As decentralized finance (DeFi) evolves, institutional asset management has become a critical market subset. However, those looking to incorporate DeFi into their asset management strategy still face many challenges, namely the number of providers coming together to deliver blockchain-based investments at an institutional level. In this article, we’ll break down each provider category, highlight some of the complexities of this undertaking, and outline how Alloy streamlines the process from end to end.
In DeFi asset management, custodians play a vital role in ensuring the safety of assets. And while certain players may opt for self-custody to lower costs and avoid third-party involvement, some regulatory bodies like the U.S. Securities and Exchange Commission (SEC) require approved custodians when a firm’s assets under management (AUM) exceed $150 million. In addition to this, the segregation of duties between the asset manager and safeguarding entity (i.e. asset custodian) is a key concept in asset management irrespective of the asset class. For large institutional investors, digital asset custodians add a layer of security when managing DeFi portfolios. Specifically, assuming responsibility for the ownership of funds (or the private keys to them respectively) while providing critical services like record keeping, and other back-end operations. This dynamic helps protect assets from theft, loss, or unauthorized access.
In addition to storing private keys and approving or signing transactions, certain custodians also provide execution services across liquidity venues, so that fund managers receive the best market prices across platforms without holding accounts with each one of them—more on these brokerage services below.
Regardless of the asset class, brokers are critical to facilitating institutional investor access to liquidity and leverage in some cases. Like their TradFi equivalent, brokers allow investors to execute trades through one entity connected to multiple venues (i.e. exchanges or market makers) — instead of requiring the investor to interact with each venue themselves. In the case of prime brokers, investors can also trade with leverage. In addition to these benefits, prime brokers offer additional services such as execution advice, market research, custodial services of the assets, and white-glove customer support. By leveraging these services, institutional investors can make more informed decisions and access larger markets faster. However, these investors need to be aware that using a broker carries counterparty risk, especially until a trade is settled.
Digital Asset Exchanges
Centralized exchanges (CEXs) and decentralized exchanges (DEXs) facilitate digital asset trading. The difference is that CEXs take custody of investor funds, while DEXs do not. For institutional investors, DEXs have changed the landscape of DeFi asset management, providing a more secure and trustless environment for asset swaps. While DEXs may offer access to a wider range of trading pairs, CEXs can offer deeper liquidity in some cases, making them more attractive for large trades. However, this advantage should be evaluated against the counterparty risk they carry.
Compared to DEXs, CEXs can also be easier to use, making them suitable for those not yet comfortable with the complexities of DEXs. Overall, DEXs and CEXs have advantages and disadvantages regarding DeFi asset management, meaning institutional investors must evaluate their risk-reward profiles before deciding which is best.
Wallets are critical infrastructure in the realm of institutional asset management in DeFi. Like a traditional bank account holds fiat currency, wallets facilitate holding a range of digital assets. In addition, wallets facilitate connectivity to DeFi protocols (and many other crypto-related services). It’s important to note that wallet providers are different from custodians in that they provide investors with the infrastructure to safeguard their assets on. While some wallets are stored directly on exchange or custody platforms (custodial), others are non-custodial, meaning investors maintain control of their private keys — effectively serving as your own bank. Further still, hardware wallets allow investors to hold digital assets offline in cold storage, enhancing security against cyber attacks.
Institutional custodians often keep a portion of digital assets liquid while holding the vast majority in cold storage to ensure they aren't vulnerable to hacks. This approach ensures investors are better protected from bad actors while allowing easy investment access. As DeFi asset management grows in popularity, trusted wallet providers will likely become increasingly important for providing secure storage and allowing users to move digital assets efficiently to interact with DeFi.
Asset Operations Providers
In addition to wallet providers, asset operations providers also fulfill a critical role in DeFi asset management. These providers can be considered additional infrastructure and business logic on top of wallets and custody accounts. Specifically, they allow institutional investors to orchestrate digital asset storage, asset transfers, tracking, and compliance processes. In addition, asset operators provide secure, automated access to digital asset markets, enabling high-volume transfers. These services provide a high level of assurance for large institutional investors managing sophisticated digital asset infrastructure in line with corporate processes and compliance.
Know Your Customer (KYC) and Anti-Money Laundering (AML) Service Providers
Although custodians and brokers usually complete their Know Your Customer (KYC) and Anti Money Laundering (AML) processes internally, specialized providers remain essential to the DeFi asset management ecosystem. These providers allow institutional investors to meet regulatory requirements when investing in DeFi protocols, offering KYC and AML checks and reviews that verify the identity and background of investors while maintaining compliance with local regulations. They can also provide insight into investment risks and help protect against money laundering schemes. Finally, in the wake of Travel Rule regulations, several providers have emerged that specialize in exchanging KYC information, helping to identify counterparties according to regulations. Simply put, institutional investors must have trusted KYC and AML providers in place to confidently invest across the DeFi ecosystem. Importantly, these providers offer services that assist institutions in fulfilling their KYC and AML obligations. However, legal liability cannot be imposed on the service provider.
DeFi asset management at an institutional scale requires robust tools for portfolio analysis, trading, and risk assessment. Fortunately, several tools have emerged in recent years to address specific functional needs across these areas. Specifically, asset management tool providers offer a variety of solutions to support access to real-time market data, risk management capabilities, trading algorithms, and portfolio management features. While these tools are useful in isolation, one challenge faced by large-scale institutional investors is to select and manage a combination of platforms. Notably, seamless data integration and interaction between tools can be challenging to achieve, especially if this functionality needs to be integrated with existing institutional systems.
Data providers are integral to the DeFi asset management landscape, providing institutional investors with critical pricing and market data for analysis and reporting purposes. These data providers specialize in streaming data for portfolio analysis, valuation, risk assessment, and reporting on the performance of DeFi protocols. By aggregating and analyzing key data points from DeFi protocols, providers can help institutional investors identify trends, assess risks, find arbitrage opportunities, and optimize their strategies. Data providers can also help institutional investors make informed decisions on where to allocate their capital by providing them with up-to-date market insights. By leveraging data from DeFi protocols, providers offer valuable insights into the ever-evolving DeFi ecosystem, helping institutional investors navigate the DeFi reliably.
Compliance and Reporting
For institutional investors, compliance and reporting are critical components of the DeFi asset management process. For example, auditors must ensure that all DeFi transactions are conducted per local laws and regulations. At the same time, research providers can help identify and monitor any risks associated with DeFi investments. In addition, tax reporting providers can offer the guidance necessary to ensure that an investor's DeFi activities are captured, categorized, and reported correctly to ensure compliance with local tax laws. To summarize, institutional investors must clearly understand the compliance and reporting requirements associated with DeFi asset management, reducing risk and ensuring all assets are appropriately managed.
The Alloy Advantage
At Alloy, simplifying digital asset management is at the core of what we do. This is deeply ingrained in the way the platform functions. We combine proprietary technology with integrations to various providers in one platform, thereby making it easy for investors to access the digital asset class. Investors no longer need to worry about managing multiple connections to counterparties or juggling different tools. Instead, they can rely on Alloy's streamlined approach to connect to various providers and enjoy institutional asset management functionalities within one platform. From investment strategy research to portfolio analysis and construction, execution, and post-execution processes, Alloy offers a fully integrated solution. This means you can manage the entire DeFi investment process within one tool. With Alloy, institutional investors can safely and confidently navigate DeFi, knowing the platform ensures they have all the infrastructure, tools, and functionalities they require.