Over the past few years, the intersection of cryptocurrency and traditional finance (TradFi) asset management has been a whirlwind, with notable events such as the remarkable debut of U.S. spotbitcoin exchange-traded funds (ETFs) and comments from BlackRock CEO Larry Fink forecasting the future of markets to be tokenized. This convergence of Crypto and TradFi asset management has signaled the onset of a new era. As assets shift towards on-chain management, institutional investors are now faced with a host of distinctive challenges.
For Ainsley To, Avantgarde Finance’s head of asset management, there is more to the debate than just speculation about future price movements. Beneath the surface lies an entire internet-native ecosystem built upon crypto rails. One of its most prominent aspects is the rise of decentralized autonomous organizations (DAOs) – digital entities transcending geographical borders and governed by code instead of traditional legal contracts. These DAOs are no strangers to the unique asset management challenges, given the substantial on-chain treasuries they have amassed.
Volatility and the Search for a ‘Risk-Free’ Asset
Volatility pervades the crypto environment, and many DAOs are wrestling with this head-on. The native tokens of most DAOs are even more volatile than bitcoin or ether. Moreover, crypto presents a distinctive challenge – the absence of a true risk-free asset, unlike traditional markets. Although dollar-pegged stablecoins are often used as a substitute, the absence of volatility does not equal an absence of risk.
One such instance took place during the collapse of Silicon Valley Bank, resulting in a drawdown of over 7% for USDC due to Circle’s exposure to the bank. The resilience of DAO communities has been tested through extreme volatility. According to DeepDAO data, over a third of the 200 largest DAOs experienced a portfolio decline of more than 50% in the wake of the FTX collapse, with 30 facing a drawdown of over 90%. To mitigate this volatility, many DAOs have turned to real-world assets (RWAs), particularly tokenized Treasury bills, marking a natural source of on-chain demand for RWAs and paving the way for broader tokenization and convergence with TradFi.
Liquidity and Diversification Constraints
Despite tokens trading non-stop, many still lack meaningful liquidity, noticeable in decentralized exchange (DEX) volumes, where DAO tokens are listed, resulting in substantial price impact for larger trades. The limited liquidity also constrains DAOs in diversifying their treasuries, leading them to hold highly concentrated portfolios on-chain. This limitation has led to exploration and development of alternative on-chain solutions through derivative protocols or leveraging their native token as DeFi collateral to counteract the constraints on diversification.
Transparency and Governance
The intrinsic transparency of on-chain portfolios offers several advantages such as auditable and verifiable portfolio transactions. However, it also comes with its tradeoffs, including information leakage, front running risks, and potentially higher transaction costs. This transparency can exacerbate governance issues, as visible trading activity signals investor confidence to the market. The visibility of large positions in DeFi protocols can also result in adverse governance actions, as seen in a proposal last year from the Aave community to freeze CRV on the lending protocol due to a large borrow position that was visible on-chain.
Many of the distinctive risks, constraints, and trade-offs faced by institutional capital managing assets on-chain are parallel to those confronted by DAO treasuries – the indigenous crypto-native institutional investor. The innovative frameworks and solutions developed by DAO service providers to navigate these challenges also present a learning ground for traditional institutional investors.