How Decentralized Finance (DeFi) Disrupts Active Asset Management


Technology has gradually changed the dynamics of financial markets. Decentralized Finance (DeFi) sends seismic waves through the finance landscape. The area of ​​active asset management is not immune to this disruption.

By the early 2000s, it became clear that computer systems had completely reshaped the market since the days of physical trading rooms (1, 2). Exchanges and trading portals have found themselves in an arms race to create and activate more sophisticated technology around data throughput and availability, order matching capabilities and execution speeds.

In the new, highly technical playing field, market players themselves have become increasingly savvy. Intelligent order routing, high frequency trade execution and the availability of live order flow data are now tilting financial markets in favor of large, highly technical players. Michael Lewis’s book, Flash Boys, has helped bring public attention to how Wall Street has been reshaped by asymmetric access to information and the execution of trading decisions.

By deepening the sophistication of trading techniques, machine learning is now a tool regularly used to assist or automate strategies. These algorithms are used to predict or forecast price action (1, 2), respond to break events (1), and automate the implementation of trading strategies (1). In an age of near instant information transfer, many hedge funds and prop stores rely on artificial intelligence (AI) to interpret and act on news sentiment, shifting capital flows, or inefficiencies in the marketplace. market to remain competitive.

Alexander Fleiss, CEO of Rebellion research, an AI think tank, financial advisory group and hedge fund, shared their experience and knowledge on investing and managing AI augmented capital. Two of the most important aspects in establishing a successful AI investment strategy, he said, are choosing the right data and the right methodology for handling that particular data. “Decent input can be turned into a good product with an inferior algorithm, but bad data cannot be turned into a valid product, no matter how powerful or powerful the machine learning or math behind your algorithm is.” , Fleiss explained.

The advent of distributed ledger (DLT) technology, especially in the form of a blockchain, has brought a new wave of innovation that is disrupting global financial markets. Bitcoin, the first DLT, competes with central bank fiat currencies and tries to serve as an alternative layer of base money settlement. More complex blockchains like Ethereum enable decentralized finance and compete widely with today’s commercial banks, traditional financial institutions, and fintechs.

Open blockchains, as opposed to centralized databases, make financial activity data accessible to the public. This data can then be exploited by active investment strategies; “funds will be able to see in more real time the movements of a number of industries. The funds pay for having advanced knowledge and the blockchain is ideal for showing as soon as possible the inflection points in the behavior of consumers or the company, ”Fleiss added.

But blockchain involves more than the active investment space than just changing the type of data available to investors. DeFi applications, built from composable open source protocols, fully open up the possibilities of new types of products and funds. Many decentralized applications operate by aggregating capital into liquidity pools that act as market makers. Liquidity providers (LPs) lock funds into a contract and then earn a return generated by the fees or other incentives associated with it. Other applications that facilitate lending or derivative markets also provide a mechanism for obtaining a return. Additional incentives, such as the distribution of governance tokens to LPs and users, are used to attract capital away from competing protocols, keep capital in the system, and give participants a say and participation in the application. herself.

Even less exotic fixed rate USD stable lending protocols, such as Performance protocol or Notional Finance offer much more attractive rates than those offered by banks. It is therefore not surprising, with such attractive returns on more passive investments, that capital continues to flow into DeFi; According to DeFiPulse.com, there is more than $ 113 billion of value stuck (as of November 15) in DeFi protocols. Although TVL is a raw metric, and sensitive to certain forms of manipulation, we can say that the ecosystem is developing considerably rapidly.

Considering how fast the space moves, volatility in rates, technical risks associated with various protocols, and steep drop in rewards, investors need to be savvy enough to compete for the best return.

Projects like YVaults by Yearn Finance or BentoBox by Sushi, are ways that allow investors to make a one-time deposit which then goes through various strategies trying to capture the highest return. Vault products help reduce costs associated with rebalancing or moving between protocols, especially for smaller balances. They also help to engage in more exotic strategies, like those take advantage of options, without having to manually run them yourself.

As more and more protocol-independent vault strategies emerge, competing platforms must encourage users to choose them even more. Convex financing (CVX token) capitalized on this by allowing these platforms to “bribe” CVX holders to provide liquidity to their system. CLC holders can simply buy, wager and even lock their tokens (for enhanced rewards) and attempt to capture more return and flexibility than they would otherwise as Curve.fi cash providers while simultaneously earning additional rewards with this feature.

As the DeFi ecosystem becomes increasingly complex, saturated with more capital, and markets become more interconnected / efficient, we can expect to see trends similar to those we have seen in traditional finance. Alexander M. Ineichen in his 2006 book, Asymmetric returns: the future of active asset management, who predicted a paradigm shift from buying and holding to active management focused on absolute return, wrote that “as markets become more efficient it will be harder and harder to all the alpha without using all the risk management tools available ”.


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