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The 101 for Crypto Asset Managers

#3 Compound Interest - The Eighth Wonder of the World

There is a famous quote, apocryphally attributed to Albert Einstein.

"Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it."

While the true source may be unknown, its simplistic wisdom is axiomatic and I'm sure a great mathematician such our friend Albert would have enjoyed knowing that it was ascribed to his name.

Einstein would definitely be a crypto bro.

In an ideal world this essay would be the #1 entry in my 101 series, however I err on the side of caution when it comes to matters of finance so I wanted to make sure my readers were given a more logical start to the fine art of asset management. That being said, in my humble opinion, compound interest is the single most important factor that a good asset manager should consider when allocating assets in crypto.

Compounding is a powerful tool for growing wealth over the long term. It works by earning interest not just on the principal sum initially invested or borrowed, but also on any interest earned in previous periods. This interest-on-interest effect accelerates returns in a way that simple interest, calculated only on the principal, cannot match.

For savings and investments, the impact of compounding snowballs over many years. Starting early allows even small regular investments to build significantly through the exponential power of compounding.

For example...

An initial investment of $1000, with a monthly contribution of $100 over 20 years at 15% interest compounded monthly would mean that In 20 years, you will have $169,439.44.

To put that in context. If you had put that money under your mattress instead of into an account earning compounding interest, after 20 years you would have saved $25,000. $25k is nice, but the compounded scenario is orders of magnitude greater.

Conversely, debt like credit cards, becomes much harder to pay down as unpaid interest compounds on top of the outstanding balances. This is why only making your minimum payment on a credit card is a terrible idea.

So What?

For crypto asset managers seeking to maximize growth for their clients, harnessing the power of compounding should be a top priority.

Regular contributions investing in growth-oriented crypto assets and held for many years can build wealth significantly. Even small monthly sums snowball as earnings beget further earnings. Starting contributions early allows more time for compounding to work its magic. A portfolio compounding at double-digit rates for decades can turn modest initial outlays into impressive sums.

Protecting existing capital and prior earnings from inflation is also key. I wrote an essay covering this very issue.

Successful compounding depends on capital remaining invested and growing undiminished. Even low rates of inflation can erode value significantly if not offset. Savvy asset managers will diversify across inflation-resistant assets to shield portfolios from rising prices.

Overall, no strategy better fulfils an asset manager's responsibility to maximize returns for clients than focusing portfolios on compound growth. Regular contributions and prudent diversification are the ingredients. With sufficient time, modest sums can be transformed into life-changing wealth through this powerful yet simple concept. Harnessing compound interest should be rule number one for any manager aiming to protect and increase their clients' crypto fortunes over the long run.

Okay. So, how?

This leads neatly on to the big question. How does an asset manager in the crypto sphere achieve compound interest/growth?

Funny you should ask that really, because it turns out that that is actually one of the killer applications in crypto. You might have heard of Decentralized Finance (DeFi) before. Some key aspects of DeFi include decentralized exchanges that allow for peer-to-peer transactions without an intermediary, lending protocols that facilitate crypto-collateralized loans, and stablecoins that aim to peg their value to fiat currencies or commodities to reduce volatility.

Snapshot of the man thinking where to allocate assets.

Well, it turns out that all of those applications generate yields and fees that would normally have been farmed by traditional banks and financial institutions. The big difference is that DeFi is permissionless and that means that a savvy asset manager can allocate capital into a disintermediated universe of relatively high yielding products. In effect you are not simply managing assets, you are turning client assets into a revenue generating financial service. Going Bankless and becoming a Bank at the same time.

It's no coincidence that out of the first cohort of DeFi apps launched in 2017, one was called compound.finance

Compound is a protocol that allows users to earn interest on cryptocurrencies like Ethereum and other ERC-20 tokens by supplying them as collateral. Users deposit these assets into smart contract compound markets and receive interest in the form of the same or similar assets in return. The protocol is designed to establish fair risk-adjusted interest rates through an algorithm that responds to supply and demand in each market.

Compound was my introduction to DeFi and I do still like to check in on it from time to time. It has an eye watering $2.2 billion dollars worth of assets locked in as collateral earning interest from 3% up to a frankly astonishing 34% for USDC on the Base chain at time of writing.

That being said, Compound is very much an elder statesman in the DeFi world. Its underlying smart-contract code, being open source, has been duplicated and modified thousands of times in a Cambrian explosion of DeFi dApps and there are now many ways that an asset manager can lock in significant compound growth strategies for their clients assets.

for instance...

Beef up your money

Beefy Finance is a decentralized finance (DeFi) yield optimizer that helps users earn returns from their crypto assets through a process called auto compounding. As an asset manager, you could leverage Beefy to maximize yields for your clients in a safe, decentralized manner.

Beefy utilizes "vaults" and "strategies" built on smart contracts to automatically claim, swap, and redeposit rewards from various yield farming opportunities like liquidity pools and automated market makers. This auto compounding process exponentially increases returns over time compared to manual farming. By aggregating users' funds into these vaults, Beefy is able to compound rewards much more frequently than individuals could on their own due to lower gas fees.

Another key advantage is that Beefy supports over 18 blockchain networks like Ethereum, Binance Smart Chain, and Polygon. This cross-chain functionality allows asset managers to optimize yields across multiple protocols and chains simultaneously.

For users and their asset managers, Beefy provides a simple interface to access this powerful yet complex system of auto compounding without the risks of manual yield farming. Returns are maximized while removing the time commitment of monitoring opportunities and compounding manually. Beefy's model of decentralized governance also gives users a voice in the protocol's development.

Crypto loves its farming metaphors.

In Conclusion...

The power of compound interest cannot be overstated for growing wealth over the long term. Whether investing, managing assets, or dealing with debt, harnessing the effects of compounding is key. As this essay has shown, modest regular sums invested for decades can snowball into life-changing portfolios through the miracle of interest on interest.

For crypto asset managers, powerful DeFi protocols like Compound and Beefy provide new ways to generate yields from client funds. By allocating capital across lending pools, liquidity pools and automated market makers, returns can be optimized and automatically compounded more frequently. This transforms the role of asset manager from passive allocation to creating revenue streams all while maximizing growth. With governance tokens also granting users a say, the disintermediated and trustless nature of DeFi is a natural fit for digital assets.

Looking ahead, as adoption increases and blockchain networks scale, the opportunities for compound growth will multiply. New protocols being built on Ethereum and beyond will create additional use cases and yield opportunities across decentralized finance. Asset managers able to navigate this evolving landscape stand to reap great rewards.

The takeaway is clear. Start practicing good financial habits like regular investing and avoiding high interest debt. Seek out advisors focused on long-term compound strategies. As technologies advance, stay educated on innovations in digital finance and look for trusted partners. With diligence and patience, modest investments can blossom into fortunes through the miracle of compound interest.

I encourage you to share this essay with others who may find its message useful. You can also follow/subscribe for more insights on crypto, DeFi and the future of digital finance. Together, through education and innovation, we can harness technology like never before to transform our financial futures.

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