Why DeFi on Ethereum Is Like Algorithmic Trading in the ‘90s

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Mona El Isa would never go back to traditional finance. 

The former Goldman Sachs vice president developed the Melon protocol, a vehicle for creating Ethereum-based hedge funds without having to spend the tens of thousands of dollars it would take to launch a fund in traditional markets.

“Managers who are used to a fund custodian and fund administrator are starting to experiment with automating technology,” El Isa said.

El Isa admits that not many founders in the decentralized finance (DeFi) space have her background in traditional capital markets. In the traditional world, DeFi resembles what algorithmic trading was in the ‘90s, said Tarun Chitra, CEO of Gauntlet Network, a business that does stress-tests on blockchain networks and DeFi platforms. 

“A lot of money was made on random equities on electronic exchanges,” Chitra said of the Clinton-era innovation. “They were people who were more technical than financial.”

Now Ethereum’s surging DeFi sector could force a similar migration.

Chitra said some traders are beginning to move away from over-the-counter (OTC) desks in favor of emerging DeFi platforms like automated market maker (AMM) Curve and lending protocol Compound. Why bother with an OTC middleman?

Still, while proprietary traders have taken an interest in DeFi, few hedge funds and banks have entertained it, he said. 

But builders who’ve come from equities to DeFi see a lot of opportunity for growth.

For example, in the Melon protocol’s first year there were almost no users and only $250,000 on the platform, El Isa said. After Melon’s user interface was updated last February, the platform’s total assets increased to $1.2 million. Now the number of funds on Melon has tripled in the last four months, although many of them are experimental, El Isa added. Around two dozen of the funds on the platform are real funds. 

“The biggest success story on our platform is now half of the whole [assets under management],” El Isa said, referring to a closed fund that only lets in whitelisted investors. “He’s got $625,000 on his network.”

For traditional funds, operation costs are normally less than $100,000 for the first year and $75,000 for every year after that, she added. On Melon, the setup cost is currently $100 for the first year and around $1,000 to $2,000 per year in gas prices after that (the cost was around a fourth of those estimates last year, before gas prices started to spike).

As funds build longer track records,  El Isa hopes Melon will become more attractive to investors. “The track records are not long enough to make that attractive for people yet,” she said. “I think in a few months people will be like, ‘Wow, this fund has consistently been outperforming ether.’”

Even if El Isa ends up moving from building protocols to launching another fund, she said she’s determined to do so in DeFi. Melon protocol is now decentralized and El Isa has launched Avantgarde Financial, a company that plays the lead developer role for Melon. El Isa was formerly the CEO of Melonport AG.

Barney Mannerings, CEO of Vega Protocol, which aims to allow users to spin up a market for derivatives anywhere in the world, said that while DeFi is still in an experimental phase, he sees a great deal of interest from the large investment banks – the ones he used to advise while at Capco and Accenture.

Instead of creating a new derivative over the course of a year, Vega will allow users to submit market proposals and deploy them over the course of a few hours.

In keeping with Ethereum’s ethos, the protocol was designed to cut out the middlemen: In this instance, the commercial bank or broker that consumers pay to trade and the investment bankers those middlemen pay to trade for the consumer. 

“I was always thinking about the traders that I knew in London and New York and the products that they used in the real economy,” Mannerings said. 

In addition to building out Vega, Mannerings said he hopes large countries like the United States develop more crypto integrations to the traditional economy. 

“If I want to hedge my U.S. dollar risk on Vega and I can do it for a fifth of the cost, that’s great, but I also need to make sure that I can get U.S. dollars into an appropriate stablecoin and take that position easily,” he said. “We have to chip away at that risk and make it less and less scary.”

   

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