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What is Asset Management in DeFi?

4.9
| by
Kofi J
-

What is Asset Management in DeFi? 

The fundamental precept of asset management is wealth creation. In DeFi, the investor rides up front choosing their strategy with increased transparency, trustlessness, and opportunity.  This gives the investor more autonomy than in TradFi, where asset management firms quantify the client’s investment goals, risk tolerance, and capital needs, then construct a portfolio managed on the client’s behalf.


Key Takeaways

  • DeFi offers a new, fully transparent standard to asset management, allowing custodial wealth growth on-chain.

  • In the span of several years, protocols offering asset management services have gone from optimizing yield on single assets to offering complex strategies .

  • Examining the overall landscape of asset management points to more and more liquidity moving on-chain in the next decade.


DeFi Asset Management Protocols and How They Work

The collapse of Credit Suisse in March 2023 has thrown many wealthy clients into the pool of potential customers, and banks and wealth managers have been scrambling to acquire these clients. Zooming out a little more. TradFi asset management comes with fees ranging from 0.01% to over 2%, sometimes tiered. However, accessing these services will typically cost clients more than 1% of their total portfolio value yearly. 

Meanwhile, DeFi introduces quasi-feeless asset management, huge diversity due to its composable nature, and fully on-chain tracking allowing clients to see the full breakdown of their portfolios in real time.

In short, TradFi needs to keep a close eye on its lunch because DeFi looks hungry and is better suited to the job. 

Asset Management in DeFi 

A core tenet of asset management is passivity. Individuals/ clients must be able to set and forget; this notion informs this article's contents. Wealth generation occurs automatically, and the investor can fully abscond any duty of monitoring. Wealth builds in the background, and users continue with their life. This element and the presumption that asset managers will secure better returns than the individual are why this service is a trillion-dollar industry.

DeFi asset management has three enormous advantages over analogous TradFi services: the composability of DeFi, the nascency of DeFi – industries in their infancy always secure greater returns in line with general principles of risk to reward – and DeFi’s permissionless nature, which means investors retain authority over their funds.   

Money Lego: Composability

Composability means that each unit within the larger framework can work together. DeFi protocols leverage other dApps and smart contracts to create new services. Developers can construct different frameworks allowing for an explosion of growth and novel use cases due to the interoperability between protocols.

Developers start with a box of functioning money legos, and as more dApps launch, the number of interconnections and potential constructions increases, further driving innovation and growth. This idea underpins DeFi so profoundly that it almost escapes conscious thought. Yearn Finance is an excellent example and one of the earliest pioneers in DeFi asset management. Yearn features vaults where investors deposit their assets, and then Yearn’s smart contract routes them to various protocols enabling investors to accrue optimum yield – a classic and simple example of composability. 

DeFi Growth Metrics

DeFillama TVL

DeFiLlama’s TVL (Total Value Locked) dashboard shows that raw capital value locked in protocols peaked in late 2021 at nearly a quarter of a trillion dollars. The first explosion happened from 2020 to 2021 (DeFi Summer), and the second leg up was from 2021 to 2022 – both periods exhibit classic hockey stick growth. This is followed by a sharp decline in 2022-2023. 

The technology adoption curve has five stages: innovators, early adopters, early majority, late majority, and laggards. The earlier an individual adopts a technology that successfully takes off and receives mainstream adoption, the greater their rewards will be. DeFi has only existed for several years, and its rapid expansion has allowed it to provide returns that outpace those available in TradFi.

To summarize, DeFi presents more risk as the frontier of finance, but as always, increased risk means increased reward.

Crypto Adoption

Source: A16Z State of Crypto

A16Z’s 2023 State of Crypto Report shows the sticky nature of crypto adoption. Participants enter the market during peaks of price euphoria; however, many stick around, and this drives long-term growth with a feedback loop establishing between interest and innovation. Crypto still has a long way to go, and asset management remains a core vector of expansion for DeFi. 

DeFi’s Permissionless Nature 

DeFi asset management introduces transparency to a notoriously opaque industry, as asset management in TradFi remains far more obscure and secretive than DeFi. TradFi clients may only get a full breakdown of their funds every quarter, whereas, in DeFi, everything is fully visible on-chain.

Another massive upside to on-chain asset management is financial autonomy, with users retaining total control of their funds. Smart contract risk must be acknowledged when discussing asset management protocols, but DeFi asset management heavily reduces third-party risk. 

Tailwinds to the expansion of on-chain asset management include the recent collapse of regional banks (short to medium-term) and the general track records of investment banks taking obscene risks due to the dominant model of socializing losses and privatizing profits in the United States (long-term). 

DegenSpartan, a renowned Crypto Twitter figure and profit maximalist, gives an interesting take on crypto more broadly as a vehicle for storing wealth. Specifically for extremely wealthy individuals keeping assets on-chain drastically reduces overhead costs, which applies more generally. Smart contracts automate functions making the human-heavy asset management services typical of TradFi appear slow, cumbersome, and inefficient compared to the DeFi alternative. 

The Rise of Front-End Services

DeFi, like any nascent technology, has grown virulently in every possible direction. Asset management protocols provide single-user interfaces where investors can track everything in one location – a DeBank wallet experience for yield. Looking briefly at the genealogy of asset management the most apparent trends have been optimizing user experience, customization, and complexity.   

History to Present Day 

Asset management is the formal term, but DeFi natives may be more familiar with yield aggregators. They are one and the same thing; they travel under different flags but serve the same king. A yield aggregator automates the wealth generation process for users through myriad strategies that have grown increasingly complex with time. A special mention must be given to Enzyme Finance, arguably the first even DeFi asset management protocol launched initially in 2017 under the name Melon protocol. 

Yearn Finance

YEarn Finance


Yearn Finance, released by the infamous developer wizard Andre Cronje in July 2020, is an excellent genesis point for understanding the growth and development of asset management in DeFi.

Yearn’s first iteration, in its most basic form, automatically routed stablecoins to lending protocols offering the best APY. Vaults for different assets introduced more complex automated strategies leveraging DeFi’s composability and marking a significant step forward for asset management in DeFi. 

Yearn Finance developed the conceptual idea of a vault where users could deposit assets and earn yield thanks to an automated strategy. Best of all, anybody can create a vault; this open-source permissionless nature always invites innovation. Regarding fees, vaults charge a performance set by the vault’s creator, but this comes from the yield earned by the strategy and never from the principal. 

Beefy Finance 

Beffy Finance

Beefy Finance launched later that year in September 2020 and finetuned the idea of vaults and automated earning. It launched initially on the BNB Smart Chain but has since gone multi-chain, allowing crypto users from across the spectrum to earn easily. Beefy Finance improved the user experience by offering zaps into vaults.

The bread and butter strategy for Beefy Finance was automated LPs. Users deposited their LP tokens, Beefy Finance sold the governance/ liquidity token for more LP tokens, and the auto-compounding LP strategy was born.

Beefy Auto-Compounding Strategy

The protocol takes a performance fee but calculates this into the predicted APY. In its current iteration, Beefy Finance offers hundreds of vaults, diverse strategies, and a highly accessible low-touch yield optimizer. Beefy Finance provided a more varied range of assets with which users could generate yield, but compared to traditional asset management DeFi lacked depth holistically.

At this stage, DeFi yield vaults provided more efficient asset management services than TradFi from a fee and performance angle but failed to deliver an overarching investment strategy. Investors were limited to generating yield on single assets/ LPs, which may be fine for token maximalists, but it was a severe limitation to developing robust on-chain asset management services. 

DeFi Asset Management Protocols Today: The Front-End Service

In DeFi, currently, there are hundreds of asset management protocols, of which three will be examined: Nested, Factor, and Sommelier. All three specialize in different areas, but all provide effective asset management services representing the next generation of protocols automating the earning process and introducing a higher-level and more complex approach to asset management within DeFi.  

Nested 

Nested DeFi Asset Management

Nested allows users to copy trade portfolios of up to twelve assets. Nested uses NFTs which represent portfolios that other users can copy. Due to the financial incentives mechanisms, each time a user’s portfolio is copied, they earn a royalty fee. Instead of somebody taking a flat fee for portfolio management, performance now dictates revenue.

Note this trend from the beginning with Yearn, the ability for anyone to create a vault/ strategy/ copiable portfolio has opened up the asset management landscape removing the trappings of TradFi, namely nepotism, and privilege, allowing any skilled market participant to create blueprints for others.

On Nested, users have the option to copy each modification made by the creator, or they can choose to keep the current weighting of their portfolio. This social element makes Nested unique, and the protocol has become a codified version of portfolio challenges that have been popular on Crypto Twitter for a long time.

Nested presents a user-friendly introduction to crypto. Portfolios consist of a maximum of twelve assets, and users can simply copy every trade the portfolio creator makes, judging the best portfolios to follow via social scores and overall performance. This simplicity, and slightly improved complexity regarding overall strategy and risk and reward, makes it a great asset management tool for crypto beginners.

Nested present users with a front-end service that has optimized user experience, outsourcing the complexity of token research, portfolio allocation, and periodic rotations to more advanced users.

Factor  

Factor Asset Management
Factor Assets

Factor, an Arbitrum native protocol, is in the process of upgrading the customization aspect of on-chain asset management protocols. Currently, Factor offers four vaults which consist of indexes that grant exposure to areas of the Arbitrum ecosystem. Featured above is the ‘ArbDeFi Index,’ which consists of a basket of tokens from leading Arbitrum ecosystem participants.

The idea of DeFi indexes is not new. The next stage of the Factor protocol, its no-code modular infrastructure, is why it features on this list. Factor will allow non-technical users to build vaults, reducing the entrance barrier to participation and spurring another wave of innovation.

In short form, skilled market participants lacking technical knowledge will be able to leverage their skills to build custom strategies. This will inevitably increase the overall complexity of strategies available within DeFi and again optimizes user experience with the ability to participate in a single transaction with USDC.

Sommelier

Sommelier Asset Management

Sommelier most closely mirrors asset management in TradFi due to the dynamism of its vaults or ‘cellars.’ The big breakthrough has been allowing modification to vaults based on market data and moving from static strategies to live strategies.

Sommelier allows users to create cellars, and once they have passed community governance, anyone can access these custom strategies. Users can decide on a management performance fee incentivizing users to construct profitable strategies.

A popular example from Sommelier is the Real Yield ETH Cellar which optimizes ETH yield through leveraged staking and provides liquidity in Uniswap V3 pools for liquid staking derivatives changing the liquidity range to maximize returns. Sommelier brings greater complexity and market data integration to on-chain asset management, marking another step forward for the industry.

User Experience, Customization, and Complexity

The newest generation of asset management protocols has focused on these core values leading to a paradigm with increasingly nuanced strategies available and accessible in a single transaction for end users. DeFi’s inherent composability has fostered the rapid rise of these front-end services. A key area to observe will be the long-tail effects of opening strategy creation to a broader audience. 

In three years, asset management within DeFi has gone from optimizing yield on single assets to constructing delicate and reactive vaults, allowing users with no crypto experience to benefit from all the economic activity occurring within DeFi. 

DeFi Asset Management User Base 

Two groups present low-hanging fruit for on-chain asset management: crypto natives and DAOs – especially the latter. As crypto natives transition through the various stages of their crypto journey, there will likely arise a point where they want to streamline their investments for mental clarity and long-term operational efficiency. Vaults provide the perfect solution for this group of users and represent the next optimization stage of the classic DCA (dollar cost averaging) strategy.

On-chain asset management provides a massive boon to DAOs with static treasury holdings. For example, Uniswap DAO had a valuation of $12 billion at the peak of the last bull market compared to its current valuation of $2.2 billion – a total round trip. Pending community approval DAOs could deploy a percentage of their treasuries to asset-management protocols generating revenue for DAOs and enabling them to undertake more expansionary policies. 

Beyond this, asset-management protocols provide an excellent on-ramp for non-crypto natives to benefit from the ecosystem growth without exchanging time or effort. The greater question is whether these protocols can scale, given that clients that utilize asset management services typically have millions, if not hundreds of millions, in liquidity to deploy. 

Challenges DeFi Asset Management Must Overcome 

The three central obstacles to the growth of on-chain asset management services are security, regulatory, and liquidity issues.

Smart contract risk cannot be understated, and users must bear the smart contract risk of the vault itself and its underlying components. However, code becomes more resilient the longer it exists in the wild, and security will steadily improve with time. Investors can also minimize this risk by deciding on the vaults they interact with. Vaults containing newer protocols will likely include more risk, but in tandem, likely more upside.

Regulatory concerns vary from jurisdiction to jurisdiction, and given the lack of global consensus on crypto regulation, compliance will vary with each user. This presents the greatest threat to on-chain asset management due to the cautious nature of larger clients and the problems users will face if they try to off-ramp significant funds into fiat.

In its current form, DeFi lacks sufficient liquidity for meaningful institutional adoption. However, constant strides are being made to improve liquidity efficiency, and overall liquidity levels will naturally grow piecemeal as the world becomes more accepting of digital assets.  

Why DeFi Can Devour Traditional Asset Management 

A comprehensive perspective results in the thesis that the rise of DeFi asset management over TradFi seems inevitable on a long enough horizon due to the characteristics possessed by the former.

DeFi asset management introduces equality of opportunity to the creation of strategies. The best strategy will not come from a constrained pool of users but from anybody who wants to create a strategy that will inevitably lead to rising new talents. The permissionless nature means anybody can access these services- there is no minimum capital requirement- and protocols offer wealth management and wealth creation services to people regardless of net worth; some may not even possess essential financial services such as a bank account.

The larger DeFi flywheel that comes from composability offers a significant tailwind. Any aspect of DeFi can be integrated into asset management strategies, including tokenized real-world assets, which opens the door for trillions of dollars to come on-chain and be managed on-chain.

From an operational efficacy standpoint, on-chain asset management reduces cost and increases efficiency; a robust smart contract will consistently outperform a human. The overhead costs of third-party services, commercial real estate rental, and administration typically borne by the client evaporate with on-chain services. These savings get passed on, increasing returns for end users. On-chain solutions also provide the added benefit of being constantly available; there are no opening hours, no time zone differences, and access only requires an internet connection.

On-chain asset management offers the industry a new degree of transparency and turns the custodial approach on its head. In TradFi, a client cedes their assets to an asset manager; in DeFi, clients retain control over assets and execution. Pragmatically most functions have already been automated by software in TradFi, and bringing these services on-chain improves the overall experience for clients and users.

In the next decade, probabilistically speaking, an increasing percentage of asset management will occur on-chain. DeFi will begin to displace TradFi, or TradFi will leverage blockchain solutions; either way the future is on-chain.

Do note that this article and the protocols featured are for informational purposes only and should not be taken as financial advice.

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Kofi J
Kofi J
Kofi J has been active in DeFi since the 2020 summer explosion and has been rugged more times than he can remember. He hopes to make the decentralized economy a little bit more accessible through his prose. Follow the author on Twitter @k_pangolin

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