What is Melon (2018 Edition)

Since its inception in July 2016, Melon has changed significantly. So, in this post we provide a short recap of what Melon is and what we’re planning to do in 2018. For more detailed, technical information see here.

First things first… What is Melon?

Melon is a fully decentralized asset management protocol which allows anyone to set up, manage and/or invest in an investment fund of digital assets in a secure, robust and permissionless manner. In three words: decentralized investment infrastructure.

How does Melon do this? At its core, Melon simply encodes the rules of how to set up and operate a fund into the smart contracts. Melon brings and combines two new concepts:

(i) Technology operated fund

  • Fund accounting (NAV calculation, performance and fees calculation)
  • Subscriptions and redemptions: The accounting and activity around creating new shares in a fund when an investor invests or removes those shares on redemption as well as any necessary KYC/AML on investors.
  • Paying out (pre-defined) management and performance fees to manager
  • Trading on integrated exchanges

(ii) Technology regulated fund

  • The fund manager defines a rulesets and parameters which he commits to comply with during his investment mandate.
  • The rules are enforced by the smart contracts (by design) i.e. the fund manager can never breach the ruleset of the fund
  • The pre-trade risk policies defined by the manager in the smart contract(s) are checked before each trade to determine trade validity.

When you think about a traditional hedge fund, the first thing that might spring to mind is the investment manager, the person or company making the investment decisions. But that is only the tip of the iceberg. The investment manager needs broad support across many domains with niche expertise to run the fund. Part of this can be done internally by operational teams. However, a large part is usually handled by an external party to the fund referred to as a fund administrator — the independent infrastructural backbone of any fund which is typically required by law.

The fund itself has reporting obligations to the fund administrator to ensure timely transaction settlement and regulatory obligations. The operational internal backbone of a fund is so cumbersome that it typically requires 3–4 operational staff per investment professional. Though rarely in the spotlight, fund administrators, operational teams and other intermediaries play critical roles in today’s asset management industry. They not only support the investment manager to run the fund smoothly, but also provide independent checks and processes to the investors that the manager is accounting for all activity accurately and acting in the best interest of his/her investors.

So what is the difference between a traditional fund and a Melon fund?

How does Melon work?

Melon is truly decentralized. The back-end of Melon is built on the Ethereum network while the front-end operates on top of IPFS. Supporting functionality and enabling web browsers to interact freely with the protocol is the javascript library, Melon.js. For the tech savvy amongst you, here is a link to our entire code base.

Design of the Protocol

The Melon protocol is (amongst other things) responsible for:

  • Asset Custody: all the underlying assets of the fund are held by fund smart contract — not by a third party — eliminating custody counterparty risk.
  • Compliance: Regulated investment managers are required to conduct KYC/AML on client investors. Melon’s compliance module provides the ability to integrate any third party provider to whitelist Ethereum addresses that may invest in your fund.
  • Performance Calculation: Since a portfolio usually contains many different assets, an aggregate performance measure, which considers allocation weights and performance of individual positions, is required for relative and absolute assessment.
  • Price feed: In order to correctly price the assets and obtain a verifiable, live valuation of the portfolio, we need reliable price data recorded on-chain. Anyone can provide price data to the Melon platform by staking MLN tokens. The top five stakers (subject to change) are selected as Price Feed Operators (PFOs). Out of the five PFOs, the median price is selected for that observation and written to the blockchain. Stakers are rewarded MLN tokens for providing this service. Malicious behavior is mitigated and disincentivized by slashing the MLN stake.
  • Investor/Shareholder Accounting: Imagine you have 1000 investors, all investing different amounts, at different times and needing to redeem their assets at different times. Keeping track of the exact allocation, profit share and fees for each investor would be a very time-consuming process. With Melon, the contracts take care of this.
  • Fee Accounting: As an investment manager, you manage the money of other people. In exchange for this service, you collect a fee. The fee consists of two components: management and performance fees. The investment manager can set his/her fee structure and the contract automatically calculates each investor’s fees to be paid.
  • Risk Management or ‘risk engineering’ means anticipating risks, not just dealing with issues once they’ve arisen. Risk Engineering is a set of modular policies, implemented as smart contracts that enforce a desired pre-defined trade criteria — for example, restricting the addition of a new token asset to the portfolio once the specified maximum allowed number of distinct token assets has been attained, or ensuring trade best execution. Monitoring isn’t required as the smart contract policy makes an active breach of the policy impossible. Melon risk engineering policies are literally woven into the fabric of the trade; if the criteria are not met, the trade cannot be executed. The fund manager can define his risk management profile at the fund creation thanks to the modularity.
  • Exchange Interaction: The main purpose of a fund is to trade. Trading is done on the exchanges. These are integrated into the Melon fund, so you can trade directly from your fund through the Melon front-end. Currently, only decentralized exchanges are integrated.

All of the above is operated and managed via code in smart contracts and enforced by blockchain technology in a decentralized manner.

Now… let’s look at how Melon benefits you as (i) an investment manager and (ii) an investor.

(i) Melon for investment managers

The operational overhead of simply maintaining a fund and abiding by regulatory requirements is a full time job in itself — even with the assistance of a fund administrator and a back office/middle office support team. Melon automates the vast majority of such tasks by replacing them with smart contracts, thus freeing up your time and energy to focus on portfolio management.

Essentially, Melon can help you operate a fund of digital assets for your clients. The blockchain itself is the custodian of your assets, while Melon takes on the role of the fund administrator and parts of the back/middle office to help you with the administrative tasks and operations. When setting up a fund, you simply define your fund configuration by choosing the different policies/parameters (exchanges, risk management profile, management and performance fees, KYC/AML solutions etc.) and deploy your fund contract to the blockchain. The whole process should cost you less than USD 50 (Ethereum gas costs) and be finished within a few minutes. At this point, you are all set to focus on your primary mission: managing a portfolio of assets and making investment/trading decisions. You can do so by trading on the specified decentralized exchanges to which your fund is connected.

In addition, Melon will enable you to generate interactive reports, factsheets and other documents for investor or regulatory reporting … all in one click.

Snapshot of reporting/marketing interface

(ii) Melon for investors

Most of us don’t work in finance or have the skills, time or inclination to become knowledgeable in this area. But instead of being excluded from the benefits of economic growth, you can simply outsource investment decisions to professionals for a fee. This is how asset management works — funds allow a manager to concentrate investment management effort towards the collective funds of many investors. Now what are some of the obstacles for a teacher, doctor or engineer to find the right asset manager to manage their money?

Traditional asset management has high barriers to entry; many hedge funds for example do not accept small investments. If you are a student with USD 300, you are going to have a hard time finding a fund that will accept your investment. If they do accept smaller investments (retail clients), fees are usually much higher. And it makes sense. Onboarding a new client is a lengthy, time consuming process. On Melon, there is no minimum investment. Whether it’s 1/10 ETH or 10 000 ETH, the fund contract will accept your investment. This is due to the fact that the subscription process for new investors (i.e., issuing new shares) is fully automated and, thus, can be scaled without a significant increase in costs.

In addition, traditional investors lack a standardized approach for evaluating funds. Most funds provide updates on performance and strategy through regular factsheets, but use different metrics, making comparison difficult. On top of that, there are very few, if any, standardized platforms where you can obtain such data on funds for free (services like EurekaHedge and Morningstar, which do offer comparative data on funds, are usually quite expensive and few individuals would get subscriptions).

Melon will provide investors with a ranking of Melon funds based on historical track records that no one can tamper with. In addition, each fund can maintain its own frontpage with standardized, transparent metrics (historical performance, volatility, VaR, fee structure, etc.). This will enable investors to make educated decisions about the funds in which they want to invest.

The Vision

In its current form, Melon is only compatible with digital assets. It is an asset management tool that allows you to create an investment fund of digital assets — that is, assets that are tokenized. Currently, that is the entire USD 300 billion cryptocurrency market. However, we believe that in the near future, most or all traditional assets will be digitalized and stored on a blockchain or, in other words, tokenized.

Why? Simply speaking, blockchains are designed to securely store ownership information and reliably transfer value. And there are already ample companies working on that: Digix tokenized gold, Bitfinex tokenized the USD, Neufund is helping new companies to issue their equity shares in token form to name a few. When the day comes that most traditional assets in the world are tokenized, you can seamlessly include them all in your portfolio. That means you will be able to manage (tokenized) stocks, bonds, commodities etc. in your Melon fund. Isn’t that exciting?

The MLN token

The main purpose of the MLN token is utilization of asset management gas units (amgu’s) on the Melon network. Melon is intended as an autonomous fund management protocol, built by the Melonport team. Once it is finished, Melonport AG, the company behind the Melon protocol, will take a step back and hand over the governance of the protocol to the maintainers of the protocol. For an in-depth description of the MLN token utility, go here.

What’s next?

When we started the Melon Project, we estimated that it would take us about two years to finish the protocol. At the time of writing, there are about seven months left. During these remaining eight months, we will focus on:

  1. Making the protocol feature complete
  2. Integrating more decentralized exchanges
  3. Building the governance system on Melon
  4. Securing the code base and performing some refactoring work.
  5. Driving user adoption through regular competitions such as our recent olympiad

When we finish the protocol in February 2019, Melonport AG, will have fulfilled its objective of getting a decentralized investment management protocol on its feet and the current plans are for the company to be wound-down. But until then … there is still a lot of work to do.

If you’ve got any more questions, feel free to join our group on Telegram or drop us an email at team@melonport.com. We would be happy to see you there.

Until next time!

The Melon Team

This blog post is subject to change as the research & development phase is ongoing. Melonport will aim to update blog-posts regularly to represent our latest thinking on a best-efforts basis but there may occasionally be time-lags between latest thinking and updated documentation. With this in mind, the author of this blog assumes no responsibility or liability for any errors or omissions in the content of this blog