Everything you need to know about DeFi robo-advisors in crypto. Benefits over traditional robo-advisors and risks of using one.
Robo-advisors have become extremely popular over the last decade, with some of the largest players, like Vanguard, having 1.1 million clients with a total of $206.6B in assets under management. Other leading solutions like Wealthfront and Betterment have $31B and $33.8B in deposits, respectively.
Robo-advisors helped millions of investors to create better portfolios in traditional markets. But what would it be like to have a robo-advisor for cryptocurrencies and decentralized finance (DeFi)?
Robo-advisor is a computer program that helps make better investment decisions. Using formulas and algorithms, robo-advisors pick the right portfolios of assets (stocks, bonds, indices) for you.
In the past, such investment advisory services were provided only by human experts — financial advisors — who were historically quite expensive. Robo-advisory technology changed this narrative and significantly reduced the cost of financial planning, which made it more accessible to a broader market.
The emergence of blockchain and cryptocurrencies developed a new sector for robo-advisory applications. Not only it created a new economy but also the technology that can further enhance the capacity of traditional robo-advisors.
Here are the key difference between traditional and DeFi robo-advisors:
To start using traditional robo-advisors, you will need to provide them with a lot of personal data (name, address, date of birth, etc.) This is because they need to perform various KYC/AML checks on you before accepting your money.
In DeFi, there is no need for that. Since no centralized entity takes custody of your funds, collecting personal data is no longer mandatory.
Because you don’t have to answer tons of questions about your personal information, user onboarding becomes much faster and simpler.
The onboarding process gets reduced from 11 screens to 3, drastically minimizing friction and making it more accessible to users.
Traditional robo-advisors charge an annual fee that typically ranges from 0.2% to 0.5% of the investment amount. On top of that, you may also need to pay trading fees and the so-called “expense ratio” or a management fee for the ETFs that your robo-advisor chooses to invest, usually from 0.17% to 0.42% per year. So the gross annual fee for using robo-advisor may add up to 1%.
When you use blockchain, you don’t need to pay various 3rd parties (e.g., custodians and administrators) to keep and administer your funds. There are no brokers and ETFs. Instead, your assets are managed by smart contracts. That’s why with the help of blockchain, robo-advisory fees can be reduced even further and be limited to gas fees.
Besides dividends, you cannot do much with your stocks — you just keep them and hope they go up in price.
DeFi and blockchain technology allows you to perform various interesting actions with your investments that simply are not available in traditional finance.
You can stake, lend your coins, provide liquidity, or become a validator — all activities bringing additional passive income.
In DeFi, instead of holding your assets and being exposed to market beta, you can put your funds to use and generate more returns on various DeFi protocols. This concept is called yield farming.
Given the inherent volatility of cryptocurrencies and the variety of yield farming options, crypto investments bear increased risk but can bring much higher rewards.
If even the most aggressive stock portfolios project you 8.77%–12.54% annual returns, in crypto, you can achieve 19–23% APR by farming blue-chip coins like ETH/BTC/USDT/USDC on Curve or GMX.
Some farmers can get to potentially higher APRs of 40–80% with riskier protocols by actively managing a portfolio.
And keep in mind that this is just an additional yield that you get on top of your existing investment. It doesn’t count for the price change of an underlying asset, which can provide an even more significant return.
The portfolio recommended by traditional robo-advisors consists mostly of stocks and bonds.
In DeFi, however, you have much more variability and optionality to craft an investment portfolio. This is because there are just so many different chains, coins, and yield protocols where you can deploy your assets.
However, this aspect may be a nuisance for many investors. Huge variety may overwhelm and cause decision paralysis. That’s why robo-advisors such as One Click Crypto help craft a personalized DeFi portfolio with just a few clicks.
By nature, most DeFi yields are variable, not fixed, meaning they change over time. And more often than not, yields only get lower.
It is mainly because DeFi protocols tend to incentivize early investors and liquidity providers with higher rewards, which diminish over time as protocol grows and liquidity increases.
Variable yields cause DeFi investors to constantly seek new and better investment opportunities and “hunt” for higher yields. This aspect shortens the average investment horizon and asset holding time.
When you use blockchain, all your transaction history — your digital footprint — becomes publicly accessible.
This opens a creative use case for AI technology to assist a robo-advisor in crafting even more personalized investment portfolios based on your on-chain profile. Some DeFi robo-advisors like One Click offer such an AI-guided portfolio creation process.
The benefit of decentralized technology is that it allows for self-custody: you no longer depend on banks and don’t have to transfer your funds to an external party to manage. With blockchain, you’re free to choose any investment opportunities from DeFi, and you solely remain in control of your assets and decisions.
Of course, this aspect comes with benefits and risks. Funds are only as safe as your private keys. Educate yourself on self-custody and how to protect your assets.
Apart from losing private keys, there are various risks that come from DeFi: smart contract hacks, governance, oracle exploits, stablecoin de-pegs — each of them is important to understand while assessing investment opportunities in DeFi.
Decentralized finance and blockchain technology created an entirely new investment sector that attracted many investors and speculators worldwide.
Robo-advisory products that proved themselves in traditional markets may provide an even more significant advantage when applied to DeFi.
Investing in DeFi is prone to higher risk and higher reward, shorter investment horizon, and a wider variety of options — all aspects where robo-advisors bring the edge.
By simplifying the yield discovery process, providing personalized recommendations, and automating rebalancing, robo-advisors are on the way to becoming a must-have tool in the hands of crypto and DeFi investors.
Disclaimer: This is not financial advice. This report is strictly educational and does not provide investment advice, solicit the purchase or sale of any assets, or encourage readers to make financial decisions. Please use caution and conduct independent research
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