Bridging TradFi and DeFi: Navigating Counterparty Risks in a Repatriating Crypto Landscape
As the U.S. administration intensifies efforts to repatriate crypto investments, traditional financial institutions (TradFi), decentralized finance (DeFi), and digital asset firms find themselves at a pivotal intersection. This evolving regulatory and market environment presents both opportunities and risks —and will require firms on both sides to reassess their risk management frameworks, particularly around counterparty risk management, given the significant differences in the DeFi asset classes.
The Evolving Regulatory Landscape
The U.S. government's efforts to bring crypto investments back within its jurisdiction have led to significant policy shifts. President Trump's administration has adopted a more crypto-friendly stance, encouraging global firms to establish operations in the U.S. This includes initiatives such as establishing a strategic bitcoin reserve and the appointment of pro-crypto figures to key regulatory positions.
Recent U.S. legislative activity aims to reshape the digital asset environment. Key developments include:
Financial Innovation and Technology for the 21st Century Act (FIT21): FIT21 provides long-awaited clarity for digital assets for digital asset developers, investors, and institutions.
Stablecoin Legislation in 2025: The GENIUS Act and the Stablecoin TRUST Act, advanced through the Senate Banking and House Financial Services Committees, establish a pathway for innovation and establish clear licensing and supervisory requirements for stablecoin markets, market participants, and products.
In addition, the Federal Reserve Board's April 24, 2025announcement signals a significant shift in its approach to crypto-asset and stablecoin activities. The Board has rescinded previous guidance and revised expectations for banking organizations engaging in these. activities This move underscores a growing regulatory focus on ensuring that banks manage the risks associated with crypto-assets effectively and implement safe and sound banking practices for this asset class. The updated stance emphasizes the need for robust risk management frameworks, particularly concerning counterparty risks, as banks navigate the complexities of integrating digital assets into their products and operations.
The U.S. pivot toward reclaiming leadership in financial innovation and investment opens the door to reimagined services, products, infrastructure, and risk programs.
TradFi's Counterparty Challenges – Addressing New Risk Vectors
Traditional financial institutions entering the digital asset space must re-evaluate their counterparty risk programs and expand them to account for DeFi-specific risks. Key areas include:
Volatility and Liquidity Risks: Digital assets are known for their price volatility and varying liquidity levels, resulting in significant changes in the risk profile for these assets. TradFi companies must invest in tokenomics analytics and update relevant risk thresholds to address risks due to token supply schedule, burn-/mint-mechanics, utility, use cases, distribution, market making, and incentives. Tokenomics offer critical insight for evaluating asset-level risk.
Technological Vulnerabilities: TradFi institutions need to develop an understanding for the infrastructure stack that underpins DeFi including smart contracts, cross-chain bridges, oracles, and permissionless protocols. Each of these components introduces unique operational risks. Smart contracts, for instance, are immutable by design but may harbor exploitable bugs or logic flaws, as seen in high-profile protocol hacks like the 2022 Wormhole bridge exploit. Additionally, the reliance on third-party oracles (e.g., for pricing feeds) creates single points of failure and potential manipulation vectors. From a cyber-risk perspective, TradFi entities must address risks emerging from key custody (hot vs. cold wallets), network consensus vulnerabilities, and novel attack surfaces such as flash loan exploits. Integrating with DeFi systems requires a fundamental shift in IT governance and cybersecurity models.
Regulatory Ambiguity: The absence of comprehensive regulatory guidelines for digital assets complicates compliance efforts and increases legal risks. The U.S. continues to lack unified federal legislation defining the classification and oversight of digital assets, resulting in overlapping jurisdictions from the SEC, CFTC, FinCEN, and state-level authorities. For TradFi institutions, this creates uncertainty in product design, cross-border servicing, disclosures, and custody frameworks. The lack of harmonized standards—especially regarding stablecoin issuance, staking services, or tokenized securities—introduces significant compliance risk.
DeFi's Counterparty Challenges – Navigating TradFi Expectations
Digital asset firms seeking to work with TradFi institutions must align with institutional risk and compliance standards, requiring them to address the following areas:
Compliance: Digital asset companies face an evolving regulatory environment in the U.S., where compliance expectations vary significantly by federal and state jurisdiction. Failure to obtain the appropriate licenses—such as a Money Transmitter License (MTL), BitLicense (NY), or registration with the SEC or CFTC depending on the token classification—can expose firms to fines, enforcement actions, and operating bans. The risk is compounded by the lack of regulatory clarity around whether a token is a security or a commodity, with firms often caught in crossfire between agencies. Additionally, compliance with AML/KYC requirements is far more rigorous in the U.S., requiring integration with third-party identity verification providers, transaction monitoring systems, and suspicious activity reporting (SAR) protocols. Compounding these demands is the need to adhere to traditional financial institutions’ vendor risk management and third-party oversight frameworks. TradFi counterparties expect documented due diligence on cybersecurity, data privacy, business continuity, financial viability, and sub-service provider controls — all of which may be unfamiliar or underdeveloped in fast-moving DeFi firms. Failure to meet these requirements can result in deal rejections, termination of partnerships, or inability onboard institutional clients.
Operational Transparency: TradFi counterparties require visibility into governance structures, treasury management, liquidity sources, and smart contract audits. Pseudonymous founders or opaque token distribution strategies can raise red flags during diligence. Moreover, DAO-controlled protocols often struggle to provide clear audit trails or centralized accountability, creating uncertainty around decision-making authority. Lack of real-time disclosures (e.g., treasury reserves, incentive spend, or protocol earnings) hinders trust. For DeFi companies, failing to demonstrate institutional-grade transparency and internal controls presents reputational and partner de-risking challenges, especially when engaging with public companies or regulated asset managers.
Technological Integration: Many DeFi-native protocols and infrastructures lack compatibility with traditional financial architecture, such as SWIFT messaging, ISO 20022 formats, and enterprise risk management systems. Integration challenges range from custody concerns (e.g., needing qualified custodians for digital assets), to data silos between off-chain and on-chain systems, and latency issues in bridging blockchain and TradFi operations. Even with APIs, , integrating smart contracts or decentralized oracle feeds into core banking platforms involves significant cybersecurity review, vendor risk assessments, and bespoke middleware development. Poor interoperability not only delays time to market but may also lead to operational failures (e.g., misrouted funds, settlement delays) that jeopardize client relationships and regulatory confidence.
Counterparty Risk Management: The Bridge Between TradFi and DeFi
Effective counterparty risk management serves as the bridge between TradFi and DeFi, enabling safe innovation, regulatory alignment, and sustainable revenue opportunities. Both sides of the ecosystem must adapt their frameworks and behaviors to mitigate emerging risks and build lasting partnerships to evolve:
Enhanced Due Diligence
TradFi Considerations: Traditional institutions must evolve their due diligence playbooks to include on-chain analytics, tokenomics assessments, smart contract audit reviews, and governance structures of DeFi protocols. This includes applying the same rigor used for assessing fintech and third-party vendors to DeFi entities—such as reviewing financial stability, cyber posture, legal structure, and regulatory exposure.
DeFi Considerations: DeFi firms must prepare for institutional scrutiny by operationalizing transparency — offering clear documentation of protocol functions, disclosing smart contract audit results, and formalizing financial reporting (e.g., treasury balance sheets, token distribution schedules). Demonstrating internal controls, compliance infrastructure, and legal entity clarity will greatly improve TradFi’s risk tolerance.
Collaborative Risk Frameworks
TradFi Considerations: Banks and asset managers should engage in co-developing tailored risk-sharing mechanisms such as custody solutions with programmable guardrails, whitelist-only liquidity pools, or insurance-backed token structures. These frameworks can mirror familiar TradFi risk mitigants such as capital reserves, netting agreements, or credit scoring—adapted for on-chain interactions.
DeFi Considerations: DeFi entities should proactively partner with TradFi players to design protocols with institutional-grade safeguards—such as circuit breakers, counterparty whitelisting, multisig governance, and real-time compliance APIs. Embedding risk-control fundamentals at the protocol level reduces onboarding friction for traditional institutions and aligns incentives.
Regulatory Engagement
TradFi Considerations: Traditional firms should use their regulatory relationships to help shape balanced crypto policy—advocating for clarity on token classification, digital asset custody, and stablecoin treatment. By participating in consultative rulemaking, TradFi can influence a framework that protects consumers while enabling innovation.
DeFi Considerations: DeFi projects should shift from “regulation aversion” to “regulation readiness,” engaging with U.S. agencies (e.g., SEC, OCC, CFTC, FinCEN) through legal counsel, pilot sandboxes, or industry consortia. This includes obtaining necessary licenses, developing compliance teams, and participating in self-regulatory initiatives expected by TradFi counterparties. Proactively engaging regulators builds legitimacy and eases entry barriers.
Conclusion
The convergence of TradFi and DeFi in the U.S. presents a landscape ripe with opportunities and risks. Bridging TradFi and DeFi is not just about technology and new asset classes — it is about trust, transparency, and mutual understanding of risk. Institutions that invest early in robust risk management frameworks with a focus on counter-party risks will be positioned to capture market share, unlock capital efficiency, and shape the future of finance across TradFi and DeFi.
Now is the time for TradFi and DeFi companies looking to take advantage of the digital-asset friendly environment in the U.S. to modernize their GRC functions (both), elevate their digital asset literacy (TradFi) and traditional finance literacy (DeFi), and champion a framework based on transparency and innovation on both sides.
Contact us at evolve@clarendonptrs.com to learn how Clarendon Partners helps clients navigate the convergence of traditional and decentralized finance.