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Welcome to Crypto Long & Short! This week, Ilan Solot and Mark Arasaratnam of Marex describe what it'll take for DeFi to get traction. Then, Chris King of Eaglebrook Advisors explains why separately managed accounts – which are huge in TradFi – matter in crypto, too. As always, get the latest crypto news and data from CoinDeskMarkets.com. – Nick Baker |
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We only find out if something is anti-fragile when it either breaks or evolves from adversity; decentralized finance (DeFi) has been through a lot, but it has never been broken. Instead, it established itself as a Darwinian sandbox for battle-testing new and old concepts in finance, economics, governance and property rights for the digital economy. But what really differentiates DeFi from traditional finance? One of the main differences is how (most, but not all) major protocols treat credit risk. In the simplest terms, DeFi swaps credit risk for smart contract risk. Credit risk is part of just about every financial asset in traditional markets, but not so in DeFi. Everything from mortgages to CME corn futures, German bunds and Amazon gift cards has an embedded credit component (and cost). In DeFi, however, your credit record is entirely irrelevant. Your borrowing power in AAVE, for example, is determined only by the value of the collateral you put in. If it falls beyond the threshold and the smart contract functions correctly, your position is liquidated. There is no recourse, no one to call, no place to explain your situation. On-chain structured products: Full transparency without credit risk DeFi's set-up is straightforward for simple financial products, like overcollateralised lending. But how can we implement a zero-credit-risk model and full transparency for products with complex, non-linear payoffs like exotic options and structured products? The answer is to place the full payoff on-chain. For example, the latest vault deployed by Ribbon Finance (rebranded as Aevo) reproduces a classic TradFi structured product – the autocallable – in a smart contract. You can see further details here, but the point is that a smart contract executes the product's conditional payoffs (like "if-this-then-that" statements in code) into the correct address in a transparent way. But most importantly, once the vault is created, neither Ribbon nor the investor have the option to default – i.e., zero credit risk. |
Source: Marex Structured products and exotic options are a great example of how DeFi can lean into crypto's transparency and "programmable money" properties. Automating complex payoffs is exactly the type of meaningful application that can put it on a sustained growth path. For reference, the global volume of structured products, like autocallables, was estimated at around $1.5 trillion in 2021, led by Asian investors, according to Luma and Morningstar. DeFi endured countless hacks, rug pulls, de-pegs and regulatory scrutiny, and it will surely outlive the current downcycle in trading volume. But the sector might have a greater chance of adoption if it sets aside some of its lofty disruptive ideals (at least for now) and focuses on improving, even if marginally, financial solutions with demonstrable global demand and adoption. |
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Come build with us and register for Mainnet 2023, the premiere crypto event of the year! Hosted by Messari, Mainnet returns to Pier 36 NYC from Sept 20-22. Mainnet unites together the leading voices in crypto and will spotlight the true innovations propelling crypto forward, with programming focusing on regulation & policy, real-world finance & DeFi, operators & builders, AI's native currency, and a wide variety of other topics. This year, Mainnet will feature 100+ in-person speakers from across the crypto and TradFi landscapes, including Coinbase's Brian Armstrong, Circle's Jeremy Allaire, Ripple's Brad Garlinghouse, Stellar's Denelle Dixon, EY's Paul Brody, PayPal's Jose Fernandez da Ponte, Onyx by J.P. Morgan's Tyrone Lobban, and many more. Register today and experience 3 days of discussions, collaborations, and solutions that will shape the future of crypto! |
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Why Wealth Managers Are Choosing These Crypto Accounts |
Wealth managers are increasingly receiving client questions about investing in crypto and how clients can gain exposure to this asset class. Most financial advisers are unaware of the pros and cons of investment vehicles available to invest in digital assets on behalf of their clients. Over the past 12 months, 90% of financial advisers have received client questions about crypto, according to The Bitwise/VettaFi 2023 Benchmark Survey of Financial Advisor Attitudes Toward Crypto Assets. RIAs and financial advisers must navigate a range of considerations when allocating to this asset class, most notably around security and compliance considerations. Advisers must be mindful of the characteristics of each structure as they select the proper investment vehicle. The current options for financial advisers are: |
- instructing the client to move assets away and invest self-directed at a retail crypto exchange (e.g., Coinbase)
- over-the-counter trust (e.g., the Grayscale Bitcoin Trust)
- private funds
- investing through a crypto separately managed account (SMA).
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Separately managed accounts have been growing rapidly over the past 10 years, with assets under management growing from $550 billion in 2011 to $1.7 trillion in 2021. Wealth managers chose SMAs due to the key advantages of tax optimization, direct ownership, professional management and customization. For those same reasons, the wealth management market is steadily adopting crypto SMAs as the vehicle of choice to invest in this emerging asset class. Below are some of the benefits: |
- Tax Optimization: The crypto market is volatile relative to other asset classes, creating attractive tax optimization opportunities. When an investor utilizes a crypto SMA, an account is opened in their name at a digital asset qualified custodian, allowing the investor to own the digital assets directly. This structure enables tax optimization in these accounts unavailable in the OTC trust or private fund structure. Crypto SMAs often have a tax overlay strategy that will find opportunities to reduce or offset the client's capital gain tax liability, like traditional SMAs.
- Direct Ownership: Direct ownership is the best structure from an investment vehicle perspective. There is minimal tracking error compared to other products, such as an OTC public trust, which can have meaningful premiums and discounts and, thus, tracking error. Further, there is 24/7 liquidity for crypto SMAs, allowing investors and advisers to sell or buy anytime.
- Reporting Integration: Crypto SMA providers can integrate directly with wealth managers reporting platforms (e.g., Orion, Addepar, Black Diamond), allowing advisers to model, report and bill seamlessly on their clients' digital asset holdings.
- Professional Management: In an emerging and complex asset class such as crypto, the expertise of professional management is even more valuable than traditional asset classes. An emerging asset class is difficult to keep up with to the extent needed to make proper allocation decisions. By utilizing crypto SMAs, an adviser can benefit from outsourcing digital asset portfolio management and trading to specialists with deep expertise in the digital asset market.
- Institutional Custody: An adviser can use a crypto SMA to take advantage of an institutional-grade custodian in an emerging asset class. Given crypto's security risk and compliance considerations, working with an established and qualified custodian is essential. Client assets are typically held at a custodian who maintains both a SOC 1 and SOC 2 from a recognized accounting firm, undergoes internal audits and is subject to regulatory oversight requirements (including capital requirements) from the New York State Department of Financial Services. The institutional-grade custodian provides institutional cold storage, trading, and security.
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Click here to read a longer version of this article. |
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From CoinDesk Deputy Editor-in-Chief Nick Baker, here is some news worth reading: |
- A COMMODITY: As has been well documented for years, a big question hovering above crypto, particularly in the U.S., is whether tokens will be regulated like commodities (aka fairly lightly) or securities (aka more rigorously). The U.S. Securities and Exchange Commission famously hints that nearly the whole business is a securities business; it's in the SEC's name! Bitcoin (BTC), the biggest crypto by market cap, seems solidly in the commodities camp, but the fate of the second-biggest, Ethereum's ether (ETH), does get debated. A federal judge just came down on the side of ETH being a commodity in a case involving Uniswap. She declined to "stretch the federal securities laws to cover the conduct alleged."
- WHALES BUY: The abrupt recent plunge in bitcoin was viewed as a buying opportunity by the largest crypto investors, according to this story. The accumulation suggests that "institutional investors are getting optimistic in bitcoin as ETF decisions approach," said Lucas Outumuro, head of research at IntoTheBlock.
- KEEP WAITING: Speaking of bitcoin ETFs, the SEC decided not to rule last week on whether to approve applications to create them from BlackRock, Fidelity and others, instead taking advantage of rules that allow it to delay the decision. The next dates to watch are in October.
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State of Crypto: Policy & Regulation |
It is now more important than ever to set industry standards and align on practical short-term and long-term objectives through pointed conversations with the best legal minds and Washington D.C.'s most important decision makers.
Join us at State of Crypto: Policy and Regulation on October 24 in Washington D.C. for an unprecedented opportunity to evaluate, dissect and ultimately shape crypto regulatory frameworks that support a vibrant, secure and healthy future for the digital economy. Save 10% with code CLS10. Learn more and register. |
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DeFi Pragmatism