Waste Management before Asset Management
Market Opportunities in the nascent Digital Asset Paradigm
The widely awaited Christmas crypto run-up is probably unfathomable right now with the ongoing US-China trade war stirring uncertainty across asset classes, the Bitcoin Cash fork, OkEx’s surprise future settlement and the most recent SEC verdict over 2 ICOs causing a prompt market meltdown which may or may not have overreacted. One thing is certain, that crypto assets wild moves have to be professionally managed within an infrastructural framework that ensures waste stoppage in a world which is getting increasingly wary of shabby intermediaries.
Here is a brief analysis on both the short-term and long-term market opportunities upon which blockchain digital asset management protocols should be focusing on.
The short-term market opportunity is to offer an infrastructure to provide professional digital asset management services to innovative investors.
At the time of writing, there is a total market capitalization of roughly USD 122bn.
Most of these are held by first-mover crypto investors who desire to have full control of their assets and portfolios and who enjoy the process of managing, buying and dealing with tokenized projects. Furthermore, we can safely assume that there is a growing group of people that is seeking exposure to this new asset class to be included in their personal portfolios but held back by its daunting complexity. If we assume that there is an initial 10% of the market capitalization interested in a solution that allows innovative investors to obtain exposure, in multiple digital assets, by doing away the structural need to control many wallets and/or many accounts on several exchanges and by going through a single KYC/AML process, we have a market potential in the whereabouts of USD 12bn. This is a conservative assumption given the exponential increase in interest for the asset class. Anyone who has tried during market upturns to open an account with an exchange can testify to the difficulty and the waiting time (which is further subject to the whims of sudden market interest hindering the provision of a stable service and hence missed trade opportunities).
The current trend suggests that this interest will only increase with family offices and institutional investors scrambling to find a way to participate, pending regulatory greenlight, without giving up their private keys to third party advisors. If we had to assume a base fee of 1%, this would lead to an initial market opportunity of USD 120m per year.
The long-term market opportunity is for blockchain projects to disintermediate the current conventional asset management infrastructure which evolved over time into a huge, heavily regulated and highly complex ecosystem. Its processes are lengthy, costly and it needs numerous and specialized intermediaries as well as trusted counterparts. All of which, add expenses and inefficiencies to Investors (IN) and Portfolio Managers (PM).
The traditional model has multiple intermediaries between Investors and Portfolio Managers. When an Investor sends an instruction to subscribe or redeem a fund, he or she typically employs a Transfer Agent (TA) whose role is to record transactions, issue or cancel certificates, process investors’ mailings and deal with other investors’ problems. A fund investment, furthermore, requires a Fund Administrator who is responsible for calculating the NAV, preparing reports for investors, paying the fund’s expenses, settling daily purchases and sales of securities, calculating dividends, preparing and filing reports and calculating performance measures.
Finally, the IN need to enlist the help of a Custodian to hold his assets for safekeeping. On top of these intermediaries the structure requires Accountants to calculate the formal accounts for the fund, Auditors to confirm that the calculations and the processes are performed correctly and Reconciliation Service Providers since all the entities above will keep individual and independent copies of the information which will naturally differ from each other.
According to a Deloitte’s paper estimation on the Luxembourg fund industry (2nd largest in the world for total AUM but largest for cross-border volume), the total spending related to dispensable fund charges to be around EUR 1.2bn. The paper also further estimates that roughly a quarter of all orders are processed manually (by over 14,000 employees in the grand-duchy) and sent around through fax with all the obvious impacts on confidentiality, security, speed, and efficiency. The US fund industry is similar in size and the rest of the world industry is around half this size. This is currently costing a total of over EUR 3bn annually, which can be potentially redistributed to improve and ensure a fair split of the economic pie for each actor involved. The scenario described just now is the direct cost imposed on the system, and hence mostly passed on Investors and residually on Portfolio Managers, but does not include the fees charged by the various intermediaries.
Case Study: Costs of fund distribution in Luxembourg are simply unbearable
Here we attempt to provide an estimation around the billions of USD lost along the “value chain” of the fund management industry:
1. Waste = USD 3bn per year;
2. Transfer Agents + Fund Administrators: According to a PWC report, 10–30bps over a USD 15tr industry = USD 8–24bn per year;
3. Custodians: 5–10 bps = USD 4–8bn;
4. Audit: USD 15,000–30,000 per fund over 25,000–30,000 funds = USD 400m-1bn;
5. Reporting Services: USD 500–10,000 per report, 1 report per client per jurisdiction;
6. Reconciliation: It is difficult to estimate the reconciliation cost since each country has a different legislation. Hence we decided to leave these costs out of our estimation;
This amounts to an overall conservative estimate of USD 15bn to 35bn annually which excludes all the indirect economic impact: today the minimum size required to participate in the industry is inaccessible for the little guy, leading thereafter to oligopolies which are well known to be naturally associated to sub-optimal resource allocation and to thwart entrepreneurship, stifle fruitful new ideas, and postpone necessary innovation.
The Power of Trust-less Smart Contract Automation
By combining smart contracts with a well-designed on ledger transaction registry based on blockchain technology, we effectively replace any type of intermediary whose role is simply to maintain a registry, cultivate trust and/or execute transactions between parties. The services provided by the financial intermediaries discussed above can be substituted easily by a blockchain solution. Transfer Agents and Registry services are the easiest to dismiss by adopting blockchain technology. To follow, Fund Administrators’ roles can also be incorporated on the blockchain by employing smart contract solutions. While Custody services are the cornerstone of the middleman business due to their high level of professionalism and available resources to ensure full protection, however blockchain technology with its tamper-resistant ledger and strict enforcement of rule-based smart contracts, can provide a higher level of trust and assurance compared to a traditional Bank. Accounting, Reconciliation, and Audit services are only required if there are multiple silos and no golden record. In a complex structure, these services are important to guarantee that the assets are properly accounted for certifying no missing assets at the end of the day and that the various silos are aligned. By moving the custody on the blockchain these roles will become redundant as accounting becomes a simple observation problem and the single golden record ensures consistency throughout.
Finally, Reporting and Monitoring will also benefit from a permissioned blockchain adoption, as henceforth funds can easily be probed by regulators and investors, instead of waiting for an active report by intermediaries. In practice with a full implementation of a Fund Infrastructure on the Blockchain, Fund Managers and Investors will be able to interact with each other directly on a peer-to-peer level.
Work is underway to codify fund transactions and agreements in a shared protocol which guarantees execution based on conditions that can be mutually and independently assessed by the parties. Fund Managers will be able to directly distribute their expertise without costly and inefficient intermediaries. Investors will be able to subscribe and redeem directly and instantaneously, to identify themselves for regulatory purposes and to prove directly to third parties ownership of assets and level of wealth.
It is common belief that at this pace, most if not all assets will find its tokenized counterpart in the near future, with many projects hailing from the blockchain industry, followed closely by the traditional banking which will attempt to innovate from within and play catch up. Once stocks, bonds, real estate, ships, infrastructure etc will be tokenized they will all naturally acquire the positive features of the distributed ledgers (speed, immutability, control, etc.) but will all be subject to the constraints that digital assets have with respect to the traditional asset management framework for which it is necessary to provide a solution addressing the four problems highlighted in the previous article.
About DEXTF Protocol
DEXTF’s on-chain asset management protocol will allow the creation, management and trading of digital-native funds units, connecting investors, arbitrageurs and portfolio managers in a way that has never been done before. Working to bring the biggest crypto investment funds on DEXTF protocol and to eliminate the need of a third party custody service.
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