DeFi Engineering part 3.
Introduction to Decentralised asset management
Decentralized Finance unlike Centralised Finance’s traditional asset management organizations like Mutual Funds and Hedge Funds are concerned with the custody and investment of Assets. Asset management groups focus on providing investment advice and action that align well with their client’s risk and return profile and understanding how the variety of investment products and their respective market conditions play into this equation is certainly a task that is worth outsourcing. But the landscape of the asset management industry is rife with moral hazard. These hazards stem from the information asymmetry between asset management professionals and their clients. Direct profit-sharing encourages an asset manager to chase returns. Risk-adjusted compensation may encourage an asset manager to shoot for a distribution of returns that generally performs smoothly, but has a fat tail on the downside. And even the direct measurement of returns can be hazy, especially with illiquid assets.
To combat the pitfalls that may befall uninformed investors, governments worldwide have placed a number of restrictions in place to better incentive actors. Return reporting is heavily scrutinized. Investment in certain asset classes is restricted to sophisticated investors. “Sophisticated” here means possessing a certain level of wealth. Sophisticated investors are better equipped to weather return drawdowns and presumably perform more due diligence on their asset management research before choosing a manager. The barrier is high with hedge funds requiring an individual’s net worth to exceed $500,000. Additionally, many investment professionals receive a strong ethical foundation for their work through the Chartered Financial Analyst program and other certification programs.
Now the point is that the decentralized approach to asset management seeks to make the relationship between client and manager more transparent. Assuming an asset manager only participates in the crypto market (and this will grow with time — some interesting projects like Polymath are working to get traditional securities on the blockchain), then the ledger of their transactions will be public and could be linked to a pre-agreed upon market price index. And that is all the data you need to execute a contract between the two parties! On a regular basis, fees are paid to the manager and when lock-up periods expire, the client can withdraw funds. For large managers, perhaps a derivative contract will be formed on their return stream, and investors can trade in and out and establish an effective “interest rate” in fees for their services.
The Figure above illustrates the general architecture of the AICB core which is the smart contract that powers the AICB Hedgefund smart-contract design for the AICB token. AICB requires asset managers to execute their strategy through the smart contract that provides an oracle Chainlink exchange data and execution parameters. The performance of the strategy is then easily tracked through their immutable smart contract. It will be interesting to watch if this framework is flexible enough for asset managers. Another project Artificial intelligence system is seeking aid from the asset managers to predict the market trend of Top hundred crypto assets and ETFs thus aiding the asset managers' decision process. The manager needs only specify the weights of holdings for a cryptocurrency portfolio, and the Binance Smart Chain will accept investment and track returns.
While ingenious in their design, these protocols have yet to address the heart of regulation and accreditation in the asset management space. An immutable stream of returns seems a large step in the right direction, but it will be important to move slow enough to build positive rapport for space, because, as always seems to be the case in the two worlds of crypto and asset management, information asymmetries may lead less knowledgeable investors to make serious mistakes.
