Why institutional investors can’t afford to ignore DeFi
Written by Will Hamilton
Professional investors are concerned about one thing: returns. Ideally, the goal is to produce constantly increasing returns that outperform the market, however, this becomes more and more difficult. Now more than ever, institutions are starting to notice that digital assets outperform most of their traditional counterparts, despite their inherent volatility.
While this has brought a new wave of reputable financial institutions and businesses into the space, there is actually an even bigger opportunity emerging, and that is DeFi or Decentralized Finance. DeFi is poised to add a new layer of financial opportunities with niche product offerings not available in traditional finance. This sub-sector of the digital asset market has been largely untapped by institutional investors, but that is changing.
Bitcoin is no longer a taboo
It took a while, but the price performance of Bitcoin (BTC) and other digital assets has turned many institutional heads in recent years. In fact, a recent survey found that 62% of investors who aren’t already exposed to digital assets plan to invest in the next year or so.
It comes as Bitcoin and its brethren are increasingly understood and more professional avenues to access them begin to become available. Reputable companies are currently offering investors access to Bitcoin-based products with great success given the heat of the market over the past year.
Large investment managers are generally opposed to declines in the digital asset market. However, the upside potential has seen many of these asset managers balance their exposure to higher risk digital assets with more stable growth products. This ultimately saw their overall portfolios add more value than they traditionally would have. Small allocations to digital assets are the first step for professional fund managers and given the attractive risk-adjusted returns of digital assets, it can be safe to assume that larger allocations to space will be made in the future. .
DeFi is the real next level
Beyond Bitcoin, there is the realm of decentralized finance, as we briefly mentioned above. Known as DeFi for short, it is a complete ecosystem of financial assets and services running on decentralized networks such as Ethereum. This is made possible by “smart contracts”, or essentially programmable money. Now, there is a whole emerging plethora of decentralized exchanges, lending platforms, yield opportunities and more.
For example, investors who own various digital assets can put them to work by pledging them to a pool of cash used to fuel a decentralized exchange. Without getting too technical, decentralized exchanges, or DEXs, essentially use these pools to facilitate transactions in a completely code-driven manner, without any human oversight. Transactions come with a small fee, which is then distributed to all liquidity providers based on their share of the pool. Because these systems are very simple and have no middlemen, lenders receive significantly higher returns than they would on virtually any existing financial platform. APYs of 5-10% are quite common, and even products that offer more than 20 or 30% are fairly easy to find.
As such, institutional investors should realize that returns on digital assets are not only generated by earnings from the underlying product, but also by the interest generated by return-producing financial products in the DeFi industry. . The emerging DeFi system is more cost effective, more efficient and overall faster than traditional financial products and services. In fact, some companies are already starting to notice this and take a step into this next frontier.
The change has already started
Things move quickly in DeFi, and institutional investment in the space has been no different. According to an upcoming report from Chainalysis, the share of total DeFi transaction volume from large institutions has increased from around 10% in Q3 2020 to over 60% in Q2 2021. This means a lot of money is benefiting from DeFi and its opportunities very quickly. .
There are also concrete and practical examples. Trovio Capital Management (TCM), an asset management company that focuses exclusively on digital native assets, announces the launch of a Digital Asset Income Fund, a market neutral, non-directional fund that plans to mine return by investing strategically in stablecoin. -based on DeFi protocols and capitalizing on more traditional arbitrage opportunities. Essentially, the fund is designed to maximize return on investment by balancing its portfolio in 90% stable coin-based DeFi opportunities, which have very low volatility, and 10% in more volatile, but still highly controlled commodities. This type of approach mitigates volatility and reflects the number of investors who are already balancing exposure to digital assets in their personal portfolios. TCM estimates that the Fund is capable of generating a return of 15-20% net of fees per year.
Clearly, the wheels are already turning. TCM is a major example, but it is not the only one, and the numbers speak for themselves as to the power of this movement. There is arguably more work to be done. Decentralized finance is still largely unregulated, and as such, many will stay away until the ink is dry on all laws, and that’s understandable. These platforms, too, are still in the works, and despite the financial opportunities, there will likely be calamities along the way. Yet this new asset class and all the opportunities it presents cannot be ignored by the professional investor community. Those who wait may be more secure, but may also be left behind in just a few years.
About the Author
Will Hamilton is Head of Trading and Research at TCM Capital. Will has been heavily involved in the cryptocurrency industry since 2016, and prior to that, he worked at Pitt Capital Partners, the inside investment bank of the Washington H. Sol Pattinson investment house (“ASX: SOL “).
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.