Introductory on-chain investment funds: understand the characteristics, advantages and disadvantages of Set Protocol, Melon and dHEDGE

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Blockchain-based investment funds try to lower the threshold of funds through smart contracts and remove the risk of custodial funds.

Original title: “DeFi Study Notes | How to Create a Chain Investment Fund”
Author: Free and easy

The popularity of hedge funds is largely due to the legends surrounding hedge funds. For ordinary people, the world of hedge funds is intangible. In most cases, we can only learn about hedge funds through film and television works such as “Big Short” and “Billions”. We are amazed by how these savvy traders Can easily earn billions of dollars in profits, but also attracted by dazzling financial terms.

However, many people did not pay attention to what happened to the establishment of these hedge funds and some of their problems.

This article will focus on the world of blockchain-based funds. These agreements try to greatly reduce the threshold of funds through smart contracts and remove the risk of custodial funds.

Through this article, you will learn:

  • Problems with traditional hedge funds
  • Unregistered funds chaos in the currency circle
  • First glance at the blockchain-based on-chain fund era Set Protocol, Melon Protocol, dHEDGE
  • Summary and outlook

The picture comes from the American drama “Billions”

Problems with traditional hedge funds

The so-called funds are actually just a combination of assets. Investors provide funds to these funds and hand them over to fund managers to manage them. In addition, they usually need to pay management fees and performance fees to fund managers.

Large companies initially set up hedge funds to avoid increasing supervision of mutual funds. They also designed these funds to hold both long and short positions. By doing this, no matter whether the market rises or falls, the fund manager can get profits in return. Basically, fund managers will hedge their trading positions, hence the name “hedge fund.”

People like to hear the legend of George Soros creating billions of dollars in profits, but most people don’t understand that most fund managers collapse because they take too much risk or they mess up the fund.

This is why, for savvy investors, choosing a hedge fund is not so much a matter of return, but rather an analysis of their strategy and related risk allocation methods.

For ordinary people, hedge funds are out of reach, because the initial investment to join these funds is usually between 100,000 and 1 million US dollars.

In order to prevent fraud and errors, traditional hedge funds have custodian banks responsible for holding investors’ funds. Therefore, when an investor buys shares in a fund, they basically surrender control of their assets. Only portfolio managers can transfer these funds to various investments. Of course, the third-party custodian bank will ensure that these funds only invest in the assets specified in the power of attorney, instead of entering some crazy, speculative risks.

and then? Third-party managers must also ensure the correct valuation of funds. As a further measure, an external auditor will audit the managers every quarter.

In addition, back-office employees (about 5 per investment professional) need to be hired. These include auditors, more administrators, custodians and transfer agents. Not to mention all relevant legal documents, fees and custodial banks.

At every stage of all processes, certain types of third-party costs are involved. And every time a newcomer intervenes, dishonest behavior or mistakes may occur. Shameless people like Bernard L. Madoff [1] will always lurch around the huge wealth of hedge funds. .

We know that the purpose of these reports and third-party supervision is to ensure the safety of investors’ property and create transparency, but this has also produced a lot of bureaucracy. Guess who will pay for these? Of course it is an investor. The current fund system is very complex, inefficient, and involves a lot of unnecessary waste.

For hedge fund promoters, in addition to operating costs, starting a hedge fund requires a cost of US$50,000, and it may take up to 8 weeks (depending on the jurisdiction) [2]. Currently, the Cayman Islands, Ireland and Luxembourg are the preferred registration places for hedge fund businesses.

In addition, a challenge in managing hedge funds is dealing with customers. Even if you only have a few customers, you still need to report weekly (some teams even want customers to keep track of entry and exit, fees, etc.).

DeFi study notes | how to create a chain investment fundPicture from PickPik

In summary, although hedge funds face less supervision than mutual funds, maintaining compliance requires a large number of audits. All these conditions make the cost of managing hedge funds very high and inefficient, which is greatly Increased barriers to entry for hedge funds. Simply put, if you don’t have a lot of money, you don’t want to engage in hedge funds.

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Unregistered funds chaos in the currency circle

Above, we briefly learned some information about traditional hedge funds, and let’s understand some of the currency circle funds.

In the second half of 2017, the currency circle entered the largest bull market in history. At its peak, the market value of the entire cryptocurrency market once reached 779 billion US dollars.

At that time, a large number of currency circle funds were born, and most of these funds were not registered, so they were not supervised by regulators. In other words, investors needed to fully trust the fund originator.

By October 2019, according to industry insiders, more than 95% of the quantitative funds in the currency circle were losing money, and some teams chose to run away because they could not explain to investors (involving funds exceeding 100 million).

And even some of the currency circle investment funds with good reputation may have some discrepancies when they are liquidated.

Obviously, currency investment funds whose funds are directly controlled by others and are not subject to supervision are far more dangerous than traditional investment funds.

First glance at the era of blockchain-based funds

DeFi study notes | how to create a chain investment fund

As smart contracts become more and more popular, people are gradually realizing that machines can replace humans to do simple tasks, they are more efficient, lower cost, and allow trusted transactions without a third party, such as Uniswap Such a decentralized exchange (DEX) that uses smart contracts has already challenged large centralized cryptocurrency exchanges such as Coinbase and Binance.

Some developers have set their sights on the direction of on-chain funds, such as Set Protocol, Melon Protocol, and dHedge that I will mention. Below we will understand them one by one:

Set Protocol

Set Protocol is a non-custodial asset management protocol based on Ethereum. It allows participants to create, manage and trade ERC20 portfolio assets (called Set), which can include assets such as WBTC, WETH, and DAI. It was released in November 2017 (April 2019, the TokenSets platform was released). After nearly 3 years of development, Set Protocol’s lock-up value has exceeded 35 million U.S. dollars.

DeFi study notes | how to create a chain investment fundData from defipulse

At present, the TokenSets platform provides two types of investment portfolios: Set social trading performed by human traders (equivalent to investment managers) and Robo portfolios with hard-coded strategies (providing trend trading, range-bound and other robot strategy trading).

According to the official website of TokenSets [3], there are currently 52 Set social transactions and 13 Robo combinations.

DeFi study notes | how to create a chain investment fundFigure: Among them, a trader named ByteTree temporarily ranks first on the Set protocol trading list, and its assets under management reach 1.9 million US dollars

As of now, Set Protocol and TokenSets do not charge traders (but managers may charge performance fees), and they have not issued native tokens.

To apply to become a trader (ie, manager) of TokenSets, you need to answer 10 questions (including name, email, trading strategy, etc.) and wait for the approval of the project team.

A brief comment on Set Protocol, advantages:

  1. It has been established for a long time, and there has been no safety accident;
  2. Participating in the investment portfolio only needs to prepare ETH, and there is no need to exchange a specific currency in advance;
  3. Launched various robot strategic investment products;
  4. The DeFi Pulse index token (DPI) jointly launched by DeFi Pulse and TokenSets is relatively popular;

Disadvantages:

  1. Since it is an on-chain transaction on the Ethereum main network, the transaction cost of buying or selling Set asset portfolios is very high. Even when the current network is not congested, the cost of a transaction exceeds $20.
  2. Becoming a trader (manager) requires an application and review, and there are certain thresholds (of course you can also consider this to be an advantage);
  3. Only support traders to buy or sell underlying assets (no short option), and only support limited ERC-20 assets;

Melon Protocol

Melon is an open source, community-run Ethereum chain asset management protocol that allows users to create, manage and invest in decentralized funds composed of ETH and ERC20 tokens. It is reported that the V1.0 version of the Mellon protocol was released in 2019 Deployed to the Ethereum mainnet in early March. Up to now, the lock-up value of the Mellon agreement is approximately US$2 million.

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DeFi study notes | how to create a chain investment fund

Like Set Protocol, Melon protocol is actually composed of a set of smart contracts, which are responsible for performing specific functions: accounting, investment/redemption, asset custody, transaction, fee distribution, etc., and are bundled together through a Hub contract. This set of smart contracts can jointly implement the behavior of the fund and enforce the rules of the fund.

Up to now, the number of funds created through the Melon agreement has reached 407, and the number of investments involved is 1,175.

The currently ranked first Melon investment fund “Rhino Fund” has assets under management of approximately US$950,000. Its current portfolio is WBTC, WETH, KNC, UNI, MKR, ZRX, REN, ANT (V2),

Different from Set Protocol, Melon protocol released the native token MLN. This MLN token will be used as “asset management gas” [4]. What does it mean? When users use the Melon protocol, in addition to paying transaction fees for Ethereum miners, they also need to pay a part of the “asset management gas” fee. This part of the fee is also paid in ETH, but it will be converted into MLN tokens through the so-called Melon engine. Then burned. In this way, the MLN token is linked to the use of the Melon network. In addition, MLN tokens will be issued in a fixed amount of 300,600 MLN per year to fund the future maintenance and development of the agreement.

To initiate a fund on the Melon agreement, you can register through the Melon terminal. The process is relatively complicated and the costs involved are also high. For example, the first step to create a framework for a new fund will cost the author About 40 US dollars in handling fee (at the time of writing), and there will be 8 steps to spend money later. Obviously, the threshold for establishing a fund through Melon is still very high, which directly leads to the Melon agreement has been in a tepid state. .

DeFi study notes | how to create a chain investment fund

Briefly comment on the Melon protocol, its advantages:

  1. DAOization (ie community governance) is higher;
  2. Due to the early launch of the token, the market popularity is relatively high;
  3. Fund managers can customize the accepted investment tokens, not limited to one token, such as WETH, DAI, USDC, etc., which is convenient for investors to inject funds (whitelists can also be set);

Disadvantages:

  1. high cost;
  2. Only ETH and ERC-20 assets are supported, and short trading is not supported;
  3. The registration and trading experience is not very good;

dHEDGE

Like the SET agreement and the Melon agreement, dHEDGE is also a non-custodial Ethereum asset management agreement, but the difference is that the dHEDGE portfolio is backed by the Synthetix derivatives liquidity agreement, which means it can enjoy the Synthetix belt The various synthetic asset transactions in the future are not affected by transaction slippage, but at the same time, this also means that dHEDGE will be restricted by Synthetix.

dHEDGE went live on the mainnet on October 25, 2020. Up to now, the number of funds created through the agreement is about 110, and the total amount of locked funds is about $500,000. Among them, the Convex Strategies asset pool created by trader CM, At present, it has accumulated US$124,900, which is the best performing dHEDGE fund.

DeFi study notes | how to create a chain investment fundSimply looking at the amount of funds, the newly launched dHEDGE obviously lags behind the other two projects, but its growth rate and supported trading methods are indeed eye-catching.

To understand dHEDGE, we must first understand the concept of Synthetix (because dHEDGE is actually an application built on the basis of Synthetix)

Simply put, Synthetix participants create and destroy synthetic assets (Synth) by collateralizing the system’s native tokens (SNX) and anchoring the price of external assets through the Chainlink oracle. Traders can use the Synthetix system to trade i series short assets ( For example, iBTC, iETH, iBCH, iDEFI, etc.), s series long assets (such as sBTC, sETH, sLINK, sDEFI, etc.) can also be traded, and even short or long legal currency synthetic assets, equity synthetic assets, gold, silver, and The newly added petroleum synthetic assets [5], which means that dHEDGE can theoretically grow into an on-chain hedge fund management protocol that can trade any asset.

The current SNX synthetic mortgage rate is set to 750% (note: this mortgage rate may also be increased or lowered through the community governance mechanism), which means that every 7.5 USD worth of SNX tokens can be synthesized worth 1 USD Assets, the purpose of doing so is naturally to reduce system risks, but it also limits the scale of synthetic assets.

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For this reason, Synthetix is ​​currently trying to use ETH as collateral (collateralization rate is 150%) to borrow synthetic assets (Synth), but it has not yet supported the use of ETH as collateral to generate synthetic assets[6].

The use of Synthetix’s underlying synthetic assets means that dHEDGE transactions are slippage-free, and you can understand it as unlimited liquidity. (Explanation: The process of fund rebalancing is actually burning source synthetic assets, and then casting target synthetic assets. They Keep the value equal by feeding the price through the oracle, which does not involve the counterparty).

Like the Melon agreement, dHEDGE has also issued the agreement token DHT (as a governance token). In addition, in the future, DHT holders can also share a 10% reward for manager performance (that is, if the manager charges a performance fee If it is 20%, the agreement will charge 2% of the investor’s profit as a token holder reward). This economic model is different from the current economic model adopted by the Melon agreement.

To create a fund through dHEDGE, it is relatively easy. You only need to connect to your Ethereum wallet, fill in the asset pool name, set the performance fee ratio and enable synthetic asset pairs. After confirmation, submit an Ethereum A transaction (currently costing approximately $15) can be created by reposting a tweet at the end, and the whole process will not involve review.

DeFi study notes | how to create a chain investment fund

(At most 5 synthetic asset pairs can be activated initially, the purpose is to reduce the handling fee, after the creation is completed, the manager can also switch by himself)

Briefly, the advantages of the dHEDGE agreement:

  1. Utilizing Synthetix’s powerful synthetic asset system, there is no slippage in transactions;
  2. Managers can trade various types of assets (including real-world assets), and support long and short transactions. In the future, as Synthetix introduces layer 2 agreements and more derivatives such as leveraged futures, dHEDGE will become a direct beneficiary;
  3. Simple interface, and the introduction of some interesting features (for example, the public strategy information released by the manager is free, while the private strategy has a threshold, which is only visible to investors who have invested more than $1,000 in the pool)

Disadvantages:

  1. The agreement completely relies on the Synthetix system, which not only means that participation in investment can only use the synthetic stable currency sUSD, but also means that the scale of the system will also be restricted by Synthetix;
  2. The online time is short and has not yet passed the test of the market (that is, the possibility of potential attacks is greater);
  3. Short-term transaction fees will also be a problem (with Synthetix supporting layer 2, this problem can be resolved)

Summary and outlook

After briefly introducing the three decentralized asset management protocols of Set Protocol, Melon Protocol and dHedge, we can get a glimpse of the original appearance of the fund world on the blockchain. It is true that the scale of funds managed by these protocols is compared to traditional Hedge fund giants with tens of billions and hundreds of billions of dollars in the financial world are like a scale in the ocean, but they have taken a solid step towards a new horizon on their ideal path towards decentralized asset management.

When comparing these agreements horizontally, we can find that they have their own advantages and obvious disadvantages, and these advantages and disadvantages will inevitably affect the market performance of their respective agreements.

Careful support for asset management is of great significance to preventing fund managers from doing evil. Under this premise, more derivatives are introduced, and measures such as layer 2 reduction of fees (thus lowering barriers to entry) are introduced. Will allow the agreement to better seize market share.

As users, while exploring these decentralized asset management protocols, we still have to remember that they are still in the early stages of experimentation, which may not only involve potential contract vulnerability risks, but may also involve oracle attacks, etc. In addition, DeFi will also face potential supervision. The existence of these uncontrollable factors means that participants must fully understand the above risks and confirm that they can take the above risks before they can participate.

1. Madoff fraud:
https://baike.baidu.com/item/ Madoff Fraud/8709431?fr=aladdin

2. https://academy.ivanontech.com/blog/introduction-to-defi-hedge-funds-and-the-melon-protocol

3. https://www.tokensets.com/

4. https://melonprotocol.com/docs/melonomics/

5. https://www.8btc.com/article/668497

6. https://docs.synthetix.io/litepaper/#snx-as-collateral

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