digital assets are 'everywhere and nowhere'; regulatory divergence potentially penalises globally regulated financial institutions and is also susceptible to regulatory arbitrage.
Regulators themselves are not immune from the international regulatory challenge. For example, the European Commission and the European Central Bank (ECB) are currently grappling with the potential commercial and systemic risks of a dual EU and non-EU issued fully-fungible stablecoin.

In time, we expect standards for digital assets regulatory equivalence and even passporting. These will come via international trade agreements and initiatives such as the UK - US Financial Regulatory Working Group.

Common standards

It is widely accepted that common international standards are important for sound, stable and well-functioning financial systems. Although it is not surprising that common standards are still developing for the nascent DLT sector, BCBS's Working Paper 44 illustrates the scale of the issue. Entitled "Novel risks, mitigants and uncertainties with permissionless distributed ledger technologies", WP44 devotes an entire Annex to exploring differing taxonomies for the foundational DLT concept of "permissionless/permissioned and public/private blockchains".

Industry recognises the problem and is actioning solutions. For example, the President's Digital Assets Working Group advocates for industry-led international technical standards via NIST. The International Capital Market Association (ICMA) has published a Bond Data Taxonomy and the DLT Bonds Reference Guide.

The compliant setting of universal common DLT standards should be treated as a priority by regulators, trade associations and the industry alike.

Wholesale digital payment

Stablecoins have a USD225 billion market valuation, are 99% US Dollar denominated and have a strong regulatory tailwind (Q2 2025 included the USA's GENIUS Act and Hong Kong's Stablecoins Ordinance). It was dubbed the 'Summer of Stablecoin', however some sentiment remains that stablecoins are not the much-needed panacea for a wholesale cash leg. Although the stablecoin industry is reputed to hold backing asset US Treasuries in excess of sovereign states such as South Korea, counterparty exposure to stablecoin issuers is a concern for some.
Tokenised deposits offer regulated commercial bank counterparty exposure as well as atomic settlement. However, tokenised deposits remain a bilateral call on a bank's balance sheet - interoperability is a current limiting factor.

Central Bank digital currencies (CBDC) have on-chain sovereign state full faith and credit. Although 91% of central banks are exploring either a retail CBDC, a wholesale CBDC or both, there is not currently a fully operational wholesale CBDC. Central bankers have voiced systemic concerns in respect of stablecoins, whereas they view CBDCs as preserving the role of central bank money (for example, the 'singularity' of money). At the same time, there are critics of CBDCs, and a USD CBDC is banned by Executive Order.

The transfer of digital value remains a limiting factor in wholesale digital asset commercial transactions. Each of the three frontrunner solutions has its proponents and its critics. Each will continue to evolve with developing market practice, regulation and innovation. One size will not fit all; and big challenges also means opportunity for each solution.

Squaring the circle

As we saw most recently with the internet, the history of the world is replete with instances of innovation waves intersecting with established industries. Each industrial revolution offers its own unique challenges and also opportunities.

Digital natives and traditional finance have much to offer each other, and the crossover of attributes continues to accelerate (for example Circle's reversible blockchain layer, and Swift's blockchain-based ledger). The industry has matured from experiments to implementation and regulatory regimes are being signed into law.

We will continue to see increased scale and manifestations of TradFi/ DeFi integration as the functions of each cross-pollinate. Some collaborations will be evolutionary dead ends; others will adapt, diversify and thrive.

View further thought leadership on our Digital Assets and Financial Innovation hub.