As the nascent concept of decentralized finance (DeFi) gains traction in cryptocurrency trading — and draws more regulatory scrutiny — new players are creating products to meet rising demand.
Enter Galaxy Digital (GLXY.TO), which this week rolled out a DeFi Index Fund, their newest blockchain-based financial asset. The passive instrument tracks the performance of Bloomberg’s Galaxy DeFi Index, and is part of an estimated $80 billion industry that's poised for explosive growth in the coming years.
DeFi is not a new segment of the crypto space, but it has grown exponentially in the past year from $6.8 billion to $80 billion, according to data from DeFi Pulse.
Ben Samaroo, the CEO of a DeFi platform called WonderFi, explained to Yahoo Finance recently that the sector "presents a faster, cheaper way to do finance." He added that DeFi allows users to borrow money "instantly" without bank approval, or earn higher-than-average interest on assets.
Galaxy Digital's new fund is an attempt to offer clients a lower risk, and more regulatory-friendly way, to gain exposure to DeFi. The fund has been seeded by NZ Funds, a $2 billion institution that manages retirement savings accounts for New Zealanders.
NZ Funds is not a newcomer to investing in the crypto space. Previously, the retirement savings institution seeded Galaxy Digital’s Ethereum (ETH-USD) fund earlier this year. Before that, it took part in a $50 million private investment in Galaxy Digital Holdings’s public equity.
The Index is composed of 9 DeFi protocols in portions of 40 to 1 percent exposure. The protocols will be considered for addition and removal on a monthly basis.
While index funds aren’t intended to be actively managed, the removal or addition of DeFi protocols will rely on Bloomberg's principles for measuring an index such as data integrity, diversification, representation and continuity.
Growing scrutiny, and opportunities to profit
DeFi is a family of crypto assets and underlying protocols which together form a complex financial system that relies most heavily on the Ethereum blockchain. Like much of the crypto world, DeFi's key selling point is stripping out the middle man in trading, which cuts costs and red tape.
Using self-executing (or "smart") digital contracts, developers can build applications on top of Ethereum and other blockchains. They are then used to devise new ways to borrow, lend and exchange assets in faster and cheaper ways than traditional finance.
While these projects cut out traditional intermediaries in the financial sector via peer-to-peer networks, not all DeFi protocols may be decentralized enough to skirt regulation. Securities and Exchange Commission Chairman Gary Gensler said as much in an interview with the Wall Street Journal published this week, in which he suggested the agency would be taking a closer look at the sector.
Meanwhile, a widening range of big money players are now gawking at cryptocurrency and blockchain-based protocols, trying to understand whether crypto is supposed to fit in their portfolios. And for many traditional investors, taking the plunge requires some level of valuation.
Nick Juhle, director of research for wealth management firm Greenleaf Trust, faces this problem. With a total of $17 billion in assets under advisement, Greenleaf provides wealth management to approximately 1000 high-net worth individuals.
Since 2017, Juhle has received calls from clients every time Bitcoin's price surges, asking why the firm hasn't parked any cash in crypto. Yet Juhle still won't budge, because his team hasn't found a way to value it based on traditional valuation frameworks like cash flow and earnings results.
"The challenge with crypto, Bitcoin being the prime example, is that it doesn't really have intrinsic value. You can price it but you can't really value it. That's always the issue that we've run into," says Juhle. At this point, valuing the best DeFi protocols runs into the same issue for Juhle.
However, there is no unifying collective valuation framework for DeFi, according to Steve Kurz, Galaxy Digital’s Head of Asset Management. It's a clear barrier for more traditional retail and institutional investors with no crypto exposure, even if they are willing to accept the higher volatility synonymous with crypto.
Currently, the Galaxy Digital team uses “different strands” of metrics, such as the total value locked in protocols and other network usage statistics, to measure potential returns similar to how early stage venture capital performs valuation. Given time, the DeFi Index could provide one more strand for measurement.
“We are marching toward a collective valuation framework that's not quite ready for institutional primetime, but there’s enough to say as a venture [capital] bet, absolutely, DeFi can make sense in a portfolio,” Kurz told Yahoo Finance in an interview.
Juhle prefers the idea of an index fund that invests in the DeFi theme broadly, as opposed to "betting on a specific protocol." He also remains wary of the DeFi index's current correlation with the price of cryptocurrencies like Bitcoin (BTC-USD) and Ethereum.
"Perhaps it will diverge over time as the market matures," Juhle suggested.
David Hollerith is a Blockchain and cryptocurrency reporter for Yahoo Finance.
For more information about cryptocurrency, check out:
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Ethereum: What is it and how do you invest in it?
The top 21 crypto leaders to watch in the back half of 2021
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