Will DeFi Revolutionize Asset Management with Trillions of Dollars in Scale?

Could DeFi Disrupt Asset Management and Transform Trillion-Dollar Scales?

Source: RWA Observer

With the development of DeFi, is it possible for new BlackRock or Vanguard funds to emerge in the cryptocurrency industry?

As of 2022, the global assets under management (AUM) amount to approximately $126 trillion. Due to the global wealth in the financial market being $329.1 trillion, around 38.3% of all wealth is managed by the global asset management industry.

However, the current size of managed cryptocurrency assets is only a few hundred billion dollars.

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Perhaps it accounts for around 3% of the size of the cryptocurrency assets?

Traditional asset management relies heavily on trust

Asset management, like many other sub-industries in finance, is built on trust.

In asset management, investors entrust their money to professional asset management companies, which then manage the money on behalf of the investors, investing in stocks/real estate/bonds, and charging management fees and performance fees.

In traditional asset management business, investors who transfer money to asset management companies go through a series of complex contracts, compliance audits, and other measures, which at least give customers a sense of security: the money is safe and still under control.

In the traditional asset management industry, well-established asset management companies with a long history always have a significant advantage in fundraising and brand image compared to emerging companies.

However, there have been cases like Madoff’s scandal, but overall, giant companies like BlackRock and Bridgewater (recent rumors as well) are still trusted by investors.

Tainted reputation of cryptocurrency asset management

With such a huge industry, the crypto community certainly didn’t miss out.

A few years ago, the hype around Yearn claimed clients could achieve up to 1200% annualized returns.

Investors could engage in yield farming/liquidity mining/staking, and various other activities, leveraging different contracts. All of these can be automatically executed through smart contracts…

However, most of it turned into a race of who can run the fastest.

It’s not just the asset management industry that lacks trust; all sectors of the crypto community also lack trust.

From the ancient times of Mt. Gox to the recent FTX and Terra, there is still a mix of good and bad in the cryptocurrency industry.

The original intention of DeFi is to create a financial landscape without intermediaries, using the power of blockchain smart contracts to give users complete control over their assets.

But in the crypto world, which should have “technology guaranteeing trust,” it is actually filled with distrust, and outsiders may even equate it to “scam groups” with “≈” symbolizing it.

Within the community, “not your keys, not your coins” is considered an investment maxim by many professional investors.

Apart from a few asset losses caused by technical vulnerabilities, most of the losses are actually caused by centralized institutions pretending to be decentralized finance (DeFi).

Traditional and Crypto are Accelerating Integration

In the past few years, asset management in DeFi has undergone significant transformations.

The initial focus was on maximizing returns on individual assets, but now the focus has shifted towards creating robust and risk-resistant asset pools to meet the needs of traditional users.

Traditional asset management giants like BlackRock are also making moves in the crypto industry, and Grayscale has already launched a Bitcoin trust fund.

If everything goes well, after the approval of a Bitcoin spot ETF, numerous ETFs for other tokens will also be approved one after another. At that time, leveraging the channel capabilities of traditional financial institutions, a large portion of crypto assets will be controlled by asset management institutions.

However, these ETFs launched by traditional institutions are still centralized financial products. When investors examine the underlying assets of these ETFs, they certainly have more trust in the record of custody addresses rather than the so-called audit reports from professional institutions.

But to achieve true integration, breakthroughs must also be made on the settlement side.

The biggest difference between blockchain transactions and traditional transactions is:

On-chain transactions are settled in real-time, while traditional transactions require authoritative institutions to complete the settlement.

Authoritative institutions are also rapidly adopting distributed ledger technology to fill in the technical gaps. If settlement can also be confirmed in an on-chain manner and there are a large number of tokenized assets, the boundaries between traditional asset management and on-chain and crypto asset management may become blurred in the future.

The Crypto Community has Its Own Cultural Characteristics

Currently, the crypto community is filled with stories of overnight riches. Compared to other markets, cryptocurrency investors have different attitudes and cultures.

Warren Buffett, as a traditional investment guru, is called the “Stock God” with an average annual return of over 10%. But cryptocurrency investors and enthusiasts are only satisfied when their investments double.

The preference for high returns among investors makes things more complicated, as it conflicts with the long-term participation that is crucial for asset management.

Due to various smart contracts, automated yield strategies, and the constant emergence of various new ecosystem gaming, the crypto community has actually built a more entertaining casino than Wall Street. People are attracted to the crypto community not only for profit and novelty, but also because it is fun and has its own culture.

If a big figure enters and participates, it will trigger a collective celebration in the crypto community, resembling a force that resists financial hegemony.

To some extent:

The issuance model of US Treasury bonds is not fundamentally different from liquidity collateralization;

The operating model of modern banks is far from transparent and reliable compared to stablecoin issuing institutions.

The printing mechanism of fiat currency has been looked down upon by bitcoin enthusiasts for many years…

Using methods like Dogecoin was initially a joke, but as more people got involved, it became a cultural belief.

Even the founder of Dogecoin did not expect it to develop to this extent.

It can be considered as a decentralized version of “occupying Wall Street”.

Non-custodial and permissionless DeFi asset management seems to better suit the characteristics of the crypto community.

If it is managed by a reputable KOL, it might lead to the next paradigm shift towards democratizing the financial market. (This sounds like MakerDao, doesn’t it?)

This shift will allow global investors to access the global financial market.

The Yearn project currently manages around $300 million in assets. Although they follow the principle of requiring permission for fund issuance, this might be the development direction of Web3 asset management in the short term.

“Non-custodial funds” – the key to breaking through in the future?

Non-custodial means that during trading or service, the platform or third party does not hold or have custody of the funds or assets. The whole process typically occurs through smart contracts.

This is in contrast to custodial services, where the service providers hold the user’s funds or assets for safekeeping or management.

Custodial services currently have advantages in recovery and security, allowing reputable centralized services to better assist users in case of theft or malicious activities, as most of them have insurance.

Non-custodial services carry the risk of smart contract vulnerabilities, where funds can be stolen through loopholes or easily flawed code. Additionally, if users lose their private keys or access to their accounts, they often have little to no chance of recovering their funds.

If asset management companies can manage user funds through technological means without custodial ownership, many regulatory issues can be resolved.

For example, smart contracts can implement investment strategies through oracles or other preset logic and ensure that profits generated for depositors adhering to the asset management company’s strategy will be automatically and appropriately distributed.

With the popularization of self-sovereign identity (SSI) in regulatory institutions, established managers can even create local strategies accessible only to existing clients. This way, they can benefit from all the advantages of cryptocurrencies without increasing regulatory risk exposure.

In fact, decentralized exchanges like 1inch and Uniswap, lending services like Maker and Compound, and the aforementioned Yearn and well-known project Solv all adopt non-custodial solutions.

However, the biggest obstacle to non-custodial solutions in the asset management industry is currently regulation:

In the 1940s, the United States enacted the “Investment Company Act,” which stipulates that fund managers cannot self-custody and must seek qualified third-party custodians that comply with SEC regulations.

The final breakthrough method could either be the introduction of a non-custodial solution by a SEC-approved custodian or the recognition of non-custodial technology based on certain standards.

However, when it comes to regulatory games, it’s best to leave it to the tech giants of the American empire~

Perhaps influenced by this, the current state of crypto asset management is as follows:

Comparing it to the scale of traditional asset management, doesn’t it seem like the smaller the current market size, the greater the opportunity (pitfall) in the future?

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