Although they date back to 2014, in 2017 we saw the rapid rise of ‘crypto funds’, or investment funds that invest mainly in cryptocurrencies such as bitcoin, Ethereum, or other ‘altcoins’. Those offering crypto funds are, in effect, managing digital assets.
But what’s the difference between managing digital assets and managing assets digitally? Many asset managers have digitised some analogue processes, but very few asset managers are truly digital in nature.
What lessons can we learn from the first few years of those that manage digital assets such as crypto funds, and how can the end investor benefit?
What does an asset manager do?
Asset managers seek to preserve and grow the wealth of their customers, commonly referred to as investors. For the sake of clarity, in this post I’m using the umbrella term ‘asset manager’ to refer to managers of any asset class, including hedge fund managers, mutual fund managers, private equity, venture capital and others. Asset managers generally deliver their value proposition through two types of products: funds and mandates, but we’ll just use ‘funds’ as a general term from here.
How does an asset manager build products?
Decisions on what assets to buy, sell or hold are made by the asset manager on behalf of the investors, and the asset manager earns between one tenth of 1%, up to 2% of net assets of the fund or mandate as their fee.
Asset managers allocate investors’ cash to single or multiple asset classes according to the fund’s strategy, and then execute this strategy through building a ‘portfolio’ of assets into a fund or mandate.
How does an asset manager sell products?
Asset managers sell their products to investors through three main channels: institutional, wholesale and retail.
- Institutional (B2B) – pension funds, sovereign funds, endowments, family offices, etc.
- Wholesale (B2B2C) – wealth management customers, platforms and independent financial advisers.
- Retail (B2C) – direct purchase of shares from the fund.
The sale of these products through the above channels is referred to as distribution. The end investor only sees the end result, representing their preserved capital and their capital growth.
How has manufacturing and distribution changed with crypto funds?
In short, very little has changed. An asset manager offering a crypto fund to investors has built a product focused on a single asset class: cryptocurrencies. However, the mainly analogue processes of selling funds to investors through multiple channels remain unchanged. Moving further into providing intelligent services through digital access points rather than just selling products is a big leap from today’s model. This is true for crypto and traditional asset classes.
For example, if an investor wants exposure to the crypto asset class, but doesn’t want to open their own crypto wallet and decide which coins to buy, hold and sell, the investor can invest in a crypto fund offered by an asset manager.
How would I invest in a crypto fund?
To invest in a crypto fund, an investor generally needs to go direct through a retail channel, which, despite crypto being fully digital, involves a long analogue process as follows:
- Download and print a PDF subscription document – if you’re lucky, you can fill this out online, but you’ll still need to print it.
- Gather all of the identity documents required by law to ensure you are who you say you are, and that you’re not laundering money.
- Sign the subscription document, scan it and fax it (or email it if you’ve been blessed) to the crypto fund’s ‘transfer agent’, along with all of your identity documents.
- Send your cash via wire or Swift to the crypto fund’s ‘collection’ account at a domestic or global bank.
- Once the cash is received and the documents are deemed complete and legitimate by the fund’s transfer agent, your cash is sent by to the fund’s custodian so the asset manager can invest it on your behalf in the altcoin of your choice.
- You then get a confirmation email anything from 3-45 days later.
(If you can invest through a platform, you might deep-six the subscription document and open account with your smartphone. However, the investment platform will still be interacting with the transfer agent through analogue channels on your behalf.)
Not very digital for a digital asset, is it? Currently, there’s no other option because (and here’s the rub) although cryptocurrencies are digital assets, crypto funds are not.
The problem? Digital asset, analogue process
What’s happening with crypto funds is that asset managers have to shoehorn a digital asset into the same analogue channels used by the wider asset management industry.
The operating model architecture for crypto funds look at crypto assets as unwieldy and volatile, rather than an elegant digital asset. The general lack of maturity in crypto funds and the volatility of the asset class means that duplicate and triplicate record keeping is the norm to make sure they get things right for investors. In short, it’s not a scalable model.
How could we redesign the model?
What’s needed is a user-friendly, efficient but scalable model that removes the need for duplicate record keeping. For the front-end, the robo-advisor-style UX comes to mind, combined with the virtual onboarding of a digital bank such as N26. Adapting the onboarding to the institutional and wealth markets is an iteration of this rather than a reinvention. The middle of the value chain is a moving goalpost with the nascent crypto markets, so the front-end and back-end need to be modular.
The back-end relies on the the crypto world credo of “I know that you can see what I see”. Perfecting the model means that duplicate record keeping may become a thing of the past, and the process becomes much more streamlined. If all of the fund’s transactions are acknowledged on a consensus basis by the network, and are immutable, why bother with the double and triple records?
Overall, I’m thinking the model looks something like the digital banking architecture from our friends at Leveris. When you line things up, you can see how the “single view of customer” concept applies across verticals, even with complex digital infrastructure, as demonstrated in this diagram:
How might things end up?
It’s a leap of faith for the most ardent architects of operational controls, but it has been proven to work in other verticals. Might this also mean that when analogue assets such as equities, bonds and derivatives enter the digital mainstream via distributed ledger technology and smart contracts, that a similar model applies? I think so, but the naysayers point to regulation and compliance as immovable obstacles on the road to a truly digital framework for asset management.
Going back to the beginning, an asset manager aims to preserve and grow investors’ wealth. It’s fair to say that an asset manager wants to deliver their value proposition at a fair price, in a convenient way, and with the right degree of transparency for their customers.
Creating intelligent digital services for investors seeking to preserve and grow their wealth is no small undertaking, but it’s far more likely with 2018’s tech than it was with 2008’s tech. With the right architecture and mindset, crypto funds and digital asset managers can create efficient, cost-effective, scalable models that then can be applied to traditional asset classes as distributed ledger technologies go mainstream.
– This article is reproduced with kind permission. Some minor changes may have been made to the text to reflect BankNXT style considerations. See more 11FS content here. Image by Africa Studio, Shutterstock.com