The “DeFi Fund” Charade

Owning DeFi Tokens as part of your Centralised Crypto Fund does not make you a “DeFi Fund”.

Over the last few weeks and months I’ve caught myself rolling my eyes whenever I hear of a new DeFi Fund launch. It’s always the same. Someone makes a claim to be launching a DeFi Fund. I get excited and do some digging, only to find out there’s nothing decentralised about the fund at all. In fact, they’re usually entirely 100% “centralised” and being pitched as a DeFi Fund. It’s a bit like saying you’re playing in a football match when you actually just bought tickets to watch.

Together with other early DeFi founders in the space, I’ve spent the last 5 years of my life fully dedicated to building decentralised on-chain asset management infrastructure. Until a few months ago, there was almost nothing to show for our efforts. Over the years countless VC funds and TradFi players have told us time and time again that we’re wasting our time. Recently, we’ve started to see the tide changing with DeFI TVL skyrocketing. Earlier this month, Google trends reached a new all time high in “DeFi” searches as people try to figure out what the hell it is.

So I get it. The word “DeFi” sells. I can see why you’d want to market yourself as launching a “DeFi Fund”… even if it’s not really …decentralised.

But today I want to spend some time setting the record straight so that those people who do care to know what the difference is have an opportunity to learn about DeFi for real.

So What Is DeFi?

In my mind, decentralised asset management is all about the automation of financial intermediation, whether that’s mundane operational and administrative processes like custody, clearing, settlement, etc or risk management, compliance, analytics and accounting. All this can be done without a single point of failure. This ultimately should lead to way more efficiency and transparency, because it replaces heavy financial intermediaries and very manual processes, with efficient code.

So what are the building blocks of DeFi? Well, first we have a decentralised settlement layer which DeFi is largely built on today, Ethereum. Think SWIFT but way faster, way more efficient, way more functional, waaaaay cheaper, and a community of young and energetic people around it who refuse to believe we can’t build a better financial system.

Aside from being a pure settlement layer, Ethereum also enables people to build decentralised applications on top of it, using its own coding language.

The first ‘things’ that people started to create on top of Ethereum — were plain vanilla digital assets. You may remember the ICO boom of 2017 — we’ve seen a huge emergence of crypto tokens ranging from stablecoins (eg. DAI, USDC, etc), gold-backed tokens, digital art (NFT’s) and many projects which issued their own tokens which represent their growth or give certain rights to holders. This was an exciting time but in many ways the token prices moved before anyone actually delivered anything, hence the bear market which followed.

Throughout the bear market though, many of the projects that live on today were heads down and building some of the critical infrastructure that was to follow and led to an explosion of new assets and asset classes on-chain. The crypto universe went from being wildly speculative to consisting of all the building blocks you would typically see in traditional finance. It’s not the “what” that’s changing, it’s the “how”. The DeFi building bricks have been emerging one by one; Decentralised P2P exchanges (Uniswap, Kyber, 0x, Synthetix, Curve), borrowing and lending protocols (Compound, AAVE), protocols that automate strategies for you (Yearn, Idle) and protocols that enable you to provide liquidity to automated and autonomous market makers whilst earning a share in the commissions and any trading P&L (Curve, Uniswap, Balancer). You can build and launch your own derivatives — Synthetix DAO famously launched synthetic tokens representing the FANG stocks not so long ago.

The Mechanics of a “real” DeFi Fund

The way I see it, DeFi asset management is very different to how it’s being pitched today. For me, a DeFi fund takes advantage of every single one of the DeFi building blocks in the decentralised on-chain asset management technology stack and makes use of both their infrastructure as well as the native profit and yield making opportunities there which benefit users in a different kind of way;

In terms of the tech stack, a DeFi fund should be using the following;

• DEX’s like Uniswap, Kyber, 0x, Synthetix, Curve, Paraswap and others to conduct trades
• AMM Pools (Curve, Uniswap, Balancer, etc) to contribute liquidity to a pair of tokens
• Borrowing & Lending Protocols like Compound & AAVE to earn interest on tokens that are idle in your portfolio or take some leverage
• Strategies like Yearn and Idle which auto-switch between best yields on your behalf
• Protocols like Enzyme to set up and customize your fund and handle investments, redemptions, NAV calculations, fees and trading permissions.

The opportunity set involves;

• Trading tokens P2P with immediate settlement and non-custodially
• High yields on stable coins and other assets which simply does not exist in Traditional Finance today
• Farming opportunities; an opportunity to earn the native tokens of a protocol by providing liquidity to AMM pools or lending protocols
• Staking — being able to earn yield by unlocking certain actions on a protocol with your token and locking them up

A real DeFi fund isn’t just about betting on the tokens of DeFi projects going up or down. The whole point is to use the DeFi tech stack from top to bottom, taking advantage of all the yield and profit making opportunities that exist and are unique to DeFi today.

The overall benefits to fund owners and investors of a true DeFi fund ares as follows;

• Investors have the option to custody their holdings
• Permission-less. Anyone can access, anywhere in the world
• Full transparency & audit trail . Look up what is happening and track and prove it on chain (Transaction history, performance, activity, fees and more)
• The guarantee that fund owners have to act within a confined set of rules that they define up front
• Superior yields and profit opportunities which are not correlated in any way to traditional finance today

All of these benefits can be achieved with just code, drastically reducing the operating and administrative costs of a fund which should ultimately result in lower fees for funds and end investors. But it’s not just that you’re paying less. You’re paying less for more with the additional transparency and accessibility about it too.

The DeFi Fund Charade

So the next time someone pitches their DeFi fund to you, the question to ask them is whether it is really a DeFi fund or whether it is a Traditional Crypto Fund that happens to invest in DeFi.

Warning signs to look out for;

• Can you hold custody of your assets or do they work with a Traditional custodian which adds to fees and doesn’t give you full control.
• Do they use a fund-administrator or are they working with the same very decentralised finance technologies they are pitching to you.
• Do you get real-time access to the performance & activities of your Fund?
• How is risk management handled? What processes are in place to make sure that a Fund Owner can’t spend your money on something that was not part of the original mandate?
• Do you get a full look through into what fees are being paid and where?

DeFi is meant to give you control and automate a lot of the financial intermediary roles to bring cheaper and more accessible products to the end user.

Bitwise and Grayscale are the latest in a series of announcements which name themselves a “DeFi” Fund but their not-so-DeFi-stack becomes quite clear when you take a look at their 2.5% fees. Bitwise uses Cohen & Company as auditor, Theorem Fund Services as a fund administrator and Anchorage as custodian. The costs clearly stack up! This far exceeds TradFi pricing logic for an index. Furthermore, running an index with a minimum investment size of $25,000+ is not very democratic.

Some like to argue that they went down this path (the usage of so many intermediaries) to avoid counter-party risk, but ironically these are the very same types of counter-party risks that DeFi was built to avoid. To date, centralised crypto exchanges and custodians have incurred far more than counter-party risk than DeFi.

DeFi’s immutability, self-custody and automation aspects can provide an opportunity for non-custodial financial services, much lower fees, the democratisation of access and lowering barriers to entry.

To Wrap Up

I’m not criticising anyone investing in Crypto funds that invest in DeFi if this is what they are consciously choosing to do. But it’s worth knowing that most DeFi enthusiasts wouldn’t consider this kind of investing a “DeFi Fund” but rather just traditional investing with a nice sellable buzz word attached to it. The real juice as far as we’re concerned, is in the tech stack being able to drastically lower costs for the end user, enhance transparency and provide new and novel profit opportunities that come natively from within DeFi.