So what’s the future of finance? Is decentralized finance better than the current financial system? What problems does it solve? And does it have a chance to improve or completely replace traditional finance? You’ll find answers to these questions in this article. 

The Financial System 

The financial system that we know today went through decades of technological advances. 

The earliest attempts to make finance more efficient started as early as the 1920s with the introduction of accounting machines and punch cards. This was followed by the rise of the mainframe computers that significantly sped up the banking system in the 1950s and beyond.  

The next revolution was the invention of ATMs and credit cards that started being popular in the 1970s. Also in the 1970s, another important element of the financial system, the stock market, started going through a radical transformation. Manual order entries and loud trading pits started being slowly replaced by computers and algorithms. 

From the 1990s, thanks to the growing adoption of the Internet, the computerization of finance got supercharged. Accessing bank accounts, making wire transfers, buying stocks, all of these operations were now possible from the comfort of our own houses. 

Then comes the fintech revolution. PayPal, Robinhood, TransferWise, Revolut and other fintech startups understood the tech-first approach known from other non-financial tech companies and offered their users seamless access to financial services – a completely different experience when compared to the clunky banking user interfaces. 

Despite a century of innovations, the financial system is far from being perfect. 

Settlement of stocks, bonds and other financial instruments takes days to clear and requires a massive amount of human capital involved in the process. 

Key decisions impacting millions if not billions of people are made behind the closed doors by a group of privileged few. 

Billion-dollar banking scandals that surface months if not years after the fact. 

Massive inefficiencies and high cost when it comes to international banking and remittance services. 

Unequal access to financial services with billions of unbanked people across the globe.

Banks hiring thousands of employees just to keep maintaining inefficient processes and being compliant with ever-changing banking regulations.   

A super high barrier to entry for the new players making it almost impossible to start a new financial company without access to the massive amount of capital, stifling innovation.

The whole financial infrastructure consists of siloed systems built with proprietary technologies and algorithms that each company has to make from scratch. 

The beautiful user interfaces provided by fintech companies only cover the fact that the financial system is built on old and inefficient foundations. Something that seems to be instant for the user can take days to fully process behind the scene. 

On top of that, the backbone of the financial system hasn’t evolved much since the mainframe computers were introduced. This is exactly why we need something new, something better, that can address some of these problems.

And this is where decentralized finance comes into play. 

DeFi 

Instead of relying on old and inefficient infrastructure, Decentralized finance, or DeFi,  leverages the power of cryptography, decentralization and blockchain to build a new financial system. 

A system that can provide access to well-known financial services such as payments, lending, borrowing and trading in a more efficient, fair and open way.  

Efficient – as all operations are settled almost immediately. It doesn’t matter that counterparties may be in completely different geographic locations with inconsistent laws and regulations. On top of this, most of DeFi protocols can operate with no or minimal human involvement. 

Fair – as all services are completely permissionless and censorship-resistant. 

Permissionless  – as everyone with a browser and the Internet connection can access them. There is no document verification, no need to provide income statements, nationality or race doesn’t matter – everyone is treated in the exact same way. 

Censorship-resistant – as no other parties can deny us access to these services. Even multiple bad actors cannot change the rules of a sufficiently decentralized system. 

Open – as everyone can build a new defi application and contribute to the ecosystem. In contrast to traditional finance, new applications can leverage the existing protocols and build on top of existing solutions. 

On top of that, everything is transparent and visible on the blockchain. Trading volume, number of outstanding loans, total debt? All of these can be reliably checked on the blockchain. Even better, these numbers cannot be tampered with. 

All of this is possible thanks to the invention of Bitcoin and Ethereum and their underlying technologies. In particular, Ethereum as a smart contract platform allows for creating any arbitrary financial applications. Because of these characteristics, Ethereum became a go-to blockchain for the vast majority of DeFi activities. 

Decentralized finance has recently been experiencing tremendous growth. 

Some of the key metrics are:

Total Value Locked in DeFi – this represents the value of all tokens locked in various defi protocols such as lending platforms, decentralized exchanges or derivatives protocols. 

This number has grown from less than $1B in April 2020 to over $32B in February 2021. 

Another important metric is the trading volume across decentralized exchanges.

This figure has grown from around $0.5B in April 2020 to over $50B in January 2021 – a 100x increase. 

Total value settled on Ethereum has reached over $1T in 2020. This is more than PayPal. 

And all of this is not only limited to cryptocurrencies that, as we know, can be quite volatile in nature. Stable coins that track the value of fiat currencies, such as the US Dollar, also experienced tremendous growth in the DeFi ecosystem. 

The market cap of USDC – a popular stable coin in DeFi – went from less than $1B in April 2020 to over $6B in 2021. Another one – DAI – went from less than $100M in April 2020 to almost $2B in 2021. 

Problems in traditional finance 

Now, to understand the value proposition of decentralized finance even better, let’s go through a few common problems in traditional finance and see how they can be addressed in DeFi.

Let’s start with a recent situation in the stock market – the famous Gamestop saga.

After discovering that Gamestop stock – GME – was overly shorted by some of the hedge funds, users of a popular Reddit group – Wall Street Bets – started buying GME as they believed this could initiate a short squeeze that would result in hedge funds having to buy back the shorted stock, driving the price higher. 

At some point, Robinhood and a few other stock brokers came up with a controversial decision to disable the possibility of selling GME and a few other stocks. 

A situation like this just wouldn’t be possible on a decentralized exchange like Uniswap. 

There is no one who can disable or alter the trading capabilities of the platform. There is no single authority making decisions on behalf of the users. DeFi democratizes access to trading.

This situation exposes another problem – decisions made behind closed doors. 

A group of people deciding to shut down trading? Or maybe a bunch of bankers deciding what the best interest rate is for millions of people? 

In DeFi, interest rates are adjusted automatically based on the supply, demand and risk parameters of certain assets that are configured by the protocol. 

Even if some DeFi lending platforms allow for changing certain risk parameters, all decisions are publicly visible and changes are voted on by multiple people who govern the protocol.  

What about this problem – paying 10-30% of the value of a bank transfer just to send money across the globe? In DeFi, you can send USD-based stable coins for a fraction of that cost. Even better, they will arrive in a matter of seconds.

With the settlement of different assets measured in seconds instead of days, the counterparty risk is dramatically reduced.

Accounting? Every record is publicly available on the blockchain, so accounting becomes super easy and can be most likely completely automated. This can dramatically reduce the human capital needed. 

Unequal access to financial services? A DeFi protocol doesn’t care who you are – it just follows predefined rules that are exactly the same for everybody.

Although DeFi presents us with a unique value proposition, it comes with its own challenges. 

Challenges 

It brings more responsibility to the users who are now truly owning their assets, so they have to make sure they store them in a secure way. There is not a lot of hand-holding here, especially when interacting with new DeFi protocols. 

There are still certain regulatory risks. Although things like KYC or AML cannot be enforced in the DeFi protocols themselves, the regulator may try to force wallet providers or dev teams responsible for certain protocols to add KYC requirements to their user interfaces. 

Scaling is another issue that has to be tackled. The popularity of DeFi resulted in a tremendous demand for the block space on Ethereum. This in turn results in high gas fees for the users. It’s not uncommon to hear about $10 or even $50 Uniswap transaction costs. 

Scaling is already being tackled by Eth2 and Layer2 scaling solutions. You can learn more about it here. 

Hacks are another challenge of the DeFi space that make using certain protocols, especially the new ones risky. 

Various DeFi protocols are also exploring different governance models, however, whales and voter’s apathy are some of the common problems here. 

Uncollateralized loans and mortgages are big areas of traditional finance that are slightly harder to implement in DeFi. Fortunately enough, there are already protocols like Aave exploring different possibilities such as credit delegation and tokenized mortgages. 

Despite the challenges, DeFi is a unique innovation, a 0 to 1 innovation. And I believe that sorting out some of these challenges is just a matter of time. 

Summary

So what will happen to traditional finance if DeFi keeps innovating and growing at this tremendous pace?

Personally, I think that traditional finance will have to adapt quickly, otherwise, they are taking a risk of slowly becoming irrelevant. Like with all other big technological changes, they often happen gradually, then suddenly.

We’ll probably very quickly see some of the incumbents trying to tap into the possibilities of DeFi. For example, by leveraging liquidity or accessing more favourable interest rates in one of the DeFi protocols. This will most likely start with fintech companies that are already involved in crypto but I wouldn’t be surprised to see banks using DeFi in a few years time. 

There are also a lot of areas of traditional finance that can significantly benefit from moving into DeFi in the future. As an example, instead of going public on the stock market, companies could issue security tokens and take advantage of globally accessible liquidity. On top of this, people investing in these tokens could lend them out and make an extra yield on their investment or use them as collateral for taking a loan. 

It’s also very likely that DeFi will become a new backbone of the financial system. With simple user interfaces, most people will probably not even know they’re using it, in similarity to how they don’t know what is happening under the hood of their traditional trading application. At this point, DeFi will just become finance. More efficient, fair and open finance.

So what do you think about the future of finance? How big will DeFi become?

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

So what are derivatives? Why are they important? And what are some of the most popular derivatives protocols in defi?  You’ll find answers to these questions in this article.

Derivatives  

Derivatives are one of the key elements of any mature financial system. As the name suggests derivatives derive their value from something. This “something” is usually the price of another underlying financial asset such as a stock, a bond, a commodity, an interest rate, a currency or a cryptocurrency. Some of the most commonly used derivatives are forwards, futures, options and swaps. 

There are two main use cases for derivatives: hedging and speculation. Hedging allows for managing financial risks. To understand hedging a bit better let’s revisit one of the commonly used examples.

Imagine a farmer that primarily focuses on growing wheat. The wheat price can fluctuate throughout the year depending on the current supply and demand. As the farmer plants wheat, they are committed to it for the entire growing season which presents them with a big risk in case the price of wheat is low when the harvest time comes. 

To accommodate this risk, the farmer will sell short wheat futures contracts for the amount that they predict to harvest. As the time of harvest approaches, the farmer will close their position and incur a profit or a loss depending on the price of wheat. 

If the price of wheat is lower than initially anticipated the short position makes a profit that offsets the loss from selling the actual wheat. 

If the price of wheat is higher, the short position will be at a loss but the profit from selling the wheat offsets that loss. 

What is important to understand is that no matter what happens to the wheat price the farmer will end up with a predictable income. 

To stay in the agricultural world, yield farmers in decentralized finance can also use hedging to offset a potential loss that can occur if the price of one of the tokens used for yield farming loses its value in relation to another token. This can happen, for example, while providing liquidity to an automated market maker like Uniswap and is known as impermanent loss. 

Besides our agricultural examples, derivatives allow other crypto companies to hedge their exposure to different cryptocurrencies and run more predictable businesses.  

The other popular use case for derivatives is speculation. 

In a lot of financial instruments including derivatives, speculation can represent a significant amount of traded volume. This is because derivatives offer an easy exposure to particular assets that may be hard to access otherwise, for example, trading oil futures instead of actual barrels of oil. They can also provide easy access to leverage – a trader can purchase a call or a put option by providing only enough funds to cover the option premium and gain exposure to a significant amount of the underlying asset. 

Speculators are important market participants as they provide liquidity to the market and allow people, who actually need to buy a particular derivative to hedge their risk, to easily enter and exit the market. 

Derivatives have a long and interesting history. From clay tokens representing commodities traded by the Sumerians, through the use of “fair letters” to buy and sell agricultural commodities in Medieval Europe, to the establishment of the Chicago Board of Trade (CBOT) in 1848 – one of the world’s oldest futures and options exchanges.

When it comes to more modern times, derivatives have been one of the major forces that drive the whole financial industry forward since the 1970s. 

The total market size of all derivatives is estimated to be as high as $1 quadrillion which completely dwarfs any other market including the stock or bond markets and of course the tiny cryptocurrency market that has just recently touched the $1 trillion mark. 

Every growing market naturally develops its own derivatives market that can end up being an order of magnitude bigger than its underlying market.   

This is also why a lot of people in the decentralized finance space are extremely bullish on the potential of decentralized derivatives that, in contrast to traditional finance, can be created by anyone in a completely permissionless and open way. This in turn increases the rate of innovation that has been stagnating in traditional finance already for a while. 

Now, as we know a bit more about derivatives, let’s jump into some of the most important derivatives protocols in DeFi.

Synthetix 

Synthetix is usually the first protocol that comes to our minds when talking about derivatives in DeFi. 

Synthetix allows for creating synthetic assets that track the price of their underlying assets. The protocol currently supports synthetic fiat currencies, cryptocurrencies and commodities that can be traded on trading platforms such as Kwenta, DHedge or Paraswap. 

Synthetix model is based on a debt pool. In order to issue a particular synthetic asset, a user has to provide collateral in the form of the SNX token. 

The protocol is highly overcollateralized – currently at 500%. This means that for each $500 of SNX locked in the system, only $100 worth of synthetic assets can be issued. This is mainly to absorb any sharp price changes in synthetic assets and the collateralization ratio will be most likely lowered in the future. 

Synthetix is also one of the first DeFi projects leading the effort of moving to layer 2 in order to lower the gas fees and make the protocol more scalable.

There is currently around $1.8B locked in the synthetix protocol – the biggest number across all defi derivatives protocols by a wide margin. 

UMA

UMA is another protocol that enables the creation of synthetic assets. 

The main difference here is that UMA, instead of highly overcollateralizing the protocol, relies on liquidators, who are financially incentivised, to find improperly collateralized positions and liquidate them. 

UMA’s model allows for creating “priceless” derivatives. This is because the model doesn’t rely on price oracles – at least not in the optimistic scenario. This in turn allows for adding a very long tail of synthetic assets that otherwise wouldn’t have a reliable price feed hence it wouldn’t be possible to create them in Synthetix. 

There is currently over $63M of total value locked in UMA’s smart contracts. 

Hegic

Hegic is a relatively new defi project that allows for trading options in a non-custodial and permissionless way. 

Users can buy put or call options on ETH and WBTC. They can also become liquidity providers and sell ETH call and put options.

Three months after the launch, Hegic had almost $100M in total value locked in the protocol, a total cumulative options trading volume of ~$168M and generated over $3.5M in fees. 

Interestingly, Hegic has been developed by a single anonymous developer which again shows the power of DeFi where, in contrast to traditional finance, even a single person or a small group of people can build a useful financial product. 

Opyn

Another DeFi project that allows for trading options is Opyn.

Opyn, launched in early 2020, started from offering ETH downside and upside protection which allowed users to hedge against ETH price movements, flash crashes, and volatility.

They’ve recently launched a V2 of the protocol that offers European, cash-settled options that auto-exercise upon expiry.  

There are 2 main option styles: European and American.

European options can only be exercised at the time of expiration whereas American options can be exercised at any time up to the expiration date. 

In contrast to Opyn, Hegic uses American style options. 

The Opyn protocol auto-exercises options that are in the money, so option holders don’t need to take any action at or before the expiration date.

Since its first release, the protocol had over $100M in traded volume.

Perp

Perpetual is yet another fairly new entrant into the decentralized derivatives space. 

As the name suggests Perpetual allows for trading perpetual contracts. A perpetual contract is a popular trading product in the cryptocurrency space used by well-known centralized platforms such as Bitmex, Binance and Bybit. It is a derivative financial contract with no expiration or settlement date, hence it can be held and traded for an indefinite amount of time.

Perpetual Protocol, at the moment, allows for trading ETH, BTC, YFI, DOT and SNX.

Trades are funded and settled in USDC – a popular stable coin in the defi space. 

All trades on Perpetual Protocol are processed using the xDai Chain – a layer 2 scaling solution. This allows for incredibly low gas fees that are currently subsidised by the protocol. 

This means that currently there are no gas fees while trading on Perpetual Protocol. Paying the gas fee is only required when depositing USDC onto the platform. 

The protocol has been live for only just over a month but it has already managed to achieve over $500M in volume and $500k in trading fees. 

dYdX

dYdX is a decentralized derivatives exchange that offers spot, margin and more recently – perpetuals trading.

dYdX architecture combines non-custodial, on-chain settlement with an off-chain low-latency matching engine with order books.

Besides that, the dYdX team has been building a new product for Perpetual Contracts on Layer 2, powered by StarkWare’s ZK Rollups that is due to launch in early 2021.

The total cumulative trade volume across all products on dYdX reached $2.5 billion in 2020, a 40x increase when compared to the previous year. 

dYdX has recently raised $10M in a Series B round led by Three Arrows Capital and DeFiance Capital.

BarnBridge

BarnBridge is a risk tokenizing protocol that allows for hedging yield sensitivity and price volatility. 

This can be achieved by accessing debt pools of other defi protocols, and transforming single pools into multiple assets with different risk/return characteristics. 

BarnBridge, at the moment, offers two products: 

Smart Yield Bonds: interest rate volatility risk mitigation using debt based derivatives

And Smart Alpha Bonds: market price exposure risk mitigation using tranched volatility derivatives. 

There is currently over $350M of total value locked in the protocol. 

BarnBridge is also running a liquidity mining program that distributes its token – BOND –  to all users who stake stable coins, Uniswap BOND-USDC LP tokens or BOND tokens on their platform. 

Summary

As we mentioned earlier, the Derivatives Market in traditional finance is huge and it will be interesting to see how big it will become in decentralized finance. 

It is also amazing to see more and more projects launching derivatives protocols and being able to create new and exciting financial products in a permissionless and decentralized way. 

One more important thing – interacting with new DeFi protocols can be risky. So before using any of the protocols mentioned in this article always do your own due diligence as most of these projects are still in their beta or even alpha versions.

So what do you think about derivatives in DeFi? How big will they become in the future? Would you like to see a deep dive into one of the projects we mentioned in this article?

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

What is DeFi?

Have you ever heard about defi before? Are defi apps the ultimate killer apps in the crypto space or just new hype? No matter if you never heard about defi before or you want to make sure you understand it right this article is for you.

DeFi or decentralized finance is a movement that aims at making a new financial system that is open to everyone and doesn’t require trusting intermediaries like banks. To achieve that defi relies heavily on cryptography, blockchain and smart contracts.

Smart contracts are the main building blocks of defi. If you don’t know what smart contracts are or you want to refresh your knowledge you can check out my previous blog post.

It’s worth noticing that currently most if not pretty much all of the defi projects are built on Ethereum. The main reason for this is the Ethereum’s fairly robust programming language called Solidity that allows for writing advanced smart contracts that can contain all the necessary logic for the defi applications, besides that Ethereum has the most developed ecosystem across all the smart contract platforms with thousands of developers building new applications every day and the most value locked in smart contracts which create an additional network effect. In fact, all the defi protocols mentioned in this article are built on Ethereum.

Now, let’s see how it all started.

Quick History of DeFi

One of the first projects that started the decentralized finance movement was MakerDAO.

MakerDAO, founded in 2015, allows user to lock in collateral such ETH and generate DAI – a stable coin that by using certain incentives follows the price of US Dollar. DAI can be also used for saving on Maker’s Oasis platform. This recreates one of the pillars of the financial system – lending and borrowing. In fact, defi is trying to create the whole new financial ecosystem in a permissionless and open way. Lending and borrowing is only one part of this ecosystem. Some of the other important parts are stable coins, decentralized exchanges, derivatives, margin trading and insurance.

Let’s talk about each of the categories one by one.

Lending and Borrowing

Besides MakerDAO that we just mentioned there are a few other important defi projects in this category.

The main one is Compound. Compound at the time of creating this article is the biggest defi project in the lending category with ~$630M worth of assets locked in the protocol.

Compound is an algorithmic, autonomous interest rate protocol that allows users to supply assets like Ether, BAT, 0x or Tether and start making interest. Supplied assets can also act as collateral for borrowing other assets.

Another popular defi project in this category is Aave.

Algorithmic Stable Coin

With clever use of smart contracts and certain incentives we can create a stable coin that is pegged to the US Dollar without having to store dollars in the real world. We already mentioned MakerDAO that essentially allows the users to lock in their collateral and generate DAI. DAI is a good example of an algorithmic stable coin.

Besides DAI, there are multiple other non-algorithmic stable coins like USDT, USDC or PAX. The main problem with them is the fact that they’re centralized as there is a company behind them that is responsible for holding the equivalent of the value of stable coins in USD or other assets. Nevertheless, these stable coins gained a lot of popularity and are extensively used in defi applications like Compound or Aave.

Decentralized Exchanges

Decentralized exchanges or dexes, in opposite to standard, centralized crypto exchanges, allow for exchanging crypto assets in a completely decentralized and permissionless way without giving up the custody of the coins. There are 2 main types of dexes the liquidity pool based and the order book based ones.

A few examples of the liquidity pool based ones are Uniswap, Kyber, Balancer or Bancor. Loopring and IDEX are examples of the order book based ones.

Derivatives

Similarly to traditional finance, derivatives are contracts that derive their value from the performance of an underlying asset.

The main defi application in this space is Synthetics which is a decentralized platform that provides on-chain exposure to different assets.

Margin Trading

Margin trading also similarily to traditional finance is the practice of using borrowed funds to increase a position in a certain asset.

The main defi apps in the margin trading space are dYdX and Fulcrum.

Insurance

Insurance is yet another part of traditional finance that can be reproduced in decentralized finance. It provides certain guarantees of compensation in return for a payment of a premium. One of the most popular applications of insurance in the defi space is protection against smart contract failures or protection of deposits.

The most popular defi projects in this space are Nexus Mutual and Opyn.

Oracles

Another really important although not strictly limited to finance part of the defi ecosystem are oracle services that focus on delivering reliable data feeds from the outside world into the smart contracts. The most popular project in this space is Chainlink.

These are pretty much all the main parts of the defi ecosystem. They can also be combined together in multiple various ways. We can think about them as “money Legos” as more complicated defi projects can be built on top of the existing blocks.

DeFi vs CeFI

Let’s compare the main differences between defi and cefi that stand for centralized or traditional finance.

What are the risks?

Before we wrap up this article we have to also mention the potential risks associated with defi.

One of the main risks are bugs in smart contracts and protocol changes that can affect the existing contracts. We described them in more details in the previous post about smart contracts. This is also when users can take additional insurance to lower the risk of potential issues.

Besides that, we always have to check how decentralized a defi project really is and what is the shutdown procedure if something goes wrong. Does someone have an admin key that can be used to shutdown the protocol? Or maybe there is some on-chain governance in place to make such a decision.

On top of that, we have to always account for the more systemic risk that can be caused by for example asset prices sharply losing their value which may result in a cascade of liquidations across multiple defi protocols.

Network fees and congestion can also be a problem, especially if we want to avoid liquidations and we’re trying to let’s say supply more collateral on time. Upcoming Ethereum 2.0 and second layer scaling solution can help to solve this problem.

There is also a set of more subtle features or changes that applied to one of the protocols may incentivise users to certain non-obvious actions that can cascade across multiple protocols. A good example of something like that would be a recent distribution of COMP tokens in the Compound protocol that caused users to get into seem to be non-profitable high-interest borrowing that was actually profitable due to being rewarded in the additional COMP tokens. Even though situations like that can be quite dangerous they make the whole ecosystem stronger and less vulnerable to similar situations in the future.

Summary and the future of DeFi

As you probably already noticed, defi is a super interesting and vibrant space that is full of opportunities. Although, we have to remember that is is still a very nascent industry, so it’s a high risk and a high reward game.

Defi is the closest thing that can actually disrupt the traditional financial industry. In opposite to most of the fintech companies defi is built on the new rails instead of relying on the outdated technologies and procedures.

Currently, most of the financial products can be only created by banks. Defi is open, permissionless and enables cooperative work in a similar way to the Internet.

Although defi is currently built predominantly on Ethereum, with more adoption of interoperability protocols we may see more projects being built on different chains in the future.

Extra

This was only an introduction to defi. In the following articles we’ll be focusing on each part of the defi ecosystem separately, so stay tuned.

Have you ever come across a term robo-advisor? Have you ever wondering what that is? The first thing that comes to your mind is probably the “robo” bit, but if you’re imagining a human-like, metal creature you cannot be further from the truth. Robo-advisors are digital, financial advising platforms that make investment decisions without or with a minimal human intervention. They make use of algorithms to allocate assets and manage portfolios. After the 2008 financial crisis, lots of people lost trust in the financial sector and were reluctant to pay financial advisors hefty fees. This is when low-cost robo-advisors came to play and started attracting lots of customers. The other factor that drives robo-advisors is that the majority of millennials are comfortable with online tools, so they expect to have a similar experience when it comes to investing.

How do robo-advisors work?

So how exactly those robo-advisors work? Let’s get into the details.

Robo-advisors collect client’s personal information, risk tolerance and investment goals. Based on that, they choose an appropriate portfolio structure. Most robo-advisors make use of Modern Portfolio Theory to allocate money between different types of assets like stocks and bonds maximising returns while minimising risk. Instead of investing money in particular stocks or bonds, robo-advisors prefer to choose exchange-traded funds (ETFs) to diversify their portfolios even further. Majority of robo-advisors make use of tax-loss harvesting to optimise customers’ taxes. The first thing that a tech-savvy person might notice is the fact that robo-advisors are not that clever. They allocate money based on predefined rules and rebalance your portfolio to bring it back to the base level if there is too much money allocated to one type of assets. Let’s look at this example. Let’s assume you are a fairly young investor and a robo-advisor decides to put 90% of your cash into a well-diversified portfolio of stocks and 10% of your cash into government bonds. If the value of your stock allocation rises to let’s say 95% of the value of your total portfolio a robo-advisor rebalances your portfolio by selling some of your shares and buying more bonds to bring the levels back to 90/10. It is as simple as that. It’s not rocket science at all.

Although the most popular robo-advisors work in this way, there is also a small subset of robo-advisors that make use of AI and machine learning to predict what the most profitable investments in the future will be. These types of robo-advisors are way more exciting, but they also carry a substantially higher risk. Of course, it all depends on how big chunk of our portfolio is actively managed by AI, but from my perspective, it looks like those robo-advisors start to resemble more hedge funds than anything else.

Different types of robo-advisors

As we know from the previous chapter, not every single robo-advisor is the same and there are some substantial differences between them. Let’s have a look at some of the common types of robo-advisors:

• Standard robo-advisors – these robo-advisors work just like described in the previous section. They allocate money between stocks and bonds based on predefined rules. They facilitate passive investment strategy.
• AI-driven robo-advisor – this is the new kid on the block. One of the most popular AI-driven robo-advisor is Responsive that rebalances your portfolio automatically as the economy changes.
• Theme based investing – Motif is a good example of a robo-advisor which allows its customers to have a greater control over where their money goes. Investors can choose from different theme based investments in their Impact Portfolio. For example, Sustainable Planet, Fair Labour or Good Corporate Behaviour.

What are the pros and cons of robo-advisors?

Like with everything there are always pros and cons. Let’s start with the pros:

• lower management fees – robo-advisors offer lower management fees when compared to the traditional financial advisors. The reason for that is quite simple. There is a minimal or no human time required to manage your portfolio and you don’t need to pay machines (besides paying for electricity, space, maintenance and developers’ salaries…)
• low barrier to entry – some robo-advisors can look after your portfolio from as low as $1 which is particularly beneficial for millennials who are, as we know, not very keen on saving money.
• automated process – your portfolio is managed online, your balance and chosen investments are visible all the time and you don’t need to waste time meeting your financial advisor.

The cons:

• lack of human interaction – for some people, especially the older generation, it is a disadvantage.
• managed portfolios are less personalized – most robo-advisors allocate your money based on the personal information and risk tolerance, but they do not treat customers individually like the real financial advisors. This might change with the help of AI.
• lack of active investment – your portfolio is well diversified and passive. There is no space for excitement and some people find it very boring, but as George Soros said: “Good investing is boring”.

What are the biggest robo-advisors?

Globally, there are over 300 robo-advisors looking after people’s money. The US takes the sheer amount of that market with over 200 of them. The biggest robo-advisors in the US are Betterment and Wealthfront. In the UK the market leaders are Nutmeg, Moneyfarm and Wealthify. Also, some bigger players in the investment business started looking into the robo-advisors space and came up with their own solutions or acquired some already existing companies. Robo-advisors industry is expanding rapidly and its asset under management (AUM) is expected to grow to stunning $4.6 trillion by 2022 (prediction by BI Intelligence).

Summary

Robo-advisors seem to be a good solution for someone who’s looking for a passive investment strategy and don’t want to necessarily go into the details of their investments. They definitely fill up the gap in the industry. From the technology point of view, it seems like robo-advisors were inevitable and I’m not surprised they are taking more and more of the financial advising business. In the future, we can only expect more solutions like that and hopefully that will be beneficial for the consumers. I’m also expecting a rise of AI-driven robo-advisors which may dominate the wealth management space.

My favourite talk was definitely “HFT to Laplace Demon, when timed data technology curves the market” by Eric Horesnyi who shed some light on the history of HFT and offered some insights into the future of AI-driven hedge funds processing hundreds of data sources in real-time to gain a competitive advantage in trading. Needless to say, I started reading “Flash Boys” straight after the conference.

The other memorable talks were:

• “Data Hunters: The Rise of Quant Consultants” by Pierce Crosby – focused primarily on the rise of alternative data sources,
• “Social Media, Real Time AI and the search for Alpha” by Dr Jamie Allsop – Twitter as an alternative data source for generating signals and insights of the architecture of Yedup,
• “A Glimpse of Python for Finance Folk” by Dr Russel Winder and Burkhard Kloss – nicely presented how easy it is to get financial data from Yahoo Finance and plot it on the screen in Python,
• The last, but not least was an eye-opening talk on hacking and security presented by FreakyClown which included some real-life stories of physically breaking into banks and other large companies. It was definitely one of the most interesting talks at the conference.

Don’t get me wrong, the other talks were really good too, I just found these particular ones the most interesting to me.

JAX Finance is not the biggest conference (yet?) I’ve been to, but the organisation and selection of topics were great. If you’re also interested in DevOps you’ll be happy to know that JAX DevOps runs in parallel to JAX Finance and you can easily switch between talks. I went to some Docker and Kubernetes talks and I enjoyed them quite a lot. I think that software developers should all aim to have a broad knowledge and specialise in one or few key areas. The DevOps part of the conference was definitely a good opportunity to broaden my knowledge.

The conference was a huge motivation to me and it was one of the reasons why I decided to start this blog. Learning about different programming languages, algorithms, ai, low latency, electronic trading, blockchain and other code/tech/finance related stuff is pure joy to me and I hope I will be able to share it with you.

To summarise, in my opinion, JAX Finance is a great conference especially for people interested in technology and software development in the financial sector and I’m looking forward to taking part in 2018 edition.