JS: Incrypt invests in and helps to build blockchain start-ups. What prompted your decision to set up a crypto fund?

SS: We believe that blockchain protocols offer a paradigm that is significantly better than the status quo. From new forms of protocols to manage identity and stores of value to decentralised financial instruments, we believe the space has a lot of potential to disrupt the status quo.

JS: In 2017, you decided to set up a crypto fund via Iconomi, a relatively well known asset management platform. Can you tell me a little about why you decided to do this?

SS: Sure, so I think the goal was to democratise access to a high quality basket of crypto assets. We thought it was interesting to let people who are new to the space invest in a fund where an asset manager is constantly watching the assets. Generally, in the real world this would be real hard. Wealthy people are able to make money because they can access great asset managers. But the idea of democratising that power was interesting and we wanted to experiment.

JS: How would you describe your investment strategy at the outset?

SS: We have always followed a fundamental, research-driven approach to make concentrated bets, and worked hard to support startups we have backed. Our fund has a mix of equity in companies building products in the space, tokens that have proven their crypto economics and some early stage protocols.

These portfolio startups are supported by the likes of Sequoia Capital, Y-Combinator, Polychain, Hashed, Consensys, Bloomberg, Outlier Ventures, First Round Capital, Union Square Ventures, etc.

JS: What was your initial impression and experience of using this platform?

SS: We had allocated ~200k of our own funds into the project in June 2018. Given the high volatility of Ethereum and Bitcoin at the time, there were considerable losses when the fund was set up. Time delays in transfer, order confirmation and the general lax attitude of the team meant we bled ~10% of the fund at the time of set up. But we stuck with it.

Over the course of time, we re-adjusted our expectations about the lack of transparency as we were a passively held fund that strategically switched positions on the basis of deep research on macro-trends and the issuing projects.

Until Q1 and Q2 of 2019, we were in fact regularly ranked as the best performing fund on the platform, beating both the market and many of our peers. Retail investors in the markets took note of this and invested in our portfolio too. Our venture capital type strategy worked extremely well for a while.

However, with the passing of time, it seemed to us that the platform wasn’t adding that much value, especially as very few retail investors actually joined the platform, despite the fact that this was one of the better-funded projects in the space.

Given the bear trend in the market, it became clear that fund managers like us were not really receiving investments from users. In addition to the lack of value-add, there was also the fact that order execution on the platform took hours, at a minimum — if not days — in comparison to the minutes we spent on traditional exchanges.

Putting all of this together: the lack of third party capital (in spite of performance that beat the best in the industry), the lack of liquidity, the delays in order execution, and the fees — it became clear that the time had come for us to pull the plug. And so we did exactly that in early August 2019 by asking them to return our own capital in IFI (the micro fund we had set up).

JS: So, for a variety of reasons, you decided to ‘pull the plug’ and recall your investment and dissolve the fund. Can you talk me through this process?

When we requested the funds to be liquidated on Aug 2nd, representatives from the platform responded stating that it may take a few days given the general illiquidity of the market. A fair ask given that we have been active market participants and are aware of how things work.

Over the next few days, what unfolded, seemed to us a shocking display of opacity and misinformation. From the day we asked for the liquidation to when we received the funds, we lost more than 15% of the funds. We think this is due to the opaque nature of the platform’s processes and information sharing.

JS: What was the liquidation process like when you eventually decided you wanted to wind down your fund?

SS: You would think that any sensible approach would have tried to sell the positions gradually or average the price. However, it seems like they sold the position at the lowest point on August 9th.

When we questioned this, their response was pretty unclear, as our recorded phone calls show.

We got nowhere when we asked for a timeline and transparency. To me, it seems very much like they were trying to cover up the opacity of their manual processes. On top of the lack of professionalism in liquidating our assets in a timely fashion, there was a general discrepancy on what portion of what asset was sold at what price.

We took a snapshot of the pool before closing. When we did the math to determine what we should have received, there was a 14% difference. We understand volatility is high in these markets, but the platform’s math only added up if they chose the worst possible scenario for the selling of each token!

JS: It sounds like there was a total lack of transparency and that the trades were being carried out manually. Were there any other issues you encountered?

SS: Yes — the elusive trading engine! This is a big part of their story. In communications we’ve had with the platform, they’ve explained that the trading engine was both slow, and aggressive. Go figure! It seems that there’s only one beneficiary of this behaviour, which is Iconomi. To me, it also seems that there’s a genuine need to find out whether the trading engine they speak of is actually made of cutting edge artificial intelligence.

When we asked them why and how all of this had happened, we received an email which was written in legalese — and seemed to have been drafted by a lawyer. This was a big red flag.

For us, there are a few concerns worth elaborating:

First, there is no on-chain evidence of the platform holding assets that the managers claim to own. If these are synthetic products that track the price of a token, that puts the fund manager at custodial risk by not being able to redeem the underlying asset and use it for the utility the token represents. For us, in the case of Numeraire, this means a challenge in setting up a small market of our own in Erasure Bay over time.

Second is the counter-party risk. If a liquidation engine does exist, then the platform should be held responsible to disclose which exchanges they currently use. If the mix of exchanges involves players involved in wash trading or even worse — a hack, then the risk of the asset’s ownership is passed on to fund managers who may not even be aware of the platforms the tokens are traded on. This lack of transparency could spell disaster as the platform scales.

Third and most importantly — fund managers should have complete transparency over the amount of liquidity available for each asset, the time frame in which it can be liquidated and the exact price at which it is liquidated. This information should be available immediately or worse case scenario, in a matter of hours. This is the 21st century, not 16th-century tulip mania. Human intervention in the order execution is unnecessary and creates undesired friction in the management of the asset.

JS: There are quite a few projects out there using the banner of decentralised finance (DeFi) but that actually centralise some or even a large number of processes and functions. It sounds like this experience raises some broader questions about the risks of CeFi projects masquerading as DeFi projects. As you’ve mentioned, there are, potentially, specific risks like custodial risks and the risk of human error which are massively compounded by the lack of transparency. What are your thoughts on this?

SS: Well from our experience, it seems like people in the space are continuing to repeat old mistakes. We’ve seen these problems balloon up to huge losses for regular people, with examples such as Mt Gox and Quadriga.

Our fear is that the regular Joe, who’s new to the space, will get onto these platforms and lose money.

JS: What lessons have you learnt from your experience on a centralised portfolio management system? Does this experience change your perspective around on-chain asset management?

SS: In the future, we believe DeFi is the rightful solution for these challenges. At the end of the day, barring a few exceptions, the vast majority of portfolios are made up of ERC-20 tokens.

Even in the case of Bitcoin, alternatives like wBTC could provide exposure to Bitcoin pegged assets without a centralised party like the platform taking its own sweet time to liquidate them.

Should one look at the likes of Melon to handle Funds? Much of the orders handled on Melon can be routed via decentralised exchanges and the on-chain nature of the asset means little custodial risk.

In addition, unlike Iconomi’s “liquidation engine”, an open-order book gives the precise amount of liquidity available for each asset and the price at which it can be liquidated. Fund managers like us should be exploring the security implications of porting to a publicly trackable fund on Melon and other DeFi instruments.

JS: So does that mean you might be setting up your own Melon Fund in the future? If not, what would it take for you to get comfortable with the idea? :)

SS: We are currently experimenting with the platform. There are a few constraints like availability of assets and user experience — which I understand Avantgarde Finance will be focusing on in 2020.

But we believe that the future is going to have a smart-contract protocol like Melon take custody of our assets vs a centralised platform.