Asset Allocation
Allocation Principle
The market-neutral strategy will not be affected by the price of digital assets. Therefore, assets will be allocated for:
Maximizing the expected APR
To create a compounding mechanism from asset allocation, the fund manager will calculate asset allocation to maximize the geometric return.
Risk conditions from digital assets
To mitigate concentration risk, there will be no asset allocated more than 50% of NAV
The fund manager will assess the eligibility score when allocating assets to mitigate risk from holding digital assets.
The fund manager will assess the subjective score when allocating assets to mitigate the risk of using qualitative data.
The fund managers can define the objective functions and constraints at their discretion based on the above conditions.
Reference Price Calculation
Reference pricing principle
Digital assets can be traded on different exchanges. Each exchange has different asset pricing and volume. Some exchanges have lower asset prices, but the liquidity is not enough for asset allocation. Therefore, the fund manager will have to diversify asset buying from different exchanges with different pricing.
To set a benchmark for further quantitative calculations in other steps, the fund manager will use a reference price as a median price from different price feeds below:
Coinmarketcap
Coingecko
Panckeswap
If any price feed cannot show the asset price, the fund manager will use price feeds from other available sources. This is a standard way for the fund since the reference price will be arbitrage-free pricing which is less volatile than referencing price from only one price feed.
This method is also used by the data oracle on DeFi when it imports data into the digital system, which can mitigate some technical risks, such as the data source being attacked, the exchanges close temporarily or permanently. In addition, referencing price from different data sources allow the fund to do further calculations even if some price feeds experience problems and cannot feed their prices close enough to the median price.
Impact and Warning for Investors
Defining the reference price based on median price from different data sources may affect the investors differently. For example, the calculation results based on the reference asset price, such as NAV per unit, might be different from the price used for trading, resulting from slippage. The difference between the reference price and trading price can affect the investors positively or negatively, and the slippage will depend on the market arbitrage mechanism. Practically, the price difference is minimal for digital assets with high market capitalization.
Treatments of Network and Protocol Distributions
Hard Fork
A hard fork is a change in protocol or policy of the blockchain that permanently splits blockchain into two chains. At the split point, there will be two similar accounts and transactions. Regardless of which chains the asset holders choose, the asset holders still have the right to hold digital assets resulting from this splitting chain. However, after a separation, the assets and transactions will be separated permanently between these two chains.
Currently, global computing systems are driving blockchains. The hard forking process will require cooperation from global computing systems, making the process a lot harder to achieve. Additionally, there are various DeFi protocols fulfilling transactions across blockchains. Therefore, hard forking to change a policy will require mutual agreement from different participants. It also needs to prepare software for the new blockchain and announce the hard fork event. This is a unique characteristic of decentralized technology.
When the fund managers have been informed about the hard fork event, they will perform some evaluation to see which assets will be affected and reconsider asset eligibility as follows:
Suppose the digital asset will not be affected by the hard fork event and still pass the asset eligibility assessment. In that case, the asset will be kept within the scope of asset allocation.
If the digital asset might be affected by the hard fork event, the asset will be removed temporarily from the current investment and sold according to new asset allocation. After the hard fork event and the fund manager receiving all necessary information, the fund manager can consider bringing this digital asset back to the investment.
Emissions, Airdrops, Staking Rewards
Emission is the process of giving away digital assets regularly when an additional block is created. The purpose of this is to reward people who help to support the blockchain or DeFi protocol.
Airdrop is the process of giving away digital assets to some specific events to promote the project. An example of conditions for the event participation is that the participants who receive airdrop have to hold the digital assets for a specified period.
Staking reward is the process of giving away digital assets to people who stake digital assets in the blockchain or DeFi protocol. The purpose of staking reward is to incentivize holding the assets to drive the blockchain or support DeFi protocol functioning.
The digital accounts can receive any protocol-supported asset from the third party without the account owner's authorization in the same way as regular bank transfers.
Receiving digital assets within an investment strategy. In this case, the receiving digital assets will be allocated according to the investment strategy and used in NAV and NAV per unit calculation.
Receiving digital assets, not in the investment strategy. In this case, the receiving assets will not be used in NAV and NAV per unit calculation because the digital assets work according to the smart contract. However, treating digital assets, not in the investment strategy, such as taking profit, transferring out to other accounts, can grant some operating permissions to the smart contract, which might be a scam. In addition, this permission can be vulnerable and may lead to security attacks in the future.
Asset Rebalance
Asset Rebalance Criteria
As risky assets usually have high growth and volatility, it is necessary to closely monitor and rebalance assets throughout the investment period to achieve the investment goal. Therefore, monitoring and rebalancing criteria will be an essential part of the investment strategy and ensure that the transaction costs are appropriate.
However, an exceptional case will be explained in the asset management principle in case the asset fails the eligibility. In this case, the fund manager can rebalance investments with their discretion immediately.
Trading Order and Exchange
When it’s necessary to perform asset rebalance, the fund manager will request the system to rebalance the assets according to the asset allocation. Then, the system will execute the order based on the smart contract through DEX aggregators.
Decentralized Exchanges and DEX Aggregators
Decentralized exchanges (DEX) is a digital asset exchange without an intermediary. Traders can exchange digital assets immediately using smart contracts without transferring their digital assets to digital wallets or wallets in the exchange. Additionally, transactions executing on decentralized exchanges are atomic transactions that exchange digital assets within a single blockchain block. This can mitigate counterparty risk and other transaction risks. Therefore, the principal risks of trading on decentralized exchanges are liquidity risk and smart contract risk.
In DeFi, there is another type of exchange service provider called DEX aggregator who acts as an exchange intermediary. Trading orders that the DEX aggregator receives will be distributed to various decentralized exchanges appropriately to have the best overall exchange rate. Utilizing DEX aggregators is similar to open bidding for liquidity from different exchanges. This method can help mitigating liquidity risk based on the number and liquidity of decentralized exchanges that DEX aggregators have been partnered with, which tends to increase continuously in the future. Additionally, DEX aggregators have to assess the technical eligibility of decentralized exchanges, which can help mitigating smart contract risk.
Since trading through DEX aggregators is a low-risk option, the fund will use DEX aggregators to mitigate counterparty risk as follows:
Trading volume and frequency limitation
If it meets the rebalance criteria, the system will not limit the volume or frequency of placing orders to rebalance assets.
High volume or high frequency of placing orders can cause problems regarding liquidity and exchange rate. This situation can occur when the investors deposit or withdraw their funds in high amounts, and the fund manager has to rebalance the assets. It can also happen during some emergencies, such as market crashing. Under this situation, suspending or delaying order placing can cause a delay in depositing or withdrawing the investors’ fund, which does not match the objectives of investing in DeFi.
Additionally, since the fund holds all of its assets as USD-pegged stablecoin, order placing with high volume or frequency will be less affected by the exchange rate.
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