Transitioning away from 10102 Etherbase Vault
Insights into the on-chain asset management industry
As we prepare to conclude our on-chain fund experiment, 10102 Etherbase Vault, we reflect on the current pros and cons in managing such an operation.
Our journey in exploring Enzyme's on-chain capabilities and its technical limitations has unveiled a broader realization. The on-chain asset management domain is still pioneering, and therefore, navigating through significant challenges in an emerging industry largely dominated by traditional regulations. On one side, there's an obligation for off-chain KYC, specific geolocation rules, and adherence to dollar-based calculations. On the other, on-chain natives seek to maintain their privacy and distinguish between their digital and real-world identities.
This endeavor has been a profound learning experience, shedding light on aspects we, as builders and users, need to absorb. Despite the hurdles, the potential of on-chain asset management remains undeniable. Below are our key insights gained from this experience.
Pros
Our experience has reaffirmed the benefits of on-chain management, including full on-chain transparency, non-custodial fund management and instant redemption. Specifically:
Faster onboarding time and less third-party interactions: opening an account at institutional banks and exchanges usually spans weeks if not months, and their maintenance requires ongoing certifications overseen by the management team. Operating directly on-chain via financial smart contracts is truly more automated and efficient in that regard. The traditional exchanges become integrated DEXes (Decentralized Exchanges), and the traditional bank accounts are the vault’s smart contracts, which are themselves integrated with further DeFi Applications, all accessible from a single interface.
A new paradigm of trust: thanks to the inherent transparency of blockchain technology, for the first time, the perspectives of the manager and the investor harmoniously converge. With no room for manipulation or opaque off-chain asset operations, the on-chain paradigm generates a unique standard of trustlessness, as for there is no longer a need to trust and rely on the counterparty operators anymore. For the first time in finance, Limited Partners (LPs) do not need to rely on management' reports, accounting, or sources. Similar to how savvy technology users examine and recompile open-source software on their own to make sure the source code is legit, any investor can independently reassess accounting and verify that the outcomes match those of the management, administrators, or auditors.
Asset custody and security: the blockchain's role as a custodian has fundamentally transformed the landscape of asset security. In our prior management of Tokenpot Capital, we grappled with the intricacies of devising a sophisticated, multi-geolocation security strategy to mitigate the risk of a single point of failure. This involved mastering all sorts of hardware and navigating the complexities of multi-sig wallets. Enzyme’s smart contracts offer a paradigm shift by allowing LPs to maintain ownership of their shares via their own Ethereum wallets, significantly reducing the dependency on the fund manager's capabilities.
Cons
There are several significant technical limitations that have been detailed in the recent Enzyme review, but we can sum up the principal findings as follows:
Meeting benchmarks with a limited asset universe: while surpassing dollar benchmarks proved feasible, consistently outperforming the major crypto benchmarks such as Ether (ETH) highlighted the crucial need for a much broader asset universe. Operating solely within a liquid-only market is already a significant challenge. However, the substantial barrier arises when desired tokens can only be included in the portfolio after they have been listed on major exchanges and weighted by Chainlink and other essential third-parties. This limitation not only impedes the timely integration of promising assets but also hampers the ability to invest early in emerging innovations.
A non-flexible, confined environment: the crypto landscape continues to evolve at a rapid pace, but the on-chain financial smart contracts remain static. This rigidity is partially by design, as these smart contracts undergo rigorous audits to ensure the security of assets. Additionally, the on-chain setup of a fund (known as vault) is confined within one single blockchain. For example, with Enzyme, users must choose between creating a vault on Ethereum or Polygon as interoperability between ecosystems is not yet feasible. Given the inherent insecurity of existing bridges, the decision of which blockchain to utilize during vault creation is paramount. Therefore, while several frictions known to the traditional financial world are alleviated with the on-chain setup, a new obstacle emerged: the inability to support new assets in a holistic, diversified portfolio that span across different blockchain ecosystems.
Navigating the complex legal landscape of different jurisdictions: Our attempt to operate an Enzyme vault as an open-ended fund in the U.S. presented insurmountable challenges, leading us to consider offshore setups as more viable alternatives for the time being. The on-chain onboarding process, for example, contradicts the appeal of conducting all operations on-chain seamlessly in one place, as the requirement to KYC procedures is not facilitated in any way by Enzyme. Consequently, if Enzyme were to serve as a new kind of “asset management administrator”, it would fail in its most basic function in many countries that require investment funds to identify and collect minimum investors’ data, and consolidate it with investors’ on-chain identities. To top it all, the U.S. specifically mandates investors to be accredited in most common structures. Given the stringent regulatory framework generally, there is no choice but to hire external administrators, and thereby diluting the allure of the autonomous on-chain functionalities we aspire to achieve - at least for the time being.
This chapter may be ending, but the insights and experiences gained pave the way for future innovations in on-chain asset management. As the industry evolves, we remain optimistic about what lies ahead.