How Blockchain Could Fix Asset Management


It’s time for asset owners to embrace blockchain.

I’m not talking about allocating to a venture capital fund focused on blockchain projects, cryptocurrencies, and non-fungible tokens (NFTs).

I’m talking about asset owners using blockchain to create their own investment DAO (decentralized autonomous organization).

A DAO is created by a group of people or entities seeking to achieve a specific goal or perform a specific function. It’s reminiscent of a traditional investment club – but in this case it’s built on a blockchain.

While most investors might not be familiar with DAOs, they’ve been around since around 2016 (and the idea appears to have originated in a 1997 paper by German computer scientist Werner Dilger). To give you an idea of ​​the DAO ecosystem, DeepDAOa dedicated DAO analytics firm, currently tracks over 4,800 DAOs with a total of $9.3 billion in their treasuries.

Many of them may seem a bit frivolous. After all, who wouldn’t want to be a member of BeerDAO (whose mission is to “collaborate with other beer lovers and beer makers to create an environment that helps all parties while providing member benefits”) or BurgerDAO (“a community of food and Web3 enthusiasts creating the first decentralized burger franchise”)?

But there are also commercial DAOs. BitDAOwhich aims to support builders of the decentralized economy, has raised $230 million from investors including Peter Thiel, Pantera Capital and Dragonfly Capital and has more than $2 billion in its treasury.

I believe that DAOs could serve not only as a mechanism for asset owners to invest in digital innovations, but also as a solution to one of the most difficult problems in the asset management industry.

My suggestion: Asset owners with a keen interest in Web3 (a decentralized internet built on blockchain) and decentralized finance (DeFi) projects form a DAO whose purpose is to invest capital in such projects to generate performance and gain first-hand knowledge of the blockchain. In a nutshell, I suggest asset owners create their own digital venture capital fund – we could call it VCDAO.

Suppose five US foundations agree to launch our VCDAO. They would collectively define the mission and purpose of the VCDAO. This statement of intent would be used to solicit interest from other parties.

Our endowments and other interested parties would then pool their assets and fund VCDAO’s treasury by exchanging cryptocurrency (usually Ether) for VCDAO’s governance token, $VCDAO.

Governance tokens are digital units created by the DAO that not only grant holders membership in the DAO, but also give holders the ability to participate in the management of the DAO. Members, not intermediaries, govern DAOs.

As token holders, members, through a consensus process, can create the rules that dictate how our VCDAO will be run – for example, how funds will be allocated, what employees might be hired, and how profits will be split among DAO token holders. .

These rules are written — or, more accurately, coded — in a set of smart contracts which are placed on a blockchain, usually the Ethereum blockchain, which makes them, and VCDAO’s membership records and financial transactions, immutable and public.

It is important to note that these smart contracts are self-executing: each time the coded conditions are met, collective decisions are made autonomously. And once encoded and placed on a blockchain, these rules can only be changed by a vote of the members of the DAO.

With rules in place and treasury funded, VCDAO would fulfill its purpose by sourcing, verifying, and investing in Web3, DeFi, and NFT projects that meet the criteria encoded in VCDAO’s smart contracts.

VCDAO would invest in these opportunities by exchanging a certain amount of cryptocurrency held in its treasury for these projects’ own governance and/or NFT tokens. It is expected that these projects and/or their respective tokens will appreciate, which will result in a profit for the VCDAO, i.e. its members.

Earnings in the form of more than $VCDAO could be distributed as dividends or retained in VCDAO’s treasury for future use, depending on rules set by members. The success of the DAO would also increase the market value of its tokens.

Although creating and managing a DAO may seem a bit complicated, there are companies that can provide turnkey DAOs.

My intention is not to offer a DAO tutorial, but to show how a DAO could be used to fix a bug in the asset management business model, which systematically disadvantages asset owners – the main problem – agent. This problem is the result of misaligned interests between dispatchers and managers, as well as an asymmetry of incentives and information.

Because a DAO is a decentralized organization, no central agent acts on behalf of customers.

With membership based on ownership of governance tokens, each member is both principal and agent – ​​in our use case, both client and manager.

Members’ interests are naturally aligned as all members have their skin in the game and are therefore incentivized – individually and collectively – to create and support the DAO and its projects in one way or another.

Thus, customers can no longer win or lose, but managers always win. If the DAO wins, the members win. Any success the DAO experiences goes directly to the members, according to its rules, without any intermediary taking a stake.

Additionally, because the rules of the DAO are encoded as self-executing smart contracts, there is no need to trust that an agent or general partner will always act in the best interests of investors. These smart contracts codify trust between all members.

Trust is further established because these contracts – along with the members, financial transactions and cash of the DAO – are all kept on a digital, timestamped, immutable and public blockchain. All members and even the public can audit the DAO (it’s now radically transparent).

This governance structure and the transparency offered by blockchain also removes the informational asymmetry that exists in the allocator-manager relationship, where asset owners subscribe to a manager’s research and development but generally do not share knowledge. acquired in this process. All the knowledge acquired through the activity of the DAO is available to its members.

It is essential to add that, despite their proliferation, DAOs are still in their infancy and carry significant risks regarding their security, legality and governance structure. (No introductory discussion of DAOs is complete without a mention of the 2016 hack of The DAOwhere, due to vulnerabilities in its underlying code, hackers were able to siphon off around $50 million worth of Ether.)

However, this idealized use case of our VCDAO as a digital-enabled venture capital fund reveals the possibility of disrupting our industry by enabling asset management to be done without asset managers – which all asset owners should adopt.

Angelo Calvello, Ph.D., is co-founder of Rosetta Analytics, an investment manager that uses deep reinforcement learning to build and manage investment strategies for institutional investors. He would like to thank Michal Lyskawinski for his technical assistance.


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