Decentralized finance (DeFi) asset management protocols and their potential to revolutionize traditional asset management. Automated vault strategies bring on-chain transparency, high yields, and low-touch investment solutions to investors. This article explores the advantages of DeFi asset management protocols and the risks related to using these products.
BlackRock, the world’s leading asset manager, has over $10 trillion of assets under management. BlackRock pools clients’ funds and deploys this capital across markets and into various investments to generate returns and bolster their clients' wealth over time. Clients pay a hefty management fee in return, and with high account minimums, this service rests outside the reach of the vast majority.
More broadly speaking, asset management focuses on increasing wealth through investments, trading, and acquisitions. What if asset management could be done transparently on-chain in a permissionless decentralized manner?
The principle core of asset management is wealth generation, but the low-touch nature is an important and often understated part of the process. DeFi is composable; therefore, the increased interest in DeFi asset management protocols was inevitable. Composability refers to the ability of DeFi protocols to integrate other protocols, hence the term money lego. One DeFi protocol can leverage another protocol, and this basic premise created the first wave of aggregator protocols.
The composability and interoperability within DeFi protocols allow for a new level of capital efficiency and, being permissionless, naturally leans toward an explosion of growth. DeFi asset management protocols all have nuances but typically involve vaults.
A vault conceptually can be understood as a strategy for interaction with the market. Anyone can build a vault, and they cater to all risk tolerances. A vault could include a trading strategy or a basket of yield-bearing digital assets. The key thing to understand is that given the programmability of vaults, they can be built to run any investment strategy within DeFi.
In layman’s terms, a DeFi asset management protocol provides a low-touch solution for investors to park their capital whilst it goes to work for them.
As the TVL of DeFi continues to grow, more and more asset management protocols will appear and play a greater role in organizing the intricacy of DeFi into controllable investment vehicles for users.
Crypto remains the fastest-growing economic sector and, according to a report from Grand View Research, will continue to expand with a CAGR (Compound Annual Growth Rate) of 42.% until 2030.
Crypto disrupting the established financial landscape means it will generate vast amounts of wealth for participants. DeFi asset management protocols allow investors to participate in this era of wealth creation.
DeFi exists in a state of flux, and given the nascent nature of the space, new protocols and assets constantly jostle for attention, and volatility remains high. Crypto can easily consume investors, and asset management protocols allow a hands-off approach. Vaults and DeFi asset management protocols optimize earnings for investors, who can better allocate their time and resources to generating more income or pursuing personal interests.
Asset management protocols give investors the best of both worlds from an ease-of-use and technical perspective. Ease of use. Vaults present a hands-off investment for the user who rests securely knowing that the smart contract makes optimal use of their capital without their involvement meaning their money works for them. Technical. Automated vault strategies such as trading or token allocation balancing have the potential to yield greater returns than the investor could make themselves, meaning they save time and increase overall profitability.
As DeFi becomes more widely accepted, traditional services from TradFi, such as asset management, will become more prevalent. Another consideration for the proliferation of crypto asset management will be the increasingly complex nature of DeFi, and newer investors will likely rely more heavily on asset management tools.
Distributed ledger technology records every transaction immutably. The end result is total on-chain transparency. Why is this important for asset management? It allows users to track the entirety of their funds in real time.
Featured above is a segment from Aave’s 2023 financial report. In DeFi, nothing can be hidden, and in Aave’s case, every single deposit and loan can be traced. Not only does this make DeFi naturally suited for asset management, but it also makes it more appealing than TradFi asset management which tends to be shrouded in secrecy. On-chain data will bring much-needed transparency to asset management.
DeFi offers phenomenal returns simply because it is a new asset class undergoing its growth phase. To give a clear example, one year United States Treasury Bonds currently offer over 5%, the highest yields have been in decades. However, DeFi users can easily find yields above 8% in secure stablecoin vaults on Beefy Finance, and this option rests at the bottom of DeFi’s risk ladder.
Crypto asset management protocols will be able to offer far more attractive yields than their TradFi counterparts solely because of the environment they operate within. And this leads to another highly attractive proposition: the possible financial returns within DeFi without necessarily engaging with DeFi.
Investors often misunderstand their own risk tolerance, and on-chain history can better identify a user's true risk tolerance. DeFi, itself, currently irons out its native yield curve. DeFi, at the outset, was typically only suited for investors with a high-risk tolerance. But the introduction of on-chain real-world assets and increasing demand for stablecoins has created a slew of new investment opportunities for those more risk-averse. And with more numerous options in DeFi, now the sphere can comfortably cater to any risk tolerance, and asset management protocols can align themselves with the financial goals of users.
There are two central risks that investors should be aware of when it comes to asset management protocols within DeFi. The first and more readily understandable risk is the financial risk of assets/ strategies underperforming. Vaults/ strategies offering higher APYs will naturally entail greater risk analogous to TradFi, where corporate junk bonds pay out greater yield compared to more stable government bonds to reflect the increased risk profile of the investment.
The second and more insidious type of risk is smart contract risk. In the current state of DeFi asset management, investors deposit their assets into the protocol’s smart contracts. This exposes the investor to the possibility of losing funds through an exploit. One of the examples below, Reaper Farm, suffered an exploit with $1.7 million of user funds drained from the vault due to a vulnerability in the code. For this reason, asset management protocols that route funds directly from wallets are preferable, suffering only from the destination smart contract risk as opposed to a double-tiered smart contract risk from the vault itself and the underlying strategies.
It is important to note that DeFi asset management protocols currently undergo their growth stage and, as such, offer varying elements of complexity and service.
At the base layer of asset management protocols sit auto-compounding yield farms. These protocols use vaults to maximize the obtainable yield from specific strategies. Reaper Farm initially launched on Fantom but has since gone multi-chain and works on a straightforward thesis. Investors deposit LP (liquidity provider) tokens in the Reaper vault, Reaper harvests the rewards and creates more LP tokens, and users can withdraw their tokens when desired.
Reaper does a fantastic job at optimizing yields but still requires investors to select their desired pairs and can be better construed as an optimizer, not a first mover. As asset management protocols develop, the selection of appropriate strategies will be the greatest hurdle to overcome.
Index provides several tokens that track a range of crypto strategies. Index’s most popular product is the DeFi Pulse Index (DPI) token which tracks the performance of some of the largest DeFi tokens allowing investors to gain broad market exposure to decentralized finance through a single holding.
Index, as the name implies, acts as an Index fund as opposed to an active asset management protocol. However, for new investors owning a single token is far more accessible. The core ethos behind Index is bringing the financial upside of DeFi’s evolution to as many users as possible. But Index remains relatively limited in its abilities given the calcified nature of the indexes, which do not mix well with the constant flux present in DeFi.
One Click Crypto has pioneered a new DeFi-specific asset management tool that routes investors’ funds to the most profitable strategies aligned with their risk tolerance. The DeFi robo-advisor marks a significant step forwards for asset management within crypto, given its ability to automate and make decisions on behalf of the user.
Until now, asset management within DeFi has fallen to yield aggregators that automate a single strategy allowing users to optimize capital gains through efficiency. However, investors have remained the first movers deciding on the asset/ LP token they want to farm with. One Click Crypto’s DeFi robo-advisor generates a customized portfolio for users, creating a risk profile using several questions and scanning the wallet’s history to build a better understanding of the user.
The robo-advisor has cross-chain functionality meaning that it deploys strategies across sixteen different chains and dynamically rebalances to ensure investors’ assets are always working at maximum capacity. Additionally, the robo-advisor leverages developer activity, on-chain data, and market sentiment from social media to identify growth areas.
One Click’s robo-advisor closely mirrors TradFi asset management services at a high level: deposit funds and rest easy knowing capital is being deployed optimally. However, due to the decentralized nature of the tool, investors retain full custody over their assets. They can withdraw them at any time, and users can see the selected strategy play out in real-time on-chain.
The robo-advisor leverages deep learning and routes assets accordingly. DeFi management will be a colossal growth area as decentralized finance continues to enmesh itself into the traditional economy. Effective asset management means exposure to the upside potential without the labor of trawling through DeFi protocols, searching for the best yield.
Protocols that develop low-touch investment vaults will accrue value, and currently, asset management protocols have applications for individual investors and DAO treasuries. However, looking forward into the future, there may be a day when pension funds employing crypto asset management protocols.
Convenience has been one of the most significant market drivers across the economy. Successful DeFi management protocols will exemplify this trait providing users the best yield on the back end with a simple dashboard, deposit, and withdraw function on the front end.
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