Enzyme: A Platform for Decentralized Asset Management
Could Enzyme replace the hedge fund operational stack?
Welcome back! Today I'm walking through Enzyme, a decentralized asset management protocol built on Ethereum.
Quick History & Overview
Enzyme started as a project called Melon and has a utility token called MLN. Founded in 2015, the project aimed to give anyone the ability to spin up a pooled investment vehicle on-demand without needing to deal with complex legal or operational challenges.
Today, Enzyme boasts $126 million in Total Value Locked (in this case, that's the same as Assets Under Management).
What problems does Enzyme solve? Let's start by looking at what it takes to start a traditional hedge fund today. Note that I'm not a legal expert and most of my context for this comes from my time working at a large university endowment. Don't take this as a comprehensive list of what it takes to start a fund.
First, there's the investment philosophy and team. This part is pretty straightforward. It's what you probably think of when you think of a hedge fund or mutual fund. Funds usually have some area of focus - maybe they look at a certain sector (like technology) or certain size companies (small cap stocks). The size of the investment team can vary from one person to hundreds of people.
If an investment firm is an iceberg, the investment team is just the tip. Behind the scenes, it takes a lot to start a fund and keep it running. There's a whole host of legal and regulatory hurdles that a fund needs to jump through, not to mention regular communication with clients and investors. Operations teams have a heavy workload. For example, they're often tasked with setting up trading relationships with banks, making sure the monthly and performance figures for the fund are accurate, and preparing reports that are sent out to investors. They also must deal with any investments to or redemptions from the fund.
Some hedge funds keep these functions in-house, but many find them so burdensome and distracting from the investment process that they'll outsource them to another company. All this operations work can get pretty expensive and time-consuming.
This is where Enzyme comes in. Enzyme takes care of all the complex operational issues like calculating performance fees, processing redemptions, and making sure assets are stored securely.
How Enzyme Works
Enzyme works off a vault-based model. Vaults are permissionless and decentralized. Anyone can spin up a vault without going through an onerous legal process. For reference, it often takes more than a few months (sometimes >1 year) to get a hedge fund up and running.
When creating a vault, the vault manager has a few decisions to make. First, they select whether or not they'd like to charge management and performance fees on the vault. Charging a management fee means that depositors will be charged a certain percentage of their assets. For example, if you were to invest $100,000 into a vault with a 1% management fee, you'd be charged $1,000 every year.
The vault manager can also choose to charge a performance fee. The vault manager earns performance fees on any profits generated by the vault. Hedge funds commonly charge 10-20% of profits as a performance fee. If your $100,000 investment grew to $150,000 and you had agreed to a 10% performance fee, you'd pay the vault $5,000 in fees for performance ($50,000 profit * 10%).
Enzyme also allows the vault manager to charge entrance fees. One could use entrance fees as a way to incentivize long-term depositors. If you had to pay a fee to join a fund, you probably wouldn't want to continuously redeem and re-invest your funds.
Next, the manager can whitelist certain Ethereum addresses. Let's say you wanted to create a vault to manage only your family's assets. You could restrict depositors to your family members' wallets. Vault managers also have the ability to set minimum and maximum deposit amounts.
What happens when a new depositor puts money in the vault? It simply appears and is ready for the vault manager to deploy.
When an investor decides they want to redeem their capital from the vault, all they have to do is press a button. Instantly, the underlying assets in the vault (i.e. whatever the vault manager bought on your behalf) are transferred to your wallet. Contrast this with the typical process for hedge fund redemptions. Often, you can submit requests for redemptions on a quarterly basis. Typically, though, you won't get all of your capital back for an entire year (or more).
Once the vault is set up, all of the trading capabilities are ready to go. Hedge fund operations teams usually have to go through a long process to set up trading relationships, fund administration, and custody of the fund's assets. Today, Enzyme supports over 200 different crypto assets. In the future, once more non-crypto assets are tokenized (like Tesla stock being tokenized through sTSLA), you could probably run a traditional equity strategy on chain!
Why Enzyme is Important
Enzyme helps solve problems for both fund managers and investors.
The fund manager's operational problems - monthly accounting, performance fee calculations & billing, trading setup - are mostly automated and decentralized. With a few clicks of a button, the manager is ready to accept deposits.
Enzyme also makes redemptions easy. When a depositor decides they want to redeem from a vault, they simply click a button and their assets are transferred to them. Normally, a fund manager would need to sell down the assets and return the cash proceeds to the investor. With Enzyme, the underlying tokens are simply transferred from the vault to the depositor's address.
Of course, vaults exist in a regulatory "gray area" today. Because they haven't yet been widely adopted, no rules or regulations have been written to govern the use of vaults. Also, regulations on funds vary wildly between different countries and regions. Because Enzyme is decentralized, they can't control who signs up to create a vault.
On the investor side, Enzyme solves a few critical issues. First, everything is fully transparent, from the trades that the vault manager makes to the way that fees are calculated. Investors in traditional funds can have very limited visibility into these areas. With some hedge funds, you may not even know all the assets that the fund owns, which is a scary thought. Enzyme removes this worry by making all trades public on the blockchain.
Typically, only people with lots of money can invest in funds. This is thanks to regulations by the SEC that are meant to protect individual investors. Enzyme removes those barriers by decentralizing the tools needed to invest in a fund.
The other challenge that Enzyme takes care of is security. Vault managers cannot remove anyone else's deposits from the fund. This is hugely important; it basically eliminates the possibility for someone to run a Ponzi scheme or steal your deposits. Had Bernie Madoff been using Enzyme, it would have been impossible for him to come up with fake performance numbers and drain the fund's capital for personal use.
Enzyme Today
You can check out Enzyme's platform by visiting app.enzyme.finance. The largest vault on the platform, USF Fund I, has over $90 million in deposits! Several others are well over $1 million in assets.
Performance data is freely and readily available. An investor is able to check the status of their investments at any time. Prospective depositors can also use the data to make decisions about where to deposit their capital.
Today, Enzyme boasts 843 vaults on its platform. All trades made by vault managers are public; in the future, this information could be aggregated and used to see which tokens or assets are the most heavily favored by vault managers.
Though Enzyme is still in its early stages, it’s not hard to see a future where Enzyme becomes the default platform that’s used by investors to start and run their funds. By taking care of all the complex operational difficulties, Enzyme helps cut out a lot of the stress and financial overhead that comes with starting a fund. If you wanted to, you could even start a small vault with your friends!