Why We Love Index Investing (Part 1)
Written by Andrew Fraser, Co-Founder @ Synchrony
We, as a species, are lazy – part of why I’m an engineer is an obsessive need to automate the trivial and sometimes not-so-trivial aspects of my life.
At Stanford, engineering students are told to be as lazy as possible, an oversimplification taken somewhat out of context; students are told to be as lazy as possible with regards to building a proof of concept – do the minimum amount of work to ensure that the concept is viable and there is a product-market fit. It’s essentially a form of DYOR.
The Pareto principle states that 80% of consequences are the result of 20% of causes – a principle that has been extrapolated to have applications in many facets of life, the universe, and everything. And Warren Buffet is famously quoted as saying “If you don’t find a way to make money while you sleep, you will work until you die.”
The point is: don’t expend unnecessary time and energy, especially in unfruitful endeavours, seek freedom: be efficient.
But Defi is complicated; it takes a tremendous amount of research to identify opportunities. And this sentiment is certainly evident in some humorously titled posts in /r/defi, such as: “My Brain is Fried” & “I’m too stupid to LP on Uniswap v3”.
Humorous as their titles may be, the discussions within offer nuanced insight into the tribulations of burgeoning ecosystem participants. Echoing the same sentiment and converging upon the need for a straightforward solution to interact with the Defi landscape: a simple solution for capital appreciation.
The obvious answer takes cues from traditional finance: index investing or maybe more specifically – passive investing.
On-chain index investing is certainly nothing new, implemented in one form or another by some of my favourite protocols: Balancer, DPI, Indexed, and pieDAO. But on-chain solutions are expensive, the cost being an unfortunate necessity arising from economies of scale. For an exchange traded fund (ETF) with 10bn in assets under management (AUM) a 0.5% expense ratio (or management fee) equates to 50mm in revenue. DPI’s expense ratio is nearly double at 0.9% p.a. Performing some quick maths on their current AUM of 200mm gives a result of 1.8mm in revenue, most likely just covering operational expenditure.
So for the retail consumer the question is: why should I navigate the complexities of the blockchain ecosystem when there exist cheaper off-chain solutions?
And why wouldn’t I utilize FTX or Binance’s ETFs over their on-chain counterparts?
There’s less to learn, there’s less friction to entry, it’s backed by an institution and so if they get hacked, or there was any impropriety or gross negligence on their part then I have much more avenues for restitution.
So how can we as an industry make on-chain index investing not just cheaper, but also more attractive? And are there any other methods of passive investment?
Tune in next week to find out!
A trader I once knew told me the key to long term growth is a diversified portfolio. He traded binary options.
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