Blockchain-Based Mutual Fund with Automated Performance Fee Calculation and Investor Protection

Core Concepts

This article presents innovations to bring the best practices of traditional investment funds, such as mutual funds and hedge funds, to the blockchain landscape. The key innovations include regularly updating fund prices like mutual funds, charging performance fees like hedge funds, and incorporating investor protection schemes like high water marks.

Abstract

The article starts by providing an overview of modern investment funds, highlighting the key differences between mutual funds and hedge funds in terms of investment strategies, fee mechanisms, performance benchmarks, and investor inflow/outflow. It then discusses the motivations for bringing such investment vehicles to the blockchain realm and the challenges involved.
The core innovations presented in the article include:

Periodic Blockchain Fund Management Methods:

Accepting deposits and withdrawal requests from investors
Calculating the fund's net asset value (NAV) or price
Levying management fees and performance fees

Automated Performance Fee Levy Techniques:

Addressing the challenges of performance fee calculations in a decentralized environment
Maintaining high water marks during periods of low market prices
Calculating performance fees across aggregated investor positions or separate positions

Investor Protection Mechanisms:

Limiting the maximum deposit and withdrawal amounts per rebalancing event
Allocating redemptions proportionately to avoid market runs and liquidity issues
Distributing the price appreciation and depreciation when investors enter or exit the fund

The article also discusses the numerical results and illustrations to demonstrate the effectiveness of the proposed innovations. It highlights how the concepts developed for blockchain implementation can also be useful in traditional financial funds to calculate performance fees in a simplified manner. The ideas presented illustrate the symbiosis between decentralized and traditional finance, where blockchain can solve issues faced by the traditional world, and innovations from traditional finance can benefit decentralized finance.

Stats

"The total number of tokens now includes the tokens burned or minted for the amount, RBLNCSLIPPAGEt, that were removed or issued."
"RBLNCSLIPPAGEt = |RBLNCPROCEEDSt| - |NETAMOUNTEV ENTt|"

Quotes

"To be able to accommodate these complexities we have found a novel solution that works elegantly - is rather straightforward to implement as a smart contract - and provides the same level of protection to every single investor."
"The concepts we have developed for blockchain implementation can also be useful in traditional financial funds to calculate performance fees in a simplified manner."

Key Insights Distilled From

The Democratization of Wealth Management: Hedged Mutual Fund Blockchain Protocol

by Ravi Kashyap at arxiv.org 05-07-2024

https://arxiv.org/pdf/2405.02302.pdf

Deeper Inquiries

How can the proposed blockchain-based mutual fund model be extended to incorporate other innovative features, such as dynamic asset allocation or automated rebalancing strategies?

The proposed blockchain-based mutual fund model can be extended to incorporate dynamic asset allocation by implementing smart contracts that automatically adjust the portfolio composition based on predefined criteria. This can involve setting rules within the smart contract code that dictate how assets should be reallocated based on market conditions, risk tolerance, or other factors. For example, if a certain asset in the portfolio exceeds a specified threshold, the smart contract can trigger a rebalancing event to bring the allocation back in line with the desired targets.
Automated rebalancing strategies can also be integrated into the model by programming the smart contracts to periodically review the portfolio's asset allocation and make adjustments as needed. This can help maintain the desired risk-return profile of the fund and ensure that it stays aligned with the investment objectives. By setting rules for when and how rebalancing should occur, the fund can adapt to changing market conditions and investor preferences without requiring manual intervention.

What are the potential challenges and limitations in implementing the high water mark and performance fee calculation mechanisms on a public blockchain network, and how can they be addressed?

Implementing the high water mark (HWM) and performance fee calculation mechanisms on a public blockchain network can pose several challenges and limitations. One key challenge is the scalability of the blockchain network, as processing a large number of transactions for fee calculations can lead to high gas fees and slow transaction speeds. To address this, optimization techniques such as batch processing or off-chain calculations can be employed to reduce the computational load on the blockchain.
Another challenge is ensuring data privacy and security, especially when dealing with sensitive financial information related to performance fees and investor transactions. Implementing robust encryption and access control mechanisms within the smart contracts can help protect the confidentiality of the data and prevent unauthorized access.
Additionally, the transparency and immutability of blockchain transactions can make it challenging to make adjustments or corrections to fee calculations once they are recorded on the blockchain. To address this, a thorough testing and validation process should be implemented before deploying the smart contracts to ensure accuracy and reliability in fee calculations.

Given the symbiotic relationship between decentralized and traditional finance highlighted in the article, what other areas of traditional finance could benefit from blockchain-based solutions, and how can the integration of these two realms be further facilitated?

Several areas of traditional finance could benefit from blockchain-based solutions, including trade finance, supply chain management, and regulatory compliance. Blockchain technology can streamline trade processes by providing a secure and transparent platform for tracking goods, verifying transactions, and reducing fraud. In supply chain management, blockchain can enhance traceability, efficiency, and trust among participants by creating a tamper-proof record of product movement.
To further facilitate the integration of decentralized and traditional finance, collaboration between industry stakeholders, regulatory bodies, and technology providers is essential. Establishing common standards and protocols for blockchain implementation, promoting interoperability between different systems, and fostering education and awareness about blockchain technology can help bridge the gap between these two realms. Additionally, regulatory frameworks that support innovation while ensuring consumer protection and market integrity are crucial for the successful adoption of blockchain solutions in traditional finance.