Crypto asset management track: The digital asset management market is booming

KingData ·2022-08-01

Original title: An article to understand the encrypted asset management track: the digital asset management market is booming
Written by: King Tuts, lingchenjaneliu, and 0xPhillan
The sharp drop in cryptocurrency prices has destroyed many crypto asset managers. However, the need for asset management is not going away: it will even continue to grow as the cryptocurrency market continues to expand. We strongly believe that existing companies still have enormous potential and will become great in the future.

1. Market size

Digital assets have been one of the fastest-growing assets in the world over the past decade, with a market value of only about $10 billion in 2014, according to CoinGecko, but has grown to about $2.3 trillion in early 2022. This is a staggering 216x growth, with a compound annual growth rate of about 96% over the past 8 years.

More and more individuals and institutions recognize that the rise of cryptoassets is an unstoppable trend. Since the launch of the first U.S. Bitcoin ETF in October 2021, the combined market capitalization of the top 10 U.S. Bitcoin-related ETFs has grown to about $2.27 billion, according to VettaFi. Morgan Stanley became the first major U.S. bank to offer a bitcoin fund for its wealthy clients in March 2021, and Goldman Sachs offered its first bitcoin-backed lending facility in April 2022. Many other large companies are also participating in the cryptocurrency industry in various ways.

While the cryptocurrency market has grown considerably over the past decade, we have to say that it still has a lot of potential for growth. According to data from January this year, the market capitalization of cryptocurrencies is 2.35 trillion US dollars, while the market capitalization of gold is 11.4 trillion US dollars, which is 4.85 times the market capitalization of cryptocurrencies.

Equities have a market cap of $122 trillion, 52 times the market cap of cryptocurrencies.

The bond market has a market cap of $226 trillion, 96 times the market cap of cryptocurrencies.

As of now, Bitcoin still dominates 40.6% of the entire crypto asset market, up from 88% in early 2014. Over the long term, Bitcoin’s dominance of the cryptocurrency market is likely to continue to decline, while the growth potential of many emerging cryptoassets will unfold.

2. Overview of Digital Asset Management Market

Asset management is a very broad concept, and just like banks in traditional finance, digital asset management companies offer various products and services to their clients.

2.1 Savings Accounts and Lending Services

Savings accounts are one of the most basic businesses of an asset management company. Similar to traditional banks, customers deposit their digital assets into savings accounts and earn interest. Most of the time, companies will lend these assets to generate income and profit from the spread. However, digital asset management (digital AM) business is very different from traditional banks:

Whereas traditional banks typically offer services in one or a few currencies, digital asset managers will support many different crypto-assets.

Whereas traditional banks cannot obtain collateral before defaulting, cryptocurrency lenders are able to lend the collateralized assets again at any time to earn additional profits.

Borrowers of crypto assets are often limited to a few top institutions across the industry, making asset management revenue highly dependent on these few clients, which is high risk.

The transparent and highly volatile cryptocurrency market makes it prone to liquidations that can hurt both customers and companies.

Most digital asset management companies offer these services. These features not only bring more operational flexibility to lenders, but also more risks. For example, Babel, Voyager, and BlockFi, the most well-known crypto asset management services recently, are facing high liquidity risks that, if unmanaged, could lead to a financial panic across the market.

2.2 Market making

Market maker is an important and highly specialized service that asset management companies do not provide to ordinary customers, but it is very important and indispensable to the digital asset management industry.

Asset managers need support from digital asset exchanges when serving clients, such as facility escrow and low fees. They also enjoy higher loan limits due to the large amount of business they bring to the exchange. However, exchanges often only offer support in exchange for robust market-making services. The greater the trading volume and depth that the company can provide, the more exchanges support the company, and the better the company can serve its customers.

Jump Trading, GSR, Alameda Research and IDEG are leaders in this space. IDEG is a fully regulated asset management company headquartered in Singapore. Its trading team has established a professional high-frequency trading system to provide liquidity on various digital exchanges. In this case, IDEG has the best rates and lowest latency on most exchanges. With these facilities, the company is better able to serve its customers.

2.3 Trading Desk

A trading desk is also a very common asset management service. Like brokerage in traditional finance, clients can buy or sell specified assets through a trading desk at their will, and the capabilities of a company's trading team determine the type of services they can provide. Most trading desks can only provide simple spot trading services, while others are able to provide a variety of trading strategies, including arbitrage, CTAs, options strategies, and more.

Genesis Trading, Amber Group, OSL and IDEG are doing very well in the trading business. Based on a powerful internal high-frequency trading system, IDEG has developed a variety of trading strategies to serve customers. The quantitative arbitrage strategy can provide customers with products similar to fixed income products, not only US dollars, but also BTC, ETH or other cryptocurrencies. Algorithmic trading strategies can help clients buy or sell crypto assets at better prices. Finally, hedging strategies can cover specific risks for clients.

2.4 Hosting

Custody is a very important service in the financial industry and it can effectively eliminate operational risk by introducing one or more approvers. In the cryptocurrency industry, there are three types of custody services:

Ordinary hosting, similar to traditional services like Bitgo, Copper, etc.

Custody services for exchanges, which can be very useful when the underlying asset is frequently traded on the exchange. Both Binance and Coinbase are supporting it.

Self-custody, a more crypto-native approach commonly used by DAOs and protocols, where clients use multi-party computing solutions to manage assets. Fireblock and Gnosis Safe can provide this service.

Asset management companies are major users of custody services to keep digital assets safe. Hosting should be adapted to the corresponding product, and only then can security be truly improved.

For example, IDEG chose Binance and Coinbase as custodians for exchange-traded products and Gnosis Safe as custodian for its DeFi products when designing the trust product.

2.5 Trust

Asset management companies typically issue financial products to manage assets for clients. In the cryptocurrency industry, most financial products are issued in the form of funds. However, some regulated companies can raise funds through trusts. Trust products have various advantages:

Limited liability is possible if a corporate trustee is appointed;

This structure provides more privacy than a company;

Allocation between beneficiaries can be flexible;

Trust income is generally taxed as personal income.

track

Tracking products actively track a single digital asset and a basket of digital assets, with higher returns. In a single tracking product, IDEG trading team will utilize quantitative arbitrage strategies to improve returns. The company will charge a spread based on enhanced returns rather than total returns, which is very beneficial to clients who are bullish on the cryptocurrency market.

In a basket of products, IDEG's professional investment team will select the best underlying assets based on fundamentals and market analysis. Additionally, the team will actively manage positions to improve returns.

Interest

Interest products provide customers with stable or fixed returns. Unlike many competing companies that pay interest from the profits of their lending operations, IDEG's interest products generate revenue through quantitative arbitrage trading with much less risk.

Mining

The Bitcoin mining products provided by IDEG are highly profitable. Its sister company, Atlas Technology, is one of the largest bitcoin mining companies in the world. Through refined management, Atlas Technology is able to achieve returns above the industry average, which makes IDEG's mining products very competitive.

New

The cryptocurrency market has always been at the forefront of technological development and is very different from traditional markets. This requires cutting-edge, multi-dimensional risk strategies to adapt to new innovations in the market and to identify many hidden profit opportunities. IDEG's years of professional research help clients select protocols and time each unique case opportunity, including monitoring performance, rebalancing strategic risk allocations, and hedging appropriate market and counterparty risk.

Structure

IDEG customizes products for diverse risk appetites. For example, the income of Bitcoin miners is closely related to the price of Bitcoin, which exposes miners to a lot of risk. IDEG can use the derivative structure to smooth the income of miners and eliminate risk.

  1. The challenges of cryptocurrency asset management

The ultra-high growth rate has attracted a large number of speculators into the cryptocurrency market, and lending services amplify the leverage of these speculators. The lack of a credit system in the cryptocurrency industry makes it easy for large institutions to obtain loans from multiple lenders without disclosing their positions and leverage. Once the market falls and someone's liquidation is triggered, a series of liquidation events will occur, causing financial panic. Recently, Three Arrows, Celsius, Voyager and Babel have all suffered severe liquidity crises that have severely hurt their clients and themselves.

The cryptocurrency lending business has rebounded sharply during the pandemic, with retail investors hyping everything up, driving prices higher. From early 2020 to early 2022, Voyager platform users grew from 120,000 to 3.5 million.

3.1 Low profit margin

Like traditional banks, savings and loans have low profit margins. According to Gurufocus, the ROA of most traditional banks is only around 1%. However, while the AUM for crypto asset management is relatively lower than banks, the fixed costs are the same. This makes most digital asset managers unprofitable. Some of them have to take more risk in search of additional profits.

3.2 Lack of regulation

Unregulated underground credit is taking place on a massive scale, with many CeFi institutions lending large-scale unsecured credit to each other. This is normal to some extent, similar to inter-bank lending in traditional finance, and is necessary for optimal allocation of capital and risk among operating entities within the banking system. However, the cryptocurrency industry is an unregulated, opaque and unsupervised credit market.

Credit lending between CeFis is conducted in an unregulated manner without peer oversight or disclosure. We can only think of these credits as underground transactions, so the positive elements of the market mechanism are not at work. For example, Three Arrows Capital, which at one point had $18 billion in assets, borrowed billions of dollars in unsecured credit from more than two dozen CeFi institutions after losing hundreds of millions of dollars in the LUNA crash.

These lenders do not know the actual asset status of Three Arrows, nor do they know what the funds are used for or how much money Three Arrows is also borrowing from other institutions. As a result, several lenders such as Voyager and Celsius were implicated in a string of bankruptcies and restructurings following the bankruptcy of Three Arrows Capital, a case that illustrates how dangerous demarketed underground credit transactions can be.

3.3 Lack of risk control

CeFi institutions usually have a trading background, and the institutions themselves often engage in leveraged trading. In the bull market cycle, institutions that dare to increase their leverage often stand out and achieve explosive growth in asset scale. Therefore, in the CeFi world, which is accustomed to judging heroes by asset size and growth rate, the winners are often those who dare to actively increase leverage and expand risk exposure. This style of risk appetite and risk management is undoubtedly responsible for the recent consecutive defaults. root cause.

4. Solutions

While there are various issues, we still believe that centralized asset managers play an important role in the cryptocurrency industry, and here are some solutions that we think may be useful:

4.1 Diversified business

The savings and loan business has low profit margins and is highly reliant on asset management. However, loan demand is limited by the size of the market. Companies can diversify their operations to increase profits.

4.2 Supervision

Many CeFi institutions are engaged in high-risk speculative businesses such as derivatives and leveraged trading. Although there is nothing wrong in itself if they speculate with only their own funds, at their own risk. However, due to the lack of information disclosure and monitoring mechanisms, they often use funds raised for other purposes to engage in speculative businesses, crowding out liquidity that should have been available to the productive sector.

In traditional finance, there are strict rules for proprietary trading. Proprietary trading (Prop Trading) refers to the trading of stocks, derivatives, bonds, commodities or other financial instruments by banks or companies with their own accounts, using their own money instead of customers' money.

During the 2008 financial crisis, proprietary traders and hedge funds were among the companies that came under scrutiny for causing the crisis. The Volcker rules are used to strictly limit proprietary trading, in order to regulate how proprietary traders operate and the amount of risk that financial institutions can take. A major concern is avoiding possible conflicts of interest between the company and its customers.

4.3 Risk Management

Risk exposure can take many forms. CeFi institutions need to establish information disclosure and risk assessment mechanisms in terms of scale, duration, directionality, volatility, liquidity, and concentration. In addition, assets and liabilities need to be matched together in a portfolio to mitigate liquidity risk and ensure there is no misalignment in terms of borrowing and lending. As markets change rapidly, so should risk exposures, requiring daily risk management practices and adjustments.

Healthy and well-functioning financing markets play a key role in the sustainability of the economy, and a well-designed risk management program is essential to drive industry growth.

4.4 Institutional Custody Assets

It is very important to understand your counterparties and their risk framework. You should also ask your brokers, market makers, exchanges and prime brokers about their default protections and find out where they keep your assets and what procedures they need to transfer your assets.

In traditional finance, custody requirements for registered funds are governed by the Investment Company Act 1940 (often referred to as "Act 40"), which requires a third-party entity to keep investors' assets in safe custody to minimize the risk of theft or loss . This is the primary purpose of the custodian.

Coinbase and Binance launch custodial sub-account services. With this product, the withdrawal of funds is completely determined by the client, and the fund manager can directly trade with this sub-account without transferring the client's assets to other accounts.

5 Conclusion

All in all, we believe that the most important aspects of crypto asset management are product diversity and regulation, and most companies in the asset management industry are working in both directions.

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