Will decentralized fund managers prevail?
Ramblings from an inspired insomniac
A key reason why I fell into Defi was its ability to financially empower all investors — and the idea of a decentralized fund manager or Venture Capital (VC) organization blew me away.
This topic hits home pretty hard, as I was working in fund management for quite some time. It made me wonder, is there a better model than what is in traditional finance?
Last night while battling insomnia, I came across this excellent article by Guy who inspired me to wonder: What will make the perfect decentralized fund manager?
Needless to say, I barely slept.
What is a Decentralized Fund Manager?
Typically, a fund (be it private equity, venture capital, real estate etc) is invested by high net worth investors, family offices, institutional investors, and a fund manager is employed to find opportunities to deploy capital. Usually, for such asset classes, you have to be an accredited or sophisticated investor to do so (basically prove that you have more than a million bucks in your bank account).
In contrast, a decentralized fund manager is owned and managed by the community, and ANYONE can gain exposure to asset classes typically only accessed by rich people.
Wonderland was one of the first protocols to come up with that concept so everyone can benefit from start-up investing in the crypto space. Its objective was to become a decentralized VC.
What did it do?
- Initially, Wonderland offered insane returns of 80,000% compounded annual returns (or APY) that drew hordes of investors to buy their currency TIME, and stake it on the platform. This removes TIME from the open market, hence removing some sell pressure.
- Investors were also offered the option to mint TIME (creating more supply), by selling their other assets to the treasury. Basically, you can think of this as people buying bonds from Wonderland, where the bond lets them buy TIME at a discount 5 days later. This was the main mechanism contributing to the treasury.
- Wonderland then used investors’ money to build its treasury made up of other assets, promising that TIME has an intrinsic value backed by it. Management promised buy-backs of TIME once the treasury was big enough.
- The treasury was then invested into yield-generating strategies by their CFO (who actually is an ex-convict, leading to its troubles later). With a bigger treasury, and more people staking and minting, it incentivized even more people to participate.
It was crazily successful until a series of unfortunate events happened, such as 1) There was a whole cascade of liquidations, as leverage was encouraged. When investors staked their TIME, they obtained an interest-bearing token in return that could be used as collateral to gain leverage. When the market for DAOs crashed and a crypto bear market subsequently followed, degens were unfortunately liquidated which contributed to immense selling pressure.
2) A truly black swan event — their treasury manager was discovered (or doxxed) to be an ex-con! And a huge one! (identity theft, changed names a few times, his ex-co founder is presumed dead but his body was never found) More on the expose below by @zachxbt. At this time, I happened to be watching Ozark on Netflix.. so much Deja Vu..
I had spent a lot of time studying the Wonderland model and was impressed by what it managed to achieve in a span of a few months, which some fund managers spend their whole lives doing. (Trust me, I used to work in fund management).
1/ In less than 6 months, it managed to raise more than US$1B in its treasury for deployment
2/ On the back of this, it created a cult-like community Frog Nation that was fiercely loyal, up to the day their trust was broken (some still are). Wonderland ingeniously solved the perennial issue fund managers face — raising capital. By rewarding early investors so well via instant gratification (the crazy 80,000% APY) they created such a strong tribe that defended and fought for its survival and leadership. How I wish my investors loved me as much back when I was in fund management.
3/ Its market cap had a meteoric rise to close to US$3B in about 3 months (lol in traditional finance, it can take 2 years to even list. Trust me I used to work in investment banking too. Now I just appear to be a serial job hopper. )
4/Created a healthy deal pipeline by announcing its first 2 investments quickly: Betswap.gg (a decentralized betting exchange) and Cross the Ages
What went wrong?
Despite its brilliance, the path to decentralized fund management is fraught with challenges. Wonderland was its first iteration, and I’m pretty sure it created a blueprint for others to refine upon. In my humble opinion (hey, I used to be a suit, so I do have some credibility), these were the core issues:
1/ Anonymity of CFO/lack of transparency on track record:
What broke everyone’s trust was letting a felon run a US$1B treasury, and not telling investors about it. In the real world, you’d be suspended from ever getting a license to manage third-party capital!
In my experience, as much as we can automate the capital raising process and deployment of capital (which Wonderland did very well), the credibility and track record of the fund manager matter the most.
Investors had NO idea that its CFO was a dude that had multiple names, was convicted of identity theft, was convicted of credit and bank fraud in the past, served time, and used to run QuadrigaCX — a Canadian crypto exchange that shut doors after its founder mysteriously “died” along with close to U$170m. I’m all about second chances, but would you trust this guy with US$1B at his disposal? (especially with such a sneaky face?)
To give him credit, he did a great job with no evidence of foul play. Some people said he was generating a million bucks per week. I guess if it was transparent at the outset, fine. But when it was a “discovered secret” — that’s when investors feel betrayed.
Solution: Investment management teams should be fully transparent (doxxed) with their track record disclosed. The teams must also be full-time with the fund to prevent any front-running behavior or conflicts of interest. There should be 2 teams ideally — 1 managing the treasury (more of yield farmers, lower-risk strategies) and 1 dedicated to deal sourcing. So for example, in Wonderland’s case, a treasury manager/CFO could be someone who is a seasoned yield farmer with an established track record, and the deal sourcing team could come from VC backgrounds. If you put the community in charge of sourcing deals…. I’m not sure how efficient that will be. The community can definitely vote on deals being passed, but in order to ensure an efficient deal pipeline, there should be a dedicated team working on it.
2/ Over-leverage leading to liquidation cascades
When investors staked TIME, an interest-bearing token called wMEMO was given to them (an IOU saying Wonderland will pay them their returns). The double-edged sword was that wMEMO could be used as collateral to gain leverage to buy more TIME to stake. This was what led to Wonderland’s astronomical growth but also what ultimately led to its demise when the markets tanked. As prices were falling quickly, investors that took on too much leverage were in turn automatically liquidated. (much like what happened during the great financial crisis)
Solution: I am a risk-averse wuss so in my opinion — leverage should NEVER be allowed in such decentralised fund managers! In the real world, this is akin to having your VC fund shares collateralized and getting a loan to invest even more into the VC fund. VC fund investing carries more risk than typical equity market investing — why should leverage even be allowed?
3/ Lack of clarity, education, and managing expectations
I felt that a big part of Wonderland’s failure was in communication and managing expectations, which led to them having a polarized investor base — investors who believed in the ultimate vision (a decentralized VC) and investors who were just in it for the insane APYs. It didn’t help that in the past, Wonderland had a calculator that calculated how many “lambos” you could own simply by staking. (Didn’t appeal to me that much, I am a terrible driver and I would never trust myself with a lambo. )
So when markets tanked, the group investors in it just for the ride were uncertain if they could still obtain those APYs. And unsurprisingly, they quickly abandoned ship.
Solution: At the very outset, the key message should be that the insane APYs are temporary and there is a strict, definite deadline to when it ends. In my mind, this should happen:
a) A announcement on social media/discord teasing the launch period of the protocol and for investors to subscribe on a first-come first-served basis. Like an IPO, there should be a target capital raise over a set time period. If the capital raise doesn’t meet the target, then the project will not take off and investors will get their funds back. The key message is that APYs are temporary, and revenue sharing is the long-term business model.
b) Investors must subscribe by a certain date in order to obtain the initial “early investor” APYs. And these investors have a moratorium of 3 months in which they can’t sell, and a vesting period over a year after for the APYs. After which, once deals are coming in, it will become a revenue share model.
c) Investors will feel “urgency” to subscribe to get the APYs and are not incentivized to sell out early as the APYs are vesting. This gives lee-way to the investment team to find deals and implement the revenue share model (Airdrops, proportion of transaction fees etc) within a year. The long term profitability projections should be transparent to attract long term investors.
d) This mechanic and model must be outlined at the outset. Once the dealflow commences, this should be completely transparent with a dashboard monitoring investments for investors (like an investor portal).
Best practices
So, in summary, what would be the best practices for a decentralised fund manager?
- Governance: Fully doxxed investment team, for both treasury management and deal sourcing. Kind of paranoid of anon teams now. The community votes for deals done.
- Managing expectations: A definite timeline on the insane APYs, after which a revenue-share model will follow from VC investments. I am a proponent of using instant gratification to lure in my #Tribe.
- Transparency on investments/returns: Once the revenue-share model kicks in, projections should be made available to investors via a dashboard. In general, sustainability should be made clear to investors once dealflow is established.
- NO leverage: The token should never be used as collateral for leverage. Their investment is already inherently risky.
- Dedicated community managers: There needs to be relationship/community managers made available to investors to allay their concerns and ensure they are in it for the long term.
But hey, don’t take it from me, not financial advice, I’m just an AnonFemale :-)
