Buying Bitcoin? Hedge Funds Will Use Blockchain, Too

OPINION
Mona El Isa
Dec 22, 2017 at 10:00 UTC  |  Updated  Dec 23, 2017 at 17:06 UTC

Mona El Isa is co-founder and member of the board at Melonport AG, a decentralized digital asset management platform, and a former VP of equities trading at Goldman Sachs.

The following article is an exclusive contribution to CoinDesk's 2017 in Review.


Imagine a future where humans play a minimal role in setting up, regulating and reporting regulatory requirements of investment funds, where the process is underpinned by reliable, cutting-edge technology.

It's a future that's not as far away as you might think, and it's not being built by an existing bank or institution that you will have heard of.

Instead, it is being built by a new group of technical pioneers who were early to blockchain and understood what it meant. These entrepreneurs are now working on a full toolkit that is fast becoming available.

Already, there are distinct innovations emerging across what can best be described as the emerging investment management chain.

Protocols are being built that allow you to:

  • Bring data securely to the blockchain (e.g. Oraclize)
  • Exchange assets in a secure, peer-to-peer way (decentralized or hybrid exchanges like 0x, Kyber, Oasisdex, etc)
  • Issue all sorts of digital assets on-chain (protocol tokens, ETFs, regulated equities, derivatives, etc)
  • Set up and regulate your investment funds.

Yet, these projects are an example of a crucial point – if all these projects were working in isolation, the concept probably wouldn't pose a credible alternative to the existing financial system.

However, the exact opposite seems to be true – bridges and highways are being built through network effects, securing an ecosystem which collectively gets stronger and stronger by the day.

Fitting in

Yet building a business in this environment isn't conventional.

To start, Melon offers a protocol, one important technology link that magnifies the network effects of the ecosystem. Our role is allowing users to set up and manage a technology regulated investment fund pre-defining a rule-set for your investment fund in a matter of moments.

The goal is to take what today occurs in a few months (and involves a couple of hundred thousand dollars) and replace it with an automated alternative.

You get to choose what risk limits your fund has, what fees you want to charge, what pricing source the fund accounting is based on, which assets and exchanges the manager is allowed to interact with and which investors are allowed to invest in your fund. All these rules are written in code and enforced by an unbiased, efficient, transparent technology commonly referred to as blockchain and adhere to blockchain accounting standards.

By following a standard template – any exchange protocols, data feed providers, digital KYC/AML companies or asset issuers can link their product suite to Melon's open-source protocol making it an available option to users.

From a user perspective, it would feel like going into an "app-store" for investment funds and picking out the different service providers you want to plug into your fund structure to meet the criteria you need to meet.

This gives regulators and investors the security and transparency around reporting, we also remove entirely the idea of human "conflict of interest."

User adoption curve

But, we are just beginning, and limitations still exist.

Like many other protocol providers, the first limit is around regulation. There are certain fund laws that are not fit for modern technology. Some of the current laws were simply created in a different time, without consideration of all available technology available. As an example, most funds today must have a custodian and fund administrator by law.

A custodian typically acts as safekeeper of the fund's assets and the fund administrator typically takes care of accounting, auditing, risk management, compliance (KYC/AML), investments/redemptions and regulatory reporting.

On top of that, it is pretty standard practice that for every investment professional in a medium-sized investment fund, there will be four non-investment professionals (ie. legal, support, operational, fund-administrator focused, trade reconciliation, custody, risk management, auditing… and the list goes on).

What if we could automate the fund administration and support function entirely by smart-contract code and allow investors to own full custody of their assets at all times, while still partaking investment fund strategies?

There is no reason why regulation shouldn't catch up to technology.

Another limitation is that today, the range of traditional investment fund assets, like fiat currencies and equities, aren't available on a blockchain. A fund that operates in a technology regulated environment will have to use modern digital assets like tokens and can't deal with paper-based certificates.

However, traditional assets are fast becoming tokenized and we're just getting started.

We don't have to look very far with Daimler recently issuing the first bond on blockchain technology, companies like Neufund, Jibrel network, Overstock and Otonomos working to put regulated equities on-chain or several central banks making public their plans to tokenize fiat currencies.

It's just a matter of time before every asset class we know will be digital simply because it is more efficient, transparent and secure. In which case, it's not too long until we can imagine a fund management world which is entirely run by digital rule-sets and transparent processes.

Crypto fund paradox

Crypto funds today are emerging left, right and center in an attempt to gain investment exposure to this new class of blockchain innovators.

The irony is, that despite all the new technology surfacing, crypto funds can be even more expensive to set up and run than traditional funds. This can be seen in some of the fees they are charging. It is typical to see higher fee structures for crypto funds than traditional asset funds.

A large part of these high costs are related to the fact that investment fund laws have been created for the "old world" and simply don't account for or understand technology like blockchain. This means that new crypto fund launches are having to squeeze into existing rules and regulations designed for a different system.

Going back to the example of investment fund law requiring fund administrators. Fund administrators are extremely expensive and mostly not ready or equipped to deal with crypto assets. However, many of them are still taking on crypto fund clients and charging handsomely for it, without necessarily solving all the problems (or charging extra for the hassle).

The crypto investment funds are likely to be the first to shift, but there's no doubt that when traditional funds see evidence of how much they can trim their everyday cost basis and pain-points by, they'll be quick to follow.

And by then, we believe all traditional assets will be tokenized.

Why wouldn't they be?

See a different future for crypto hedge funds? CoinDesk is accepting submissions to its 2017 in Review. Email news@coindesk.com to contribute.

Vintage calculator via Shutterstock

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Hedge FundsDecentralized Exchanges