Wall Street veteran on how to invest

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  • Luca Prosperi moved from Wall Street to DeFi with the belief that DAOs will be the future of finance.
  • These are decentralized structures that have much lower operational costs than traditional banks.
  • Investors should view them as similar to high-risk, small-cap tech startups, he said.

There is no doubt that blockchain technology is disrupting many industries, including the banking and investment worlds.

Traditionally, centralized institutions like corporations and banks are responsible for providing trust for transactions. In the future, these entities may face increased competition from blockchain-based protocols, including Decentralized Autonomous Organizations (DAOs).

DAOs are made up of a community of participants who support a protocol in various ways, such as through governance and programming activities. They can take any form, including DeFi-supporting platforms, NFT marketplaces, and metaverses.

Prior to getting involved in DAOs, Luca Prosperi spent 15 years in traditional finance and on Wall Street, including more than three years at Morgan Stanley as a partner in the investment banking division. He also worked in a few buy-side shops where he focused on investing in banks. His interest in DAOs came from his understanding of how they could restructure finance.

Today he is still heavily involved in finance but in a different way. He manages loan monitoring at MakerDAO, an Ethereum-based lending protocol. He is also a freelance researcher for his own medium called Dirt Roads, a DeFi newsletter.

Prosperi was attracted to MakerDAO because he saw it as an efficient and transparent version of a bank with a low cost of capital and a very fluid balance sheet.

MakerDAO lends capital in the form of a stablecoin called dai. Borrowers have pledged their crypto as collateral. The protocol allows 18 collateral options, including Ethereum (ETH), Wrapped Bitcoin (WBTC), Tether (USDT), and Chainlink (LINK).

For MakerDAO, the collateral-to-loan ratio varies depending on the crypto being staked, but it is always over-collateralized. For example, to borrow $100, a user might need to lock in $150. This ratio is increased according to the degree of risk of a token.

Borrowers also pay a fluctuating “stability fee” to the network, which can change significantly based on governance votes, but has historically increased from 0.5% to 16.5%. The fees are similar to the interest rates paid to banks for loans. Prosperi said the value generated from fees supports the ecosystem as it is used to pay participants, hold reserves or redeem tokens, similar to a stock buyback model.

Today, DAOs hold approximately $9.5 billion in cash value across more than 4,800 platforms, according to DeepDao, a live value tracking tool. This represents an increase of more than 94% since June 2021, when the total value held was approximately $607 million.

“Most likely over the next 10 years you’ll see DAOs intermediating more business volume than JPMorgan. So I think that’s really important,” Prosperi said.

Borrowers may find DeFi platforms more attractive than banks because they can skip credit checks and income verification and, in many cases, remain anonymous.

“In some ways, DeFi is already competing with traditional banks,” says Grace Rachmany, DAO consultant and co-author of “So You’ve Got A DAO.”

Whenever new technologies are introduced, they eliminate the inefficiencies of current systems, she said. A good example of this is Amazon, which has revolutionized retail.

Investors and DAO: the good, the bad, the ugly

A digital, decentralized world can be murky. In particular, DeFi projects can often have unknown founders, random users woven together by social media platforms and public forums, and projects that often have no legal structure. If things go wrong, there’s often no one to call.

The recent explosion of Terra’s ecosystem after its stablecoin was unlinked from the dollar, has further afflicted DeFi’s already trending negative reputation.

So why should investors care about DeFi, especially DAO-based ones? Despite all the flaws, Prosperi thinks these structures have a bright future.

Take a top exchange like Coinbase for example, it is a publicly traded company that had a valuation reaching $80 billion in 2021 with thousands of employees. Recently, it took a hit due to market dynamics in the crypto sector, Prosperi said.

Coinbase (COIN) shares have fallen around 69% year-to-date to around $79 on Tuesday. The company told staff it would slow down hiring and reassess its staffing needs.

At the other end, you have a protocol such as a DAO that has a smaller number of “employees” or rather participants. They can step in on more volume than these mega-companies thanks to smart contract automation. For this reason, Prosperi believes these structures are well placed to compete with older business models.

Indeed, due to the absence of high labor and operating costs, DeFi has the lowest marginal costs compared to traditional banks and non-banks, according to the Global Financial Stability Report. of the International Monetary Fund.

However, the same report also highlights many issues with these platforms. These include exposure to riskier borrowers and higher liquidation due to crypto


volatility

which occurs when the loan-to-value ratio falls below a certain margin, cyberattacks, money laundering, and legal and jurisdictional uncertainties.

Also, investing in a DAO is not as simple as investing in stocks. Investors do not receive quarterly earnings reports, nor is there a government agency responsible for oversight and investor protection for this jurisdiction.

In publicly traded companies, you can buy a stock. In crypto, things are not so standardized. In general, a governance token is the closest comparable to buying a share in a company, Prosperi said. A token can grant its holder the ability to participate in the decision-making process and receive feedback if the value of the token increases. Often, the more tokens a user holds, the greater their governance power, Prosperi said.

“An investment in a governance token is very similar to an investment in stocks. It is therefore a residual claim on the cash flows of a project. It can therefore fall to zero, like stocks,” said said Prosperi.

But beware the buyer. According to Rachmany, unlike a stock, the value of these governance tokens is solely based on the demand for the token, rather than the company’s underlying asset.

MakerDAO’s governance token is MKR. On Wednesday, it was trading at around $1,322, down nearly 78% from its all-time high.

In short, think of it as a small-cap tech startup, Prosperi said.

There are three primary risks. According to Prosperi, investors need to understand this type of structure.

First, like any startup, a lot of the future value is embedded in the value of the token and that value can fluctuate quite a bit, he said. Therefore, investors should consider its level of risk similar to that of a small cap technology company.

Keep in mind that some DAOs are more centralized while others are completely decentralized and are purely governed by smart contracts, he noted. MakerDAO fits the latter model, meaning it’s purely decentralized.

Second, there is operational risk. Like software, new projects often have bugs and flaws that could open the door to hackers. It takes time for these structures to mature and improve.

Third,


liquidity

is also a sensitive point. Even if you hold some value in the form of a token, there must still be market demand to trade it. If demand drops for any reason, such as a loss of confidence in the ecosystem or the competition, this value can be lost very quickly. For example, when the Terra stablecoin fell around $0.10 against the dollar, it took around 3 days for the value to plunge even further, falling below $0.20. To this day, it is worth just $0.02. He also trained his sister piece LUNA with it.

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