Trends Watch: DeFi

November 23, 2021

By Elana Margulies-Snyderman

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with Patrick Horsman, CFA, Managing Partner, Coral Capital.

What is your outlook for investing in digital assets, more specifically decentralized finance (DeFi)?

We are extremely bullish on DeFi as an emerging asset class. DeFi is the killer use case to date for distributed ledger technology.  You can think of DeFi as porting Wall Street’s most profitable business (lending, market making, exchanges, derivatives) and codifying those verticals into software that runs autonomously on smart contract blockchains.  We are talking true global peer-to-peer markets, with financial instruments and markets that can be spun up in minutes for fractions of a penny relative to traditional financial markets.

DeFi is what FinTech was supposed to be and what was promised during the advent of the internet. Unfortunately for individuals, the internet created fewer and larger incumbents and massive consolidation in the financial sector. Unlike traditional financial firms, DeFi protocols run with significantly lower overhead and thus create massive value in comparable markets to incumbents. For example, the risk-free rate on stablecoin deposits in DeFi hovers around 6-8% at a time when depositors are thrilled to park cash at 0.5% at depository banks.

These DeFi platforms don’t have internal capital to run their protocols and instead look to the community to provide balance sheets to make the platforms function.  The platforms then share the fees generated with those providing the liquidity, providing excellent risk adjusted yield.

The amount of capital invested across DeFi platforms has grown 277x since May of 2020 ($277 billion total value locked in DeFi as of Nov 2021 up from $1 billion in May 2020) and we are still in the very early innings, according to DeFiLlama, a platform which provides metrics and rankings for DeFi protocols  Investing in DeFi is technically challenging; you need a wallet like MetaMask, you need an onramp to get USD from your bank account and you need the knowledge of the platforms to put it all together.

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Source: defillama.com – 11.10.21

What are the greatest opportunities you see and why?

DeFi is at such an early stage and we are only now scratching the surface of use cases.  Our team has decades of relationships from traditional Wall Street investment banks and hedge funds; many of our friends and former colleagues (even those deep in digital assets) are unaware of what DeFi is.  As an asset class, DeFi onboards billions of dollars of assets every week. We are no doubt on the cusp of a meteoric shift in the way value is transacted across the internet. At an increasingly rapid pace, every pillar of traditional financial firms is being replicated in a more efficient manner on distributed ledger technology platforms like Ethereum. 

What are the greatest challenges you face and why?

The greatest challenge for digital assets is changing users’ behavior and deeply rooted beliefs. For people that grew up in the 1950s, it’s very difficult to comprehend how digital gold can be a larger market than physical gold. DeFi is likely a generational play, as younger users will grow up knowing how to navigate digital wallets natively.

What keeps you up at night?

Regulatory risk is probably the biggest unknown in crypto and digital assets.  It’s unfortunate that some of the best projects and entrepreneurs (Sam Bankman Fried - FTX, Arthur Hayes - BitMEX) have been driven offshore or pushed out of their companies.  Overall, we are very optimistic and excited about the space and what’s to come.

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.

 

About Elana Margulies-Snyderman

Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.