A New Generation of dHEDGE Funds

The following report was written by Messari Hub Analyst(s) and commissioned by the dHEDGE, a member ofMessari Hub. For additional information, please see the disclaimers following the article

The traditional asset management business today manages over $100T in client assets. In charge of all that capital are investment managers, the people sitting atop the skylines of major financial hubs. And though fund managers are rewarded lavishly, it’s a notoriously difficult field to break into: One typically needs an Ivy League background, a strong network, and a deep rolodex of current and potential clients — prerequisites unattainable for the majority of the world’s population, regardless of actual investment skill or competency.

Enter the blockchain, a technology designed for trustless activity. In theory, the blockchain is uniquely suited to tackle the challenges above. There’s investor anonymization, so investors are judged purely on their results or merit without qualifying factors like family, race, or gender; there’s performance transparency, meaning investment returns are easily evaluated without risk of fraud; and there’s asset composability, which allows clients to retain assets ownership even as fund managers decide where to allocate capital.

Want to be a dHEDGE Fund Manager?

dHEDGE, a decentralized platform for fund managers, removes the barriers to active fund management. The project lets individuals establish funds on a peer-to-peer basis while maintaining a compensation structure beneficial for all parties. Utilizing smart contract technology, dHEDGE allows managers to create non-custodial pools where investors can allocate capital without giving up direct custody to the manager.

In essence the fund manager controls the investment of funds without having direct access to investor capital, eliminating the risk of theft on the part of the manager. Fund managers can be any party, be it an individual, team, or a programmed investment strategy.

The first iteration of dHEDGE began as a platform built via integration with Synthetix Protocol, allowing for zero-slippage trades via synthetic assets. Fund managers could direct client capital to a plethora of Ethereum-based assets similar to an investment manager would with stocks, bonds or other securities. Unfortunately, with the run up of transaction costs on the Ethereum network, this has become unusable for most. As a result, the recent launch of dHEDGE V2, using re-engineered smart contracts, introduced multi-chain asset management starting with support for Polygon. These new smart contracts enable easy EVM chain deployment, allowing the protocol to easily whitelist new protocols or assets for integration. dHEDGE plans to continue to add additional chains to the platform in support of the platform's goal of trading any asset, anywhere.

Navigating Around dHEDGE Pools

Pools are the smart contracts where clients can deposit funds for dHEDGE managers to invest. Ownership never changes hands as the assets are locked and stored within the smart contract. In addition to security, this model also allows for ease of liquidity as funds do not require lockup periods. Investors can deposit and remove assets at any time without the discretion of the fund manager or dHEDGE.

When establishing a pool, managers create both a fund name and a corresponding token, the latter of which gets distributed out to investors when funds are added into the pool. These tokens represent a pro rata share of the investor's portion of total assets in the pool. Pricing of each token is based on the Net Asset Value (NAV) of the pool’s assets divided by the total number of fund tokens. Fund tokens are redeemable for their share of the pool’s assets, however, future updates will allow for single-asset withdrawals.

This token mechanism can be illustrated with an example. Let’s pretend a $100,000 fund mints its Fund A token at $1 with a maximum supply of 100K tokens. Now assume the manager’s investment strategy pays off and the fund’s NAV is worth $175,000 at some point the following year. At this valuation, the Fund A tokens would now be worth $1.75 each. Investors are then able to redeem their tokens for a pro rata share of the fund’s underlying assets. Notably, dHEDGE plans to offer investor’s the ability to redeem fund tokens for a single asset such as USDC or ETH rather than just their invested share of the fund’s portfolio.

Just as with TradFi, strong performance can be lucrative for top investors. High-performing managers are eligible for performance fees when their fund value overtakes the previous high-water mark value. This benchmark is set each time a fund surpasses its prior peak value, ensuring managers don’t earn fees for poor performance. When the fund does overtake its high-water mark, fees are minted by the manager as new tokens in the fund. Thus, astute observers might note fund managers grow their percent ownership of the fund as performance continues to rise; meanwhile, investors face slight dilution offset by larger investment gains. This also helps managers to — for lack of a better phrase — “put their money where their mouth is.”

Aside from performance fees, dHEDGE runs a liquidity mining program designed to encourage use of the protocol, drive staking towards active pools, and reward high-achieving managers. All investors can earn these rewards if they stake their assets with an eligible fund. Pools must meet four criteria requirements to qualify:

1. The pool must achieve a positive Sortino Ratio — meaning return on investment is above a particular risk-adjusted metric
2. The pool must be active for longer than four weeks, demonstrating some resemblance of an investment track record
3. The pool must be public and open to any participant in the dHEDGE ecosystem
4. The pool must have a minimum 20% yearly return

dHEDGE Scoring

To measure performance across the platform, dHEDGE utilizes a proprietary scoring system. Fund managers are evaluated on their risk-adjusted ability to generate alpha on behalf of their investors.

Manager Score = Sortino Ratio x sqrt(7-day Avg NAV)

dHEDGE’s manager score utilizes the Sortino Ratio, a financial metric used to measure risk-adjusted return calculated by dividing the ROI of a fund by the downside deviation. In summary, the ratio describes the manager’s performance relative to the risk taken. To qualify for a score, manager’s must have at least 4-weeks of performance data. The top 10 managers on dHEDGE’s overall leaderboard have scores of between 1,500 and 4,500 with the top three outperforming the average of the greater 10 as seen below.

While dHEDGE’s manager score measures the risk-adjusted return of a fund manager, the most popular pools by AUM often choose less efficient strategies. On the Ethereum platform, dHEDGE’s own Top Index fund is only $20K shy of being the largest pool on the platform while ranking 7th on the leaderboards by manager score. In fact, pools created and maintained by dHEDGE consistently draw the most assets on the platform even if they don’t always produce the best returns for the amount of downside risk. This disconnect likely highlights a continued lack of trust in anonymous fund managers regardless of their ability to generate returns.

dHEDGE hosts pools on both the Ethereum and Polygon networks with each offering a slightly different set of assets and strategies to choose from. As mentioned prior, trading on Ethereum is propagated through synthetic assets in conjunction with Synthetix Protocol. Polygon pools, meanwhile, are facilitated through five core protocols: SushiSwap, Quickswap, Balancer, 1inch, and Aave. And unlike Ethereum-based funds, which limit pools to 5 assets, Polygon pools can hold up to 10 assets. Both may seem like limitations, but it’s worth remembering the vast majority of pools on either blockchain hold fewer than three tokens at any time.

DHT Tokenomics:

Aside from fund pool tokens, dHEDGE has a native token named DHT, which is primarily used for governance of the project and Uberpool, the project’s treasury. First distributed in September 2020, 7% of total supply was sold through an auction on the Mesa DEX. The token’s current total supply sits at 100M. However, DHT holders do have the ability to adjust max supply if they so choose. The token distribution, shown below, was relatively fair with only ~18% of total supply going to private investors and partners and ~19% going to the core team, both with three-year vesting periods. Interestingly, more than 50% of total supply hasn’t been designated. Future use cases for the unallocated supply could go towards future strategic partnership, capital raises, or other initiatives aimed at growing the platform’s users and AUM.

dHEDGE DAO and Protocol Treasury

The organization launching into new blockchains is the dHEDGE DAO, governed by DHT stakers. Like many other DAOs, dHEDGE manages an internal protocol treasury. dHEDGE’s treasury is funded by a portion of manager performance fees, currently sitting at 10%. As of November 18th, the treasury had collected approximately ~$3.32M in manager fees.

To stake DHT, users must first select a time lock period between 1 month and 3 years. DHT is then exchanged one-to-one with vDHT, which burns after 1 month (i.e. 1 vDHT = 1 month locked). For longer lock up periods, stakers are rewarded additional vDHT in order to increase the voting power of their staked DHT.

Owners of vDHT are eligible for three types of rewards:

1. Traditional staking rewards (25K DHT per week)
2. Performance mining (5K DHT per day)
3. Platform dividends

As mentioned earlier, dHEDGE collects 10% of all manager performance fees for the protocol treasury. Each quarter, 10% of those assets in the treasury are either reinvested into dTOP or distributed to stakers in the form of a protocol dividend. This decision to reinvest or distribute lies at the hand of vDHT holders. The most recent Quarterly Distribution Vote ended on October 9th with ~81% voting to distribute half and reinvest the other half. If dividends are decided upon, as was the case with the recent vote, then they are “paid” out via DHT repurchases, meaning roughly $142K designated for distributions will be used to repurchase 131,365 DHT. This method rewards stakers without diluting DHT holders overall.

dHEDGE is a relatively unique project in the decentralized asset management industry. Though some competitors exist, there are not many. Let’s take a look at two categories.

• Broader decentralized asset management
• On-chain active asset management

Broader decentralized asset management would include many of the protocols investors use on a routine basis, names such as Curve, Compound, and Yearn.Finance. These platforms offer decentralized lending pools, yield optimization, and asset aggregation, respectively. While not direct competitors, projects like these offer a disaggregated version of the services provided by dHEDGE and can be looked at as individual parts that sum up to dHEDGE.

The few other, on-chain, active asset management projects are more similar to dHEDGE. Within this subsector, dHEDGE has two primary competitors: Enzyme Finance and Set Protocol.

The first is Enzyme Finance, previously known as Melon Finance (MLN). Enzyme is built on Ethereum and offers active, on-chain asset management similar to dHEDGE. The platform manages over $146M of non-custodial assets across 919 pools and 2,344 identifiable investors. Managers can choose from over 200 ERC-20 tokens for their portfolios and can participate in yield farming, staking, and liquidity provisioning. A notable difference rests between the native tokens of the two projects. MLN provides utility when using the platform; MLN can be used to pay fees and establish funds as well as trade and denote the value of investment pools, but trading is restricted to Ethereum without support for other L1 or L2 networks.

The second competitor is Set Protocol, another protocol active on Ethereum and Polygon. Set Protocols allows for the bundling for crypto assets into a basket represented as ERC-20 tokens, a premise similar to the securitization of traditional assets commonly found on Wall Street. Managers in charge of each basket become effectively asset managers who maintain the performance of the product. Just as with dHEDGE and Enzyme, investors can choose to allocate capital with the manager in exchange for the tokenized basket of assets. In some sense, Set Protocol offers broader use cases as it can help build structured products, such as Index Co-Op’s various crypto-based indices, as well as for social trading, such as active fund management. The tradeoffs compared to dHEDGE, however, include limitations on asset classes (no synthetic asset system) and the inability to short assets in the token basket.

Roadmap:

So what is next for dHEDGE?

To fuel the next stage of growth, dHEDGE conducted a “treasury diversification” event in October raising $2M in treasury funding led by Synthetix with participation from 0xVentures, Mask Network, Ellipti, Meld Ventures, and others. The funds are expected to be used for additional protocol integration projects, product development, and tech and marketing spend. Notable developments set for implementation include a single-asset withdrawal feature and the introduction of non-performance based management fees. Both proposals passed with 100% community support.

The project roadmap includes the continued evolution of dHEDGE V2 and their multi-chain asset management strategy. The introduction of Polygon was the first step towards interoperability. The protocol recently went live last week on Optimism and the dHEDGE team plans to continue additional chain integrations to give investors alike the ability to gain exposure to all that crypto has to offer on a single platform.

While a crypto-native firm is expected to begin with crypto assets, dHEDGE V2’s motto of “any asset, anywhere” begs the question around whether or not the platform looks to offer access to traditional equities or other alternative assets. As crypto continues to gain mainstream adoption and legacy companies begin to tokenize their traditional financial assets, dHEDGE may be well positioned to capture a desire for decentralized asset management for all asset classes, not just crypto.

With $300B in annual revenue up for grabs in the active investment management industry, it shouldn’t be surprising to see decentralized asset management platforms like dHEDGE begin to take market share from current players. If clients manage to find a way to overcome the fear of investing with anonymous fund managers — perhaps by evaluating track record or highlighting other metrics — then perhaps those sitting high up in city skylines might need to watch out.