The decentralized finance industry is growing rapidly, and it's time for portfolio risk management to keep up with innovations.
Central banks and key leaders are increasingly raising further alarms for rising inflation, causing spirals of doubt across the world. Just recently, United States Treasury Secretary Janet Yellen called for Congress to either raise or suspend the U.S. debt ceiling, stating that the government will run out of money to pay its bills by October.
What seems to sound more like a horror film of the future is merely the front news of global financial publications at the moment. Yellen stated that the overwhelming consensus among economists and Treasury officials of both parties is that failing to raise the debt limit would produce widespread economic catastrophe, “potentially precipitating historical financial crises, stock sell-off and recession, creating severe market volatility.”
The value of the U.S. dollar will continue to decrease in the future, and individuals need, more than ever, simple, rather than complex, tools to protect themselves from financial risk and diversify their portfolios.
Risk events have also become more common in global finance, with margin calls and liquidation issues now impacting both traditional finance and decentralized finance (DeFi) as they become increasingly interconnected. The ongoing Evergrande real estate crisis is further evidence that poor-decision making from a wide variety of markets will impact markets we thought weren’t connected, like crypto.
General confidence in global finance has declined, and understanding of how money works has worsened over time. Historically, poor moves by policy-makers have left more than 31% of the world’s adult population unbanked.
However, more countries are beginning to explore different currencies as decentralized finance becomes more widely adopted. Crypto, which is inherently complex, is finally moving into the next iteration, seeing the rise of tool and infrastructure development that is helping newcomers navigate the risks and uncertainties of the burgeoning but nascent movement of finance. It is up to leaders in this space to help newcomers reduce their portfolio risks.
Democratizing finance involves lowering the entry barriers to risk management
Unfortunately, cryptocurrencies are inherently volatile. Hundred-billion dollar market wipeouts are still nothing out of the ordinary, with the market capitalization recently taking a $2 trillion hit. Speculation, announcements and other happenings can easily influence investor confidence or a lack of confidence, as demonstrated by recent events with the SEC crackdown and El Salvador in the last few weeks. The SEC was forced to tell investors to be wary of volatility and fraud of cryptocurrencies as regulators amp up crypto scrutiny.
The market is relatively new to mainstream adoption, and cryptocurrency assets tend to be concentrated among an abundance of whales. The actions of large players heavily influence price movements of cryptocurrencies, and new investors with less holding power are more likely to be caught unaware due to the complex nature of the DeFi and cryptocurrency market.
While in this phase of being vulnerable to whales’ actions, understanding how to control levels of risk are critical to encouraging mass adoption, especially for new investors with less capital.
Cryptocurrencies have brought democratization of wealth access: 24 hours a day, anyone can access financial assets with the click of a button, with assets that earn a higher yield than any fiat asset held by a traditional bank. The removal of bureaucracies and intermediaries has enabled greater opportunities for wealth creation, providing the assets and tools that can be understood.
But, at the moment, crypto is simply mirroring the wealth gap in traditional finance because those who are fluent in the languages of crypto understand how to be strategic. Ultra-wealthy crypto holders have the means to pay investment funds and brokers who have access to traditional backed investment tools such as providing trading, custody and financing services to ensure their investments are correctly balanced against the market at all times.
What is portfolio rebalancing?
Portfolio rebalancing is the process of realigning the weightage of a portfolio of assets, involving buying or selling assets periodically to maintain a targeted level of asset allocation and risk. It can help investors manage downside risks while still participating in most of the upside.
This process is critical during moments of financial instability to help individuals mitigate the risks of loss and depreciation of their digital assets. Many investors, especially those under 40, are unaware of how to, nor have time to, pay attention to and manage risk in their portfolios or understand why rebalancing is essential for wealth stability and generation.
Rebalancing not only prevents overexposure but helps to instill good trading habits by building customer discipline to stick to a long-term financial plan that allows investors — both young, old, new and experienced — to regularly monitor any potential market movements that could cause losses.
Most rebalancing strategies are time period-based (i.e. yearly, quarterly, monthly, etc.) but can also be reactionary — i.e., based on allowable percentage compositions of assets, which is more cost-intensive. For example, if the original target asset allocation was 50/50 among assets A and B and asset A performed well, it could have increased the weighting of the portfolio to 70%.
This means an investor may sell some of A to buy more B to return to the original target allocation of 50/50. While the split does not need to be even among assets, rebalancing is most effective with a good mix of volatile and non-volatile holdings in the portfolio, as it safeguards investors from overexposure to undesirable risks.
In traditional finance, rebalancing is either done manually by the investor tracking through spreadsheets and buying/selling through exchanges/brokers or investing in funds where portfolio managers handle it. This process is inconvenient and out of the budget for retail investors and shouldn’t be limited to only those who have the time and money to afford it. There are certainly new advancements in technology in TradFi through the use of applications that help track, analyze and automatically rebalance portfolios which are being used by applications such as Sigfig, Personal Capital or Motley Fool Advisor.
Rebalancing in DeFi can be more advantageous to the investor, as the process can be automated and doesn’t require you to monitor your portfolio and cross check the value of your assets against the stock markets constantly. People can go to work, to sleep, on holiday as automated smart contracts distribute their gains across their assets while allowing the portfolio to retain a net positive gain.
Expecting your intermediary to do this for you when they begin their nine-to-five job is of the olden times now.
We have an opportunity to bring better rebalancing tools to the masses through DeFi
As the value of our dollar continues to decrease, individuals need, more than ever, simple, rather than complex, tools to protect themselves from financial risk and diversify their portfolios. Now is the perfect opportunity to bring decentralized rebalancing tools to the masses by empowering customers and investors with access to democratized wealth in DeFi that isn’t at the mercy of a centralized bank or government struggling with a recession, and facilitating their financial gains and security for the future.
Decentralized finance holds great wealth potential. From millennials using crypto to buy near million-dollar homes, claiming that crypto is the secret to homeownership as confidence in traditional savings drops, the bureaucratic-free world of finance offers opportunities for anyone with the internet to grow wealth, or help accelerate financial inclusion, particularly for the unbanked.
But, it’s usually the experts, the coders, the trading experts and the pros who survive aftermarket volatility. It’s the normal users, the newcomers, and those without the privilege of understanding the deep complexities of this space who end up losing the most money during these times of financial instability.
Twelve years on since the first Bitcoin was generated, you’d think we would have simplified the user experience of blockchain-based finance. We’re getting there, but we still have some time to go. DeFi is still overly complex for newcomers, which is slowing down the adoption of the space. People shouldn’t have to undertake courses to understand how to develop decentralized trading strategies or be forced to manually rebalance a portfolio of multiple tokens through seemingly endless steps as well as trade them separately on a decentralized exchange, or DEX.
Users need to be able to decide how to rebalance their portfolio with a few clicks. Ideally, these parameters can be customized freely by the users to fit their risk profiles. The DeFi industry is growing rapidly, and it's time for portfolio risk management to keep up.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.