DeFi Fund: What is the return on investing in 10 DeFi protocols?
With 2020, a new decade has started. A decade, that we believe will also bring new advancements in the field of blockchain-based finance. Instead of just hypothetically writing about decentralized Finance (DeFi), we made a small investment of 1000€ into ten carefully selected DeFi protocols on the 1st of January 2020. Think about it as a lazy-man’s educational DeFi fund. No trading. No selling. We will track the performance throughout the year and write regular reports about the fund and do deep dives into the DeFi protocols. — Authors: Victor von Wachter, Maximilian Feldmeier, Philipp Sandner
- The DeFi fund incorporates 3 lending instruments, 3 utility tokens and 4 derivatives/exotic tokens
- All DeFi protocols invested are Ethereum smart contracts. The projects have been selected by degree of decentralization, transparency, true non-custodianship, user adoption, media popularity, innovation
- Setting up took only 2 hours applying MetaMask as a popular wallet
- After two weeks the fund significantly outperforms traditional asset classes
What is the benefit of investing in DeFi?
2019 saw the rise of a flashy newcomer within the blockchain narrative: DeFi. Broadly speaking, DeFi is an ambitious attempt to decentralize core traditional financial use cases like trading, lending, investing, wealth management, payment and insurance on the blockchain. Simply speaking, DeFi can be described as a set of interconnected smart contracts. DeFi protocols are financial instruments like LEGO bricks which can be plugged together. Utilizing the Ethereum blockchain as the core infrastructure, DeFi is based on decentralized Applications (dApps) or protocols. As with LEGO bricks, every dApp can be uniquely combined creating a peer-to-peer, open-source financial network.
The projected benefits of DeFi are true decentralization, censorship resistance, worldwide participation regardless of social status while dispensing with trusted (and expensive) third-parties. Yet, DeFi is experimental and technically complex. In order to explain DeFi as simply as possible, we invested an equal amount of money into ten DeFi projects on the 1st of January 2020.
Think of it as a lazy-man’s DeFi fund for educational purposes. Buy and hold only. No trading. No rebalancing. This keeps things as simple, objective and tangible as possible. In regular updates we will report about the performance of the DeFi fund and showcase the projects in more depth. We want to show at the start of the decade what is already possible and share our excitement for what the future will bring. Furthermore, we want to document the experience of using the DeFi platforms, the risks involved, investments’ volatility, the funds’ returns and the comparison with traditional benchmarks such as gold.
The rules for our DeFi fund
We specified the following rules for our DeFi fund
- Investment volume: just 100 € to be invested into 10 different DeFi protocols to generate passive income.
- Starting date: 1st January of 2020.
- Investment criteria: It has to be an open platform, precisely: Non-custodial (i.e., full control of the funds), advanced decentralization (i.e., protocol is making significant effort to decentralize), accessible by anyone (i.e., no KYC/onboarding), high transparency (i.e., open-source code).
- Minimum market capitalization: 1 million € to have a certain level of user adoption
- Protocol variants: If there are multiple options within a protocol to choose from, we will go with either the most popular, or the one with the highest returns.
- Low maintenance: The project should require no remaining actions or minimal additional actions after making the initial investment. In doing a naive investment strategy, our educational DeFi fund is therefore for crypto beginners and experts alike.
- Important condition: The projects should be innovative and fun.
- Benchmark: Comparison of the performance against a variety of benchmarks.
Applying these criteria, we screened dozens of DeFi financial instruments of which we selected the following ones: Compound, Fulcrum Lend, Fulcrum Trade via DeFiZap, Kyber Token, Maker Token, Maker with Oasis Save, Synthetix Token, Synthetix Trade, TokenSet, Uniswap via DeFiZap. More details can be seen in Table 1.
Step 1: Funding the fund and investing in DeFi financial instruments
We started end of 2019. Supported by many dApps, we opened a MetaMask wallet and moved 10 ETH into this wallet.On New Year’s Day, after having a strong coffee, we started by opening a Chrome browser with a MetaMask extension. From that moment, it took roughly two hours to execute all transactions. For some protocols, the setup literally took one click (e.g. Uniswap, DeFiZaps), whereas others were more complex (e.g. TokenSet). Nevertheless, that’s not more than 15 minutes per dApp. Also we never (!) had to provide any personal information like name, email, credit card, or identity card — all dApps connected simply to our MetaMask wallet. This fascinated us! During the entire process we conducted 19 transactions with transactions costs of 0.012 ETH or 1.47 € in gas fees.
The transaction record can be inspected here. Thus, the cost per transaction were only a few cents, due in part to dApps currently charging no fees as a margin for their services. One exception was Uniswap: It charged a service fee, that is subsequently allocated to the liquidity providers of the exchange. The speed, ease of setup and low costs experienced in the creation of our fund is simply not possible in traditional finance. Of course, we acknowledge that DeFi is in an early stage and that IT security issues might occur due to poor smart contract audits.
Step 2: Monitoring the investments
After the initial transactions, we set up monitoring for the investments. Generally the educational fund can be seen and tracked transparently on the blockchain. See the following link to our Ethereum wallet for all our transactions.
More on Etherscan: https://etherscan.io/address/defi2020.eth
For data enthusiasts and potentially future research, we set up a script to track all relevant data automatically on a daily basis. To make this even easier, we tested aggregating platforms, that provide an interface for tracking DeFi investments in one convenient place (e.g. InstaDapp, DeFi Watch, mydefi.org, Zerion). At this point in time, there are only a handful of them. Zerion did a good job of showing the transactions and providing an overview of DeFi investments, but does not yet account for all protocols.
See more here: https://app.zerion.io/defi2020.eth/overview
Risks are still very high
Therefore, a clear warning: DeFi still remains a risky business. The market’s volatility is significant, the protocols potentially include tech vulnerabilities with limited possibilities for insurance, and the protocols’ development as well as the price feeds (i.e. oracles) are still often centralized. The drawbacks are a result of a still immature industry and could be more openly stated in disclaimers, but on the positive side it is an important topic already being worked on.
From our side, before setting up the fund, we already had a basic understanding of the protocols being invested in. It is safe to assume that without this knowledge it would have taken longer to invest. Admittedly, people interested in DeFi also have to have a profound tech and Ethereum understanding.
But instead of DeFi, why not invest in simple government bonds?
In order to compare the performance of the DeFi protocols, we also track the performance of benchmark investments starting on the same date. The benchmarks are covering a variety of traditional investments and can be found in every newspaper (see Table 2). It is important to note that performance should generally always be considered with the risk taken. The reason is simple: Higher risk corresponds to a higher return.
As can be seen in Figure 3, our DeFi fund performs better compared to bonds. However, it apparently performs worse in comparison to Bitcoin and Ethereum. But as Figure 3 also shows the volatility of our DeFi fund seems to be lower. It might be possible that the risk-adjusted return (e.g. as it would be measured by the Sharpe ratio) might have excellent metrics with regard to our DeFi fund. To keep it simple, we defer the exact computation of these metrics to future articles.
In setting up a DeFi fund, we want to share insights into innovation, user experience and performance of the DeFi ecosystem. The fund itself is a hands-on, lazy man’s educational fund without complex rebalancing and daytrading. Furthermore, the performance of 1000€ invested on the 1st of January 2020 is easy to follow and reduces overall complexity. The investment into the 10 protocols can be followed publicly on analysis tools like Etherscan.
Finding protocols meeting our selection criteria, e.g. advanced decentralization, was not trivial, highlighting that DeFi is still a comparably nascent and experimental field. Every protocol initially invested in, follows an innovative idea, proving that the vision and speed of development is compelling. We will publish on an ongoing basis further articles analysing the funds’ performance, the DeFi ecosystem and provide deep-dives into each of our DeFi protocols. Let’s get started with Defi 2020. If you want to know more about our project, please write us. We will reply!
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Do you want to learn more about how blockchain will change our world?
- Blockchain knowledge: We wrote a Medium article on how to acquire the necessary blockchain knowledge within a workload of 10 working days.
- Our two blockchain books: We have edited two books on how blockchain will change our society (Amazon link) in general and the everything related to finance (Amazon link) in particular. Both books are available in print and for Kindle — currently in German and soon in English. The authors have been more than 20 well-known blockchain experts in startups, corporations and the government from Germany, Austria, Switzerland and Liechtenstein — all contributing their expertise to these two books.
Victor von Wachter is product manager and blockchain engineer at the Swiss-based Smart Valor Digital Asset Exchange. His fields of interest are primarily blockchain protocols, Staking, STOs, and DeFi at the interface between business, technology and data. His research at the Technical University Munich contributed to the development of the ERC1400 and ERC1410 Security Token Standard. You can reach him via email (email@example.com) or via LinkedIn (https://www.linkedin.com/in/victor-von-wachter).
Maximilian Feldmeier is a Corporate Finance Manager at a German based startup. Through his passion for finance, digitalization, and disruptive technologies he became a DeFi enthusiast. You can contact him via mail (firstname.lastname@example.org), or via LinkedIn (https://www.linkedin.com/in/maximilianfeldmeier/).
Prof. Dr. Philipp Sandner has founded the Frankfurt School Blockchain Center (FSBC). From 2018 to 2021, he was ranked among the “top 30” economists by the Frankfurter Allgemeine Zeitung (FAZ), a major newspaper in Germany. He has been a member of the FinTech Council and the Digital Finance Forum of the Federal Ministry of Finance in Germany. He is also on the Board of Directors of FiveT Fintech Fund, 21e6 Capital and Blockchain Founders Group — companies active in venture capital financing for blockchain startups and crypto asset investment management. The expertise of Prof. Sandner includes crypto assets such as Bitcoin and Ethereum, decentralized finance (DeFi), the digital euro, tokenization of assets, and digital identity. You can contact him via mail (email@example.com) via LinkedIn or follow him on Twitter (@philippsandner).