iZUMi Research: Clarifying the Landscape and Trends of DeFi On-Chain Fund Track from 22 Projects

Written by: iZUMi Research

Abstract

1. Compared to the opacity of CeFi, DeFi on-chain funds offer a more efficient and transparent asset management model.

With the continuous maturation of on-chain exchanges, lending, and various derivatives platforms, DeFi on-chain funds now have ample investment space and feasible development. By customizing smart contracts to set operational scopes, combining multi-signature with permission control, and layering automated algorithms, DeFi on-chain funds can effectively integrate the advantages of security, transparency, and high efficiency. Although the overall size of DeFi on-chain funds is still small, especially for actively managed strategy funds, there is significant growth potential in the future.

2. The increasing variety of on-chain assets brings more diversified investment portfolio targets for DeFi on-chain funds.

The emergence of new on-chain assets and derivatives such as LP liquidity provider tokens, perpetual contracts, and perpetual leverage pools provides DeFi on-chain funds with greater combinability, enabling diversified hedging and risk dispersion, thus offering users safe, transparent, and balanced risk-return financial products.

3. Lowering user entry costs and the trend of packaging complex financial products is evident.

During our research, we clearly observed a trend where platform-based projects began to build or collaborate through ecosystems to create clearly packaged, easy-to-understand financial products that do not require frequent user operations, such as the Vault created by Umami Finance and Opyn's Crab Strategy.

4. After verifying the security of on-chain funds, wallets will be an ideal traffic entry point.

Similar to the logic of Web2 financial brokerage software, pushing fund products on wallet pages is a reasonable trend. For funds, it represents a channel for traffic and capital, while for wallets, it can provide a source of income, rather than relying solely on the traditional method of extracting transaction fees. However, for wallet users, the security of funds is crucial. Transaction scenarios are one-time events; once completed, users leave, and as long as the transaction process is problem-free, the wallet bears no responsibility. However, if an on-chain fund product encounters an incident, the consequences can be severe. Currently, the entire sector is still in its early stages, so more time is needed to validate product security.

Intro

The cryptocurrency market is always fraught with risks and opportunities that we cannot imagine. In May, the top ten cryptocurrency project Luna saw its market value of hundreds of billions of dollars drop to zero in a week, triggering a wave of collapses among institutions such as Celusis, 3AC Capital, Babel Finance, and BlockFi. The fundamental reason lies in the lack of regulation in the cryptocurrency investment field, leading to the opacity of asset conditions across various companies, while continuously borrowing from each other in an optimistic market.

Leverage accumulates outside the regulatory framework, and risks accumulate in the shadows. Luna ultimately became the match lit in a fireworks factory, triggering a series of explosive events that even threatened centralized exchanges that have experienced two rounds of bull and bear markets. Historically, the subprime mortgage crisis in 2008, although broader in scope, had fundamentally similar causes.

This article will explore and analyze a track in the DeFi field that has yet to explode: on-chain funds/asset management, starting from the traditional financial fund management industry.

We collected nearly 60 projects from the market, filtered, categorized, and organized them, and selected 22 projects that meet the definitions for analysis. We conducted an in-depth analysis of three representative projects: Ribbon Finance, Umami Finance, and iZUMi Finance.

Fund Overview

Anyone can name a few well-known fund names, and the operation of "funds," which concentrates small and public investors into large funds, actually emerged two hundred years ago.

The emergence and vigorous development of new things often require the demand of the times. The essence of finance is to enhance the efficiency of capital utilization, and as a socialized financial tool, funds can achieve more efficient resource allocation, originating from the capital demands brought about by the development of the real economy.

In the 19th century, Britain had just experienced the first industrial revolution, with a significant increase in productivity, colonies and trade spread across the globe, and wealth growing rapidly. However, the general public, hearing similar myths, struggled with a lack of relevant knowledge and understanding of the overseas investment environment, leading to the idea of entrusting funds to relevant professionals for management.

At the same time, some merchants and sailors had sufficient relevant experience but lacked financial support. Subsequently, the British government supported this idea, establishing investment companies through government intervention, entrusting specialized financial experts to invest on behalf of small and medium investors, allowing them to share in the returns from international investments and disperse risks. In 1868, Britain formed the "Overseas and Colonial Government Trust" organization, publishing a prospectus in The Times to publicly offer stock certificates to society.

Funds originated in Britain but experienced the most rapid development in the United States. After World War I, the U.S. economy grew rapidly, transforming from a capital-importing country to a major capital-exporting country.

In 1926, the Massachusetts Financial Services Company in Boston established the "Massachusetts Investment Trust," becoming the first modern mutual fund in the United States. However, in the 1920s, the rapid development of the U.S. fund industry saw total assets grow at an annual rate of over 20%, even exceeding 100% growth in 1927, followed by the great crash of 1929.

After experiencing the crash and the impact of World War II, the U.S. government established comprehensive legal requirements such as the Securities Act, Securities Exchange Act, Investment Company Act, and Investment Advisers Act, laying a solid foundation for the development of the U.S. financial industry.

With the continuous development and improvement of the financial system, the fund or asset management industry has also flourished. By 2021, asset management (funds) had become a trillion-dollar market, growing rapidly at an annual rate of up to 12% in recent years. Moreover, the share of passive investment has rapidly increased, reaching one-third in 2020, indicating a growing preference among investors for passive financial management and investment strategies that diversify risks through portfolio strategies.

Data Source

Funds raise capital by issuing fund shares, concentrating investors' funds to form independent assets, which are managed by fund custodians and operated by fund managers, conducting securities investments in a way that shares benefits and risks.

Why are funds so popular?

Funds broaden investment channels for small and medium investors, operating through experts to assist many small and medium investors in portfolio investments. By converting savings and idle funds into investments, funds release social capital, providing momentum for industrial development and economic growth. In this process, investors gain returns, society releases idle funds, and fund managers earn income related to performance.

Moreover, the development of funds, managed by professional investors, also contributes to the stability and development of financial markets. Generally, funds tend to focus more on long-term strategies and engage in less frequent trading, thereby reducing volatility in the securities market. Similarly, a stable financial market creates a more stable and predictable financing environment for enterprises.

As a new type of asset, crypto assets have reached a trillion-dollar market value in just over a decade. The management of crypto assets has also emerged in ways completely different from traditional finance. Currently, most crypto assets are still managed using traditional fund operational methods, governed by the existing legal system, regulatory organizations, and assessment institutions.

However, based on decentralized, permissionless blockchain networks and smart contract technology, a more efficient and transparent fund operation method has been continuously explored and developed in recent years. These methods treat code as law, eliminate intermediaries, and combine emerging on-chain assets to provide higher efficiency, lower risk, and more diversified financial products.

DeFi On-Chain Funds

DeFi applications have rapidly mimicked traditional finance in just five years, introducing tiered funds, futures, options, and various derivatives, mixed with various innovations such as perpetual options and liquidity provider tokens (LP), covering a very broad scope. Here, we will limit the discussion to "DeFi on-chain funds" for ease of research and discussion, defined as follows:

Project parties/fund managers invest user funds (mainstream tokens such as BTC/ETH/mainstream stablecoins) into one or several types of decentralized financial products based on a pre-agreed strategy, using fully on-chain operations to achieve asset appreciation for users.

Expanding on this, the following standards must be met:

About Users: Based on the anonymity and openness of DeFi, any user can participate in investing in funds, although some on-chain funds may have whitelist features.

Returns and Investments: The product's goal is to achieve appreciation in mainstream currency, either through the product itself or in conjunction with other products. Here, returns are in mainstream currencies, not in more volatile altcoins obtained through staking or other activities (some platform tokens may be used as incentives, but the main income is from mainstream tokens). Thus, fund products can capture long-term returns through strategies rather than short-term gains from economic model inflation.

About Operational Permissions and Scope: Permissions are controlled by smart contracts, with all operations occurring on-chain, interacting with a set of other contracts defined by the contract or operating a combination of assets specified in the contract. Operations are on-chain, ensuring transparency of funds, rather than being invested in CeFi or CEX for opaque operations. Permissions are controlled by the contract, defining the operational scope to ensure the safety of funds.

What is the market space for DeFi on-chain funds?

Currently, global funds manage a total of $112 trillion in assets. According to Twitter KOL Alf, the global stock market is valued at $109 trillion, the bond market at $124 trillion, gold at $12 trillion, and digital assets at less than $2 trillion. Assuming that 10% of assets are managed by various funds, with 30% managed in the form of on-chain funds, based on the current $1.2 trillion market value of cryptocurrencies, there would be $36 billion entering on-chain funds, while the current size of on-chain funds is far below this amount.

https://twitter.com/macroalf/status/1488960411349110784

Comparison of the Ecological Roles of Traditional Funds and DeFi On-Chain Funds

The traditional fund industry has developed a complete ecological industrial chain, including front-end services, back-end ratings and certifications, and related legal and regulatory systems. In contrast, DeFi on-chain funds currently lack standards, certifications, and related upstream and downstream services, and at present, they only have certain advantages in asset transparency and efficiency brought by disintermediation due to technological advantages.

Classification of DeFi On-Chain Funds

Traditional funds are classified based on fundraising methods (public, private), operational methods (closed-end, open-end), investment philosophies (active, passive), legal forms (contractual, corporate), trading methods (on-exchange, off-exchange), investment objects (stocks, bonds, currencies), and many other criteria. However, whether in DeFi or traditional finance, regardless of the underlying asset or framework, strategies are the most fascinating part. Therefore, we will classify them based on strategies and conduct multi-dimensional analysis on 15 projects collected from the market.

The classification is as follows:

First, the products will meet our definition of "DeFi on-chain funds," and then be categorized into three types based on the specific execution forms of strategies: algorithmic strategy funds, active strategy funds, and passive strategy funds, defined as follows:

Active Strategy Funds: Fund managers/teams use their expertise to operate on-chain within the range defined by the contract, aiming to achieve returns that exceed market averages. Examples include DeFiEdge Protocol, Arrakis Finance, etc.

Algorithmic Strategy Funds: Users invest funds, and the contract automatically executes based on defined algorithms and strategies to help users build structured asset portfolios or execute repetitive operations. Typical products include Yearn.Finance and Ribbon Finance products.

Passive Strategy Funds: Mainly index funds, diversifying investments in a specific asset class or tracking the performance of one or multiple asset classes, providing users with broad market exposure, low operating costs, and low portfolio turnover rates. Typical products include DeFi Pulse Index (DPI), Metaverse Index, ETH 2x Flexible Leverage Index, etc.

Risk from high to low: Active Strategy Funds > Algorithmic Strategy Funds > Passive Strategy Funds

Returns: Active Strategy Funds > Algorithmic Strategy Funds > Passive Strategy Funds

Active Strategy Funds: Contracts as Law, Forging Diamonds with Precision

Active strategy funds are relatively straightforward, with mechanisms primarily defined by contracts regarding investment scope. During the deployment of the fund pool, the operational range is set, and fund managers can only operate within the pre-defined range, such as lending on large platforms like Aave and Compound, or providing liquidity for specific trading pairs on Uniswap V3.

These funds are closer to traditional fund models, charging certain management fees and commissions. Currently, these funds are relatively small in scale, with significant growth potential.

Algorithmic Strategy Funds: Combining Newborn Assets, Algorithms Shine

Algorithmic strategy funds are more diversified compared to the other two types. Yearn Finance and Beefy Finance belong to the algorithmic strategy fund category (these are referred to as "yield farms," and there are relatively many projects, so they are not listed here). Algorithmic strategy funds tend to be more innovative, combining more DeFi newborn assets, such as liquidity provider tokens (LP), perpetual contracts, etc., and hedging with other long/short leveraged products, becoming fund products close to neutral strategies. These products generally offer higher returns with lower risks.

Shares of algorithmic strategy funds are generally not tradable, but users can deposit or withdraw at any time or wait for periodic settlements to deposit/withdraw.

Passive Strategy Funds: Constructing Synthetic Assets, Automatically Anchoring Targets

Passive strategy funds typically issue ERC20 tokens to represent fund shares, with invested funds buying and selling corresponding targets according to rules during adjustments. Platforms attract users to purchase index funds through staking rewards in the form of platform governance tokens or incentivize liquidity for the ERC20 trading pairs on DEX with platform tokens. Platforms allow users to trade fund shares in the market, making them closer to ETFs, and can achieve arbitrage through minting and redeeming shares.

Typical Project Examples

Ribbon Finance - On-Chain Automated Strategies Based on Options

Ribbon Finance is a DeFi structured product based on Opyn's early options products, with the entire process of minting, selling, and exercising options occurring on the Ethereum chain. Currently, the structured products launched include Covered Call (holding stock protection strategy) and Put Selling strategy (unprotected bearish), with contracts deployed on Avalanche, Solana, and Ethereum. As of early August 2020, it had over $70 million in AUM on Ethereum, making it the largest in its category.

After investors deposit funds, Ribbon Finance sets the option strike price through algorithms on the Opyn platform and mints option oTokens, selling options on multiple platforms every Friday. If the options are not exercised, they can earn premium income, providing returns to investors. In the future, Ribbon's main trading products will cover options, futures, fixed income, etc. (currently mainly options products), helping users improve the risk-return of their funds.

Core Products & Design Principles

The core product currently launched by Ribbon Finance is called Theta Vault, which includes Covered Call and Put Selling strategies, with a total of 12 products.

Ribbon Finance's Covered Call strategy involves holding the corresponding cryptocurrency and selling call options on that cryptocurrency every Friday to earn premium income. Put Selling is the opposite strategy, where users invest USDC and sell a certain number of put option combinations every Friday to earn returns.

The algorithmic strategy sets a fixed Delta value, incorporating current market volatility factors into the consideration. In Ribbon Finance V1, the team manually calculated the option strike price based on delta=0.1. In V2, the contract reads the current spot price from Chainlink and automatically calculates market volatility, combining the pre-set delta value to automatically calculate the strike price. All options have a validity period of one week.

Additionally, in the latest version, Theta Vault combines with Yearn Finance, investing idle funds into Yearn Finance to add a small portion of risk-free returns. All operations on Ribbon are executed through smart contracts, making it a typical algorithmic strategy fund.

Risks and Returns

Whether selling call or put options, the way to earn returns is to hope that the options are not exercised (thus expiring) at settlement. From Ribbon's historical performance, since January 2020, less than 5% of the time has been exercised (resulting in losses). Due to the high volatility of the altcoin market, it is easy to breach the strike price, and funds that are exercised are mostly from altcoin covered call strategies.

Overall, in the absence of extreme market conditions, Ribbon Finance can indeed provide users with appreciation in coin value. If not exercised, Ribbon Finance can bring users annualized returns of 34% for ETH, 27% for BTC, and 50% for USDC. However, considering the volatility of the crypto market, the overall returns are not ideal, with the BTC fund currently yielding 6.05% in coin value over the year, Ethereum at 3.38%, and USDC at -28%.

Considering the design of Ribbon's product mechanism, the Covered Call strategy is more suitable for bear markets, avoiding the exercise of call options due to rapid price increases, thus earning some coin value returns. In bull markets, the Put Selling strategy using USDC is suitable to avoid the exercise of put options due to rapid price declines.

Umami Finance - High-Yield Hedge Fund Based on DeFi Innovative Assets

Preface: Umami Finance closed this fund project on August 19 and is currently researching the second version. The reason for the closure was that the Mycelium leverage token algorithm produced deviations during extreme market fluctuations, where the short token did not perform as expected when hedging against downside risks. Ultimately, the team chose to close this project and compensate affected users with team funds.

Umami Finance initially operated as a decentralized financial reserve platform similar to Olympus DAO on Arbitrum. Last month, it launched a USDC fund based on GMX's GLP and Mycelium (formerly Tracer DAO) Perpetual Pool - GLP/TCR USDC POOL, achieving around 20% annualized returns in USDC by combining GLP and Perpetual Pool for risk hedging.

Source: Umami Finance Documentation

Underlying DeFi Lego Modules: GMX's GLP and Mycelium's Perpetual Pool

GMX is a decentralized perpetual contract exchange currently deployed on Arbitrum and Avalanche networks, which do not interconnect. GLP is the liquidity provider in the GMX ecosystem, serving as the counterparty for contract and spot trading, providing liquidity for various trading scenarios within the GMX platform. In GMX, trading occurs without slippage, directly exchanging based on Chainlink's quotes, with the counterparty's funds coming from GLP, and limits set based on the size of the GLP pool.

Here, Max ETH in and Max USDC out represent the limits set for exchanging ETH for USDC (or during contract trading).

Additionally, as trading amounts increase, fees will also rise, ranging from 0.3% (for small trades) to 0.8% (for large trades).

GLP is provided by users and consists of a basket of asset combinations, with proportions set by the platform. Users can mint GLP using any asset from the basket. To maintain proportion stability, users incur fees during the minting process, incentivizing them to mint with the assets that are lacking in GLP to keep the pool balanced. For example, when the amount of WBTC in the GLP pool is significantly below the set proportion while ETH is above it, users minting GLP with ETH will incur additional fees, while minting with WBTC will reduce fees.

70% of the earnings from activities such as trading, minting, and burning GLP, leveraged trading, and liquidation (collectively referred to as Platform fees) will be distributed to GLP in ETH. The remaining distribution goes to the governance token GMX. GLP can also participate in staking to earn GMX rewards.

Since GLP is a basket of assets with a certain proportion, its unit net value will fluctuate with the price changes of the tokens. The following chart shows the composition of GLP.

Composition of GLP (August 7, 2022), Source

GLP Net Value Change Curve (August 7, 2022)

Mycelium's Perpetual Pool

Taking the 3x leverage token as an example, Mycelium has built 3x long and 3x short tokens, allowing users to mint long or short tokens directly using USDC. The long/short tokens represent shares in the long/short pools. Mycelium periodically adjusts the proportions of the two pools based on Ethereum's price. For instance, if the asset price rises by 1%, the threefold leverage pool will automatically transfer 3% of funds from the short pool to the long pool during adjustments, thus creating a leveraged product that will not be liquidated.

The pool adjustments are based on the following curve (the chart uses 2x leverage as an example), with the horizontal axis representing changes in the underlying asset's price and the vertical axis representing the amount of funds transferred between pools. It can be seen that the greater the price change, the more difficult it is to adjust the leverage accurately.

Additionally, an arbitrage model is used to maintain the balance of both pools, and a portion of the fees is extracted to trigger contracts for stable product operation.

Umami's Strategy:

As seen above, GLP contains approximately 40% volatile assets (mainly BTC and ETH, along with tokens like Uni) and over 50% stable assets (primarily USDC). Therefore, purchasing GLP is equivalent to holding this basket of asset combinations, while also generating cash flow income from various fees on the GMX platform in the future. Thus, Umami's Vault uses Mycelium's threefold leverage tokens to hedge against the volatile asset portion according to the proportion (Mycelium only supports ETH and BTC but has hedged most of the risks), aiming to achieve stable returns. The contract adjusts once daily to ensure the accuracy of the hedged amounts.

Additionally, a small amount of funds is used to purchase insurance for GLP from the insurance platform Insurace to avoid unexpected losses due to hacker attacks and other incidents.

Risks and Returns:

Umami's product takes various risks into account, including purchasing insurance from Insurace and Risk Harbor to avoid sudden security incidents with GLP, as well as using Mycelium to hedge against GLP's risks. However, due to the underlying product's mechanism issues, risks still exist:

• Risks from Mycelium: Mycelium periodically rebalances the long/short pool ratios to maintain leverage, but its curve is a close simulation. If large-scale price fluctuations occur, Mycelium cannot guarantee that the pool distribution will be completely even.
• Additionally, there are other contract-related risks associated with Mycelium. Currently, Umami's insurance does not cover the Mycelium portion.
• If large-scale withdrawals or deposits of GLP cause an imbalance in proportions, Umami's rebalancing every 9 hours incurs additional costs.
• According to on-chain data, at the current scale, each 9-hour rebalancing incurs about 1% of the fund, and the fees paid to GMX and Mycelium during the rebalancing process may account for several points of the total amount over a year, significantly reducing the final returns for users. If the GLP proportion becomes uneven, purchasing costs will increase, leading to higher expenses.

Professionally Managed Closed-End Active Fund - iZUMi Finance

iZUMi Finance is a multi-chain one-stop liquidity service platform that provides various products around liquidity services, including liquidity incentive tools like liquidity box and efficient decentralized exchanges like iZiswap. iZUMi Finance is about to launch three products: fixed income bonds, dual-currency wealth management, and impermanent loss insurance.

Among them, fixed income bonds and dual-currency wealth management both belong to DeFi on-chain funds and are classified as active strategy funds. Compared to the previously mentioned fund products, iZUMi Finance offers closed-end funds, which cannot be traded after purchase and can be redeemed with principal and interest upon maturity.

iZUMi Finance Fixed Income Products

iZUMi Finance's fixed income bonds are implemented through a Gnosis multi-signature wallet. Permission control is achieved through the Cobo DaaS multi-signature widget, allowing a party to perform operations within a pre-defined range, such as trading on Uniswap and adjusting price ranges on V3.

The bond product offered by iZUMi Finance has a term of 30 days, with an annualized yield of 10% for investments in USDT, repaying principal and interest upon maturity. The funds raised through the bonds are used to provide liquidity in decentralized exchanges, with strategies provided by a professional trading team.

The multi-signature wallet is jointly managed by iZUMi Finance and LP, with liquidity provision and price range adjustment permissions only open to the Market Maker (MM) team. At the end, funds are extracted with signatures from all three parties. The bond yield is a fixed 10% APR, with any additional earnings going to the Market Maker. If LP earnings are insufficient, the Market Maker will cover the shortfall with collateral.

iZUMi Finance Dual-Currency Wealth Management Products

Another wealth management product from iZUMi Finance is dual-currency wealth management, which carries slightly higher risks and returns compared to bond products. The product invests USDT, allowing users to choose a lock-up period of 1/7/30 days, with funds used to provide liquidity on the BTC/USDT trading pair on DEX.

The final assets returned from dual-currency wealth management are determined by market prices. When purchasing the product, a price range is set, and during investment, the contract automatically trades a% of USDT for BTC at market prices to provide liquidity within that price range.

If the price remains within the set range at redemption, users can withdraw liquidity corresponding to their principal and earn annualized returns of 50% to 150%. If the price exceeds the upper limit, users can receive USDT in excess of the corresponding amount of liquidity tokens. If the price falls below the lower limit, users will receive BTC corresponding to a lower amount of liquidity tokens.

Compared to other active strategy funds, in addition to maintaining the security and transparency of on-chain funds, iZUMi Finance's products, through professional team operations, are more flexible and can provide stable returns that are largely independent of market bull and bear cycles, making them relatively competitive.

iZUMi Finance Impermanent Loss Insurance Products

After users provide liquidity on Uniswap V3 and obtain liquidity proof NFTs, they can deposit these NFTs into the iZUMi Finance impermanent loss insurance product's smart contract. The contract automatically calculates the amount to hedge and related costs, with the insurance market lasting for 30 days. The contract will automatically allocate a portion of LP fee income as the cost of purchasing insurance. iZUMi Finance will provide impermanent loss insurance for users through a combination of hedging strategies in CEX.

Settlement occurs when the insurance expires or when liquidity leaves the designated price range, paying users the premium. By purchasing impermanent loss insurance, users can avoid impermanent loss while providing liquidity, thus earning stable market-making fee income.

All three products from iZUMi Finance are innovative attempts, with the first two classified as DeFi active strategy on-chain funds, while the insurance product combines CEX strategies, but the calculations and payments for impermanent loss are transparent and verifiable on-chain. Currently, iZUMi Finance is participating in the incubation of Glass Finance, which has joined the first phase of the Cronos Accelerator, looking forward to the upcoming product launch.

Advantages of DeFi On-Chain Funds

Asset Transparency and Security: Asset operations are fully traceable on-chain, reducing opaque operations. Whether active, passive, or algorithmic strategy funds, the holdings and adjustments of the funds are real-time verifiable. Moreover, most funds allow for withdrawal at any time, providing better protection for user funds.

New Asset Combinability: On-chain funds such as Thetanuts Finance, Index Coop, and Cook Finance have issued corresponding ERC20 tokens as certificates representing fund shares, allowing participation in other staking activities, and potentially serving as certificates for lending activities in the future.

Diversity of Investment Targets: Traditional funds, considering risk control, only allow investments in permitted asset categories, such as money market, equity, and bond funds. DeFi on-chain funds can invest in a more diversified range of targets, including interest-bearing tokens, perpetual contracts, leveraged tokens, liquidity provider tokens, etc.

By combining different new products and hedging, they form low-risk, high-return (stablecoin returns exceeding 20%) products that carry a certain amount of risk. However, compared to Luna's Anchor Protocol, which provided about 20% stable returns, these products have stable sources of returns and controllable risks.

Disadvantages of DeFi On-Chain Funds

Excessive Transparency: This can make them vulnerable to attacks from malicious counterparties, such as maliciously inflating option prices, leading to losses for some algorithmic strategy funds. The layered nature of assets can easily accumulate risks.

High Operational Costs: Some funds with automated strategies require frequent on-chain operations, resulting in high transaction fee expenditures.

Imprecise Calculations: DEXs using AMMs find it difficult to make precise estimates during trading. Additionally, designs like Mycelium's simulated leverage curves can also lead to significant deviations during extreme market fluctuations, resulting in additional losses and expenditures for the funds.

Contract Risks: On-chain fund products often consist of combinations of multiple assets, linked to multiple smart contracts, with funds held in smart contracts. If any contract encounters issues, it can impact the entire product. However, most fund products currently allow users to purchase insurance policies from platforms like Insurace or Risk Harbor to hedge certain risks. Umami Finance's USDC Vault product even directly includes Insurace's policy.

Complex Products: Compared to centralized financial products, DeFi fund products still have a high entry threshold. This includes not only the smaller user base and complexity of DeFi products but also the various sources of fund returns, operational principles, etc. For example, understanding the composition and risks of Opyn's Crab Strategy requires knowledge of perpetual contracts and Opyn's Squeeth products.

Innovative Products Are Not Yet Stable and Need Time for Validation: Umami Finance used Mycelium's leverage tokens for hedging, hoping to hedge the volatile asset positions in GLP without liquidation risks. However, Mycelium's mechanism is designed to adjust every 8 hours, which can lead to deviations during extreme market fluctuations, resulting in significant losses for Umami's USDC Vault between August 18-19, leading Umami to decide to close this Vault and compensate the gap with team funds. Such innovative products using on-chain algorithms still carry significant, unverified risks that require time for validation.

Trends and Opportunities

Platform self-developed fund products: During our research, we found that DeFi trading platforms are developing financial products based on their platforms, packaging them so that users only need to understand the existing risks and returns without needing to manipulate the funds themselves. A typical example is Opyn's Crab Strategy based on its Squeeth.

Combining DID will be the future direction for active strategy funds: In an anonymous environment, even with smart contracts ensuring fund security, users find it difficult to trust active strategy fund products.

Most fund projects, such as DeFiEdge, are relatively early, and the platforms themselves cannot provide sufficient credit endorsement for fund managers. Some projects use Twitter account associations, but the effect is relatively limited. If they can combine DID to provide verifiable historical performance of fund managers on-chain, confirming that the fund manager is indeed managing the fund, it could enhance the product's credibility and potentially lead to the emergence of fund ratings in an anonymous environment.

The demand for stable liquidity from DEXs: DEXs like GMX and Uniswap hope to have ample and stable liquidity. Funds launched by Umami Finance, DeFiEdge, etc., can help DEXs provide long-term, stable liquidity support. Additionally, for Umami Finance's products, combining liquidity with leveraged tokens for hedging provides users with high-yield financial products, benefiting all four parties (Umami Finance, GMX, Mycelium, and investors).

Opportunities in Fund Marketing Channels: Using wallets as entry points, or aggregating entry points similar to traditional brokerage software and financial pages, can horizontally compare various on-chain fund returns and risks, helping users reduce decision-making costs and directing traffic to reliable DeFi on-chain fund products.

Conclusion

Overall, DeFi on-chain funds are still an underexplored track with significant potential, with a relatively small overall AUM. However, innovative products like Umami's USDC Vault and Opyn's Crab Strategy are still in short supply, indicating that market demand indeed exists. The market's high volatility and speculative activities are typical of early-stage markets, and many on-chain fund products face challenges due to market conditions and inadequate infrastructure.

Compared to traditional fund models, the standards, operational processes, models, and ecological roles of on-chain funds are still in very early stages, with many ecological roles even missing. We look forward to seeing more builders emerge with more explorations and ideas to construct a more robust DeFi ecosystem in the future.