The rise of DeFi Robo-advising

DeFi slowly but confidently mirroring current financial offerings. It started with trading, then lending and borrowing, with synthetics and derivatives coming close. With the built-in programmability, automated management of crypto assets is only a matter of time.

The scope and design of Robo-advising can be defined in several ways. In the most inclusive definition, it’s a product that takes a user’s goals, preferences, and risk tolerance, and outputs a portfolio that this product then manages under the user’s name. The portfolio might change over time.

To start, I don’t know a single solution that goes full way from a questionnaire to automatic asset management. Currently, DeFi Robo-advising is not anything close to what we accustomed to in traditional finance. There are several reasons for that. First, incorporating automatic asset management into smart contract logic is expensive and prone to bugs. Second, there is not a lot of demand to delegate asset management right now: most of the DeFi users are pretty sophisticated and prefer to operate their crypto assets themselves (many are likely enjoying it). Third, the industry of advising is highly regulated in most countries.

So, how it will look like? To answer that question let’s look at what’s already there. If you will think that calling some of the examples below a Robo-advisor is a bit of a stretch, you’re probably right.

It all started with crypto funds. Several funds appeared in 2016-17, just before the crypto bull trend. Few (if any) survived. Some even had a token, effectively making them an ETF. One such fund is Satoshi•Pie, which started in 2016. The fund included over 30 assets, including bitcoin, ether, ripple, and others. As with everything at that time, it looked like a decent investment. The problem, of course, is that all crypto was (and mostly still is) tied to Bitcoin price. Satoshi•Pie never exited to USD, so 2018 started terribly for them. The bug in Parity multi-sig (which Satoshi•Pie used to manage Ethereum-based assets) didn’t help either. In 2018, managers decided to shut the fund down and liquidate all the assets.

Does that mean that crypto funds are a bad idea? I don’t think so. It’s just too early for them. The current market situation is the following: the market is bearish or neutral, there are not many tokens with real utility, and everything is tied to Bitcoin anyway. Besides BTC and ETH, what’s out there ready for mainstream retail investors? Bitcoin Cash, anyone? By investing into fund now, you don’t diversify, you just buy a bunch of shitcoins.

Talking about DeFi and algorithmic asset management, it would be a crime not to mention TokenSets. It’s a product built on top of Set Protocol that features several algorithmic indices. Most of these sets occasionally rebalance into USD (in the form of DAI or USDC). At the moment, the market values that, and such indices consist of over 90% of the total TokenSets market cap. In fact, in the initial version of TokenSets ↗, 2 of the 3 sets were a basket of ERC20 tokens, but TokenSets found the real product-market fit only when it introduced crypto/USD strategies.

Finally, I want to talk about products that are formally not qualified to be “advisors”, but 1) which serve that function nevertheless, and 2) are going to play a key role in automated advising inside DeFi. I’m talking about various tools, ratings, and charts.

One of such tools is recently launched Pools ↗. It provides a historical performance of Uniswap pools, giving insight into possible returns. For example, assuming all stablecoins have similar risks and will stay at around 1 USD per token, one can pick the pool solely based on historical ROI. By the way, Uniswap itself is an example of automatic asset management, similar to TokenSets. By design, it continuously rebalances your portfolio to keep it 50/50. Balancer ↗, an extended version of Uniswap, might allow even more granular exposure.

Another group of tools showcases interest rates across lending protocols. Again, assuming the technical risk of those platforms is the same, one could regularly check those rates and move their assets to the protocol which currently offers higher yields. Of course, this process might and will be automated (RAY ↗ by Staked, Topo ↗).

Speaking of risk models of these protocols, there are first steps to asses and score them. One of them is DeFi score ↗ by Consensys. It dissects technical and financial risk, as well as diving into regulation uncertainty and insurance funding.

I’m also really bullish on market-driven advisors. It includes ranking assets based on market cap, lending protocols and pools based on total supply amounts, staking based on total amount staked, sets and funds based on AUM. This might sound insecure in terms of delegating risks to a single source of truth (and might create a vicious cycle out of thin air), but this is exactly what happens in the world of ETFs, where the market cap of each share is an important data point. It simply develops further on that idea to provide more sophisticated strategies.

So, how will Robo-advising look like in the world of decentralized finance? It’s going to be democratized and therefore highly segregated. Advising will be done by one party (centralized and likely regulated), managed by another party (mostly, decentralized protocols), and glued together under a single UX via another party. Speaking of advising, it will quickly evolve to include myriads of factors encompassing asset, technical, and incentive risks.

Although this offering will work completely different from traditional advising under the hood, just as with DeFi itself, it will look very familiar to end-users. An example of such a product would be a web app that starts by asking about a user’s risk tolerance and exposure preferences (between fiat, gold, and crypto). It then recommends a basket of tokens, Uniswap pools, Compound markets, and sets, allowing account funding by depositing USD from a credit card. This is possible now, but it’s only the beginning. In the future, as staking, usable ERC20 tokens, yield tokens, and undercollateralized debt will come to life, the number of possible baskets will explode.