Crypto for Advisors: On-Chain Investment Tools and Vehicles

As we covered in last week’s newsletter, the advancements of Web3 are driving innovation across almost every industry, and TradFi is no exception. It’s forecasted that an increasing number of investment products will be created and traded on-chain and in tokenized format. How do these products work, and where is the industry in this evolution?

The ways investors can participate in digital assets are evolving. Today, Jordan Tonani from Index Coop explains on-chain index products, how they work, and the investment exposure they provide to decentralized finance (DeFi).

Mike Cavanaugh from Regiment shares insights on the industry in our Ask an Expert section.

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Will Diversified Indexes Gain Traction On-chain?

For the last 50 years, index products have been the primary way most people gain exposure to diversified baskets of assets. In Europe, 20% of managed assets are held in passive strategies, about half in exchange-traded products and half in index funds. Since 2015, passively-held assets under management have doubled, with around one-fifth of European retail investors holding such products.

Although most have yet to be made aware, index products exist on-chain as well We have been building such products since 2020, along with yield-earning, leverage and strategy tokens. We use the term “on-chain structured products” to refer to these types of tokens and we think they have a promising future.

For advisors and their clients, on-chain products offer simple, diversified, accessible exposure to some of the most important themes in digital assets. For now, many of these themes (like DeFi, the Metaverse, crypto, or liquid staking) are not widely available off-chain. Furthermore, these products are available to previously underserved constituencies globally (except in jurisdictions that impose restrictions on such products). And while it is sometimes possible for users to replicate the basic strategies of our tokens independently, doing so would mean numerous transactions, associated transaction fees and sometimes burdensome tax reporting requirements depending on where they live. With index tokens and on-chain structured products, users gain access to the most significant assets in a given theme with one purchase of one token. Users can redeem the index token with the underlying constituents at any time, and like most digital assets, index tokens can be traded permissionlessly 24/7.

Already these products have proved popular with a small segment of digital asset users. At the height of the 2021 bull market, our on-chain structured products captured over $550 million in total value locked (TVL).

While the current bear market has slowed the growth of this sector, recent upticks in digital assets prices and changes in the DeFi and TradFi landscape signal that momentum is returning to our space. The U.S. appears to be on the precipice of approving BlackRock’s spot bitcoin ETF and Grayscale’s spot Ether ETFs which we think will stimulate demand and drive increased awareness of the value of digital assets and the importance of accessible instruments for users. That said, we think on-chain indices will be the more attractive proposition for a global, on-chain user-base because of increased transparency, enhanced security, global accessibility, automation, composability and liquidity.

Overall, we’re profoundly bullish on the potential of on-chain diversified indexes. This nascent sector is currently small, making up just .07% of the overall crypto market, but has the opportunity to grow quickly over the coming years. For advisors, familiarity with the growing options in this category will be critical in coming years as more and more people seek access to digital assets. The Index Coop annual state of the on-chain structured product market white paper provides more information on this space.

Ask an Expert

Q. If a spot bitcoin ETF is approved by the SEC, what are the implications for other popular cryptocurrencies?

I think there will be interest in ETH, but I don’t see a scenario where there is a rush to launch ETF’s around everything. The expense to create an ETF is a large enough moat to deter most from entering the ETF market.

Q. The broader crypto market has witnessed a sharp rebound over the past couple months. Do you perceive this as a broader warming sentiment about crypto, or that it’s mostly driven by anticipation of a spot bitcoin ETF approval?

I do believe the buying interest is being developed by the warming sentiment around the BTC ETF; the interesting part is the HODLers – the people that have been long on BTC and remain long on BTC. They are not the natural sellers here, they continue to hold and selling scarcity with demand on the bid is causing considerable upticks into the daily market.

Q. Besides payments, what are some other use cases for cryptocurrencies that have captured your attention?

The tokenization of real assets is a major headline right now. We are seeing a lot of projects that are using blockchain technology to enable smoother transactions across many industries. Without getting into the specifics of the chain or specific projects (I’ll save the shameless shilling…) we have noticed that real world problems are being solved by the tokenization of assets. Commercial real estate, supply chain logistics, ISP providers, data-governance in social media, HELOC origination … .the problems that exist in these areas are being solved rapidly by blockchain based projects, and it’s a great time to be alive.

– Mike Cavanaugh, Regiment, LLC

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