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As bitcoin surpasses $51,000 for the first time, the CIO of a $900 million crypto asset manager breaks down an emerging investing opportunity that's riding on the digital currency's relentless ascent

Matt HouganBitwise Asset Management

Summary List Placement

As bitcoin rallied to another record high of $51,700 on Wednesday, crypto asset manager Bitwise was already working to capture the next emerging opportunity in crypto — DeFi, or decentralized finance. 

The San Francisco-based company, which has seen its assets balloon to over $900 million from $120 million since its flagship Bitwise 10 Crypto Index Fund started trading over-the-counter in December, has launched the world's first index fund to track the emerging sector of DeFi. 

While decentralized finance may be an unfamiliar concept to mainstream investors, it has been the "most exciting story" for those operating in the crypto space, according to Matt Hougan, the chief investment officer at Bitwise.

Disrupting finance with DeFi

But what really is DeFi? 

Hougan said the easiest way to understand DeFi is by thinking about how software has disrupted every aspect of daily life and almost every industry except financial services.

"We still have traditional bankers that are processing mortgage applications. We still have Wall Street traders that are very well paid and provide liquidity in the market," he said. "We still have escrow agents and lawyers sitting in the middle of transactions."

True to its name, decentralized finance aims to use public blockchains and crypto assets to disrupt the traditional financial sectors such as trading, loans, and interest accounts, Hougan said. 

While DeFi started in the crypto space doing things like creating decentralized exchanges, which are similar to traditional stock exchanges except for being powered exclusively by software and open to every investor, its potential implications are now spread across finance.

"Prior to 2020, DeFi was mostly a theoretical idea and there wasn't a huge amount of live activity in the space," Hougan said. "In the last six months of the year, the growth has just been spectacular. We saw decentralized exchanges like Uniswap, which competes with traditional exchanges like Coinbase go from trading nothing to trading billions of dollars of volume per month."

The greatest stories never told

Uniswap, a decentralized exchange or automated market maker, is the largest current holding in the market-cap-weighted Bitwise Decentralized Finance Crypto index.

Much like well-known Wall Street firms such as Jane Street or Susquehanna, Uniswap provides similar market-making services. But where Uniswap differs is that it essentially replaces what human traders do with software, which automates that market-making process.

Hougan adds that while Wall Street market makers use their own capital and therefore keep profits from the process as their own, Uniswap allows for anyone to contribute to the capital pool and be rewarded for the liquidity they provide. 

"It's software instead of people. It's open and everyone can participate instead of the traditional Wall Street, and it's just growing so enormously fast," he said. "It did more than $30 billion in trading volume last month. It's the greatest story never told, no one's heard of it.

Besides Uniswap, the index tracks eight other DeFi assets, whose weightings (as of 4 p.m. ET on Tuesday) are illustrated in the chart below. 

DeFiBitwise Asset Management

The value of indexing the DeFi sector 

DeFi is growing at an exponential pace every day and Hougan calls it "the story of 2021." The Nasdaq-listed Decentralized Finance Index, which tracks blockchain tokens focused on DeFi, has soared 638% over the past year. 

But the sector is at such an early stage that it has not even penetrated the entire network of crypto investors yet. 

"I think its long-term potential is really significant, but this is a very early, very risky space," Hougan said. "Investors, jumping into this space should know that there is a possibility that they'll be hacked. My optimistic view of the future may not pan out exactly that way."

The volatility, security risks, and early-stage nature of these DeFi assets are part of the reasons why Bitwise chose to take an index-based approach to invest in the sector. 

"You will have winners and losers. You will have assets that become very important and also assets that might fall out of favor or effectively to zero," he added. "The index lets you make sure you have exposure to the space without trying to pick winners and potentially being wrong."

Hougan said the index is overseen and rebalanced monthly by the Bitwise crypto index committee, which is also supported by a group of five DeFi experts.

They are Aleks Larsen from Blockchain Capital, Scott Lewis of DeFi Pulse, Avichal Garg from Electric Capital, Ben Forman from ParaFi Capital, and Michael Anderson from Framework Ventures.

The fund will charge a 2.5% expense ratio and custody with Anchorage Digital Bank, which secures over $5 billion in crypto assets today, according to Bitwise. 

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