Exploring the Challenges of Decentralized Finance with Hendo Verbeek

One of the core challenges of participating in DeFi is mitigating risk. For example, losing one's entire principal can happen through Exploits, Economical Hacks, or Protocol Losses. 

This challenge affects the DeFi ecosystem heavily since it makes big participants hesitant to onboard and creates uncertainty among users regarding the risks they are exposing themselves to.

I am speaking with Hendo Verbeek, Head of Risk at Spool DAO, and in this interview, we will discuss the challenges of decentralized finance (DeFi) and how they impact the DeFi ecosystem.  

We will also discuss how institutional investors can manage their risk effectively when investing in DeFi, and why it is crucial to prioritize risk management. 

Additionally, we will explore the key factors driving the DeFi investment and trading activity surge and how sustainable this trend is. We will also cover the biggest misconceptions about investing in digital assets and how investors can separate fact from fiction. 

Lastly, we will talk about how DeFi platforms can help institutions and users build more risk-managed DeFi portfolios and the recent failures in the blockchain industry. Ultimately, we will provide advice to investors looking to enter the DeFi market for the first time and how they can manage their risk effectively.

Can you explain decentralized finance's challenges and how they affect the DeFi ecosystem?

The core challenge of participating in DeFi is mitigating risk. Whereas normally mitigating risk refers to mitigating drawdown (and the holistic approach of minimizing the potential loss), in DeFi, the core goal becomes minimizing the probability of losing "your entire principal." Losing one's entire principal can happen through Exploits, Hacks, Economical Hacks, or Protocol Losses.

This particular challenge affects the DeFi Ecosystem quite heavily since it makes big participants hesitant to onboard and creates a lot of uncertainty among users regarding what kind of risks they are exposing themselves to.

What steps can institutional investors take to manage their risk effectively when investing in DeFi?

First, it's crucial to carefully investigate the DeFi initiatives and networks before committing any money. This entails investigating the projects' teams, histories, technologies, procedures, and conformance with regulations. Doing your homework can help you avoid unpleasant surprises and make sure the endeavor is a good match for your financial goals and level of risk tolerance.

The importance of diversification cannot be overstated. Diversify your DeFi holdings by investing in multiple commodities and procedures. By doing this, you may lessen your vulnerability to market swings and the failure of a single component.

Furthermore, risk management instruments can be extremely helpful in assisting with efficient risk management. For example, DeFi systems provide users with various services, such as real-time market tracking and analysis, risk rating and analysis tools, and portfolio adjustment options. These resources can aid traders in spotting and minimizing dangers to their assets.

Also, make sure your assets follow any DeFi-related laws by staying abreast of legislative changes. This can lessen the likelihood of future judicial or governmental involvement.

Finally, consult with knowledgeable DeFi investors and experts for advice and assistance on risk management. In addition to keeping you abreast of the latest market advancements and trends, they can provide invaluable input and advice on financial strategies and risk management practices.

Can you discuss risk management's role in DeFi, and why institutional investors must prioritize it?

Retention of assets is almost always more important than generating profits on said assets. Think of the simple example where a 50% loss means you'd have to make 100% profit to get back equal to where you started. The simple mathematical logic behind this ensures that mitigating losses is more important than generating profits, especially on a bigger scale. 

What are the key factors driving the DeFi investment and trading activity surge, and how sustainable is this trend?

During the inception phase of DeFi, most of the driving force was speculation and willingness to take a risk. With what has happened in the banking sector, the activity surge is mostly related to the transparency DeFi offers to the end investor. Therefore, the trend of demanding ultimate transparency regarding your assets is quite sustainable, with an eye on recent global economic developments.

What are the biggest misconceptions about investing in digital assets, and how can investors separate fact from fiction?

The biggest misconception all-in-all is that crypto itself is just investing for the sake of being able to sell "to the bigger fool." This concept does apply to certain investments / Crypto Projects, but there is a giant wave of legit development in crypto that is worth keeping an eye on. DeFi specifically: AMMs, Decentralized Exchanges, Decentralized Lending Protocols, Decentralized Oracles, Decentralized Derivative Products, and Decentralized Yield Generation. 

Separating the facts from the fiction is most easily done by asking, "Does what I am investing in create a usable, sustainable, and legit product, or is its core purpose increasing in value." 

How can DeFi platforms help institutions and users build more risk-managed DeFi portfolios?

By providing clients with a wide variety of tools and services, DeFi platforms can play a pivotal role in assisting organizations and consumers in constructing better risk-managed DeFi portfolios.

DeFi platforms play a crucial role by giving users access to numerous DeFi protocols and goods, enabling investors to spread their risk across numerous asset classes and management philosophies. By reducing reliance on any one commodity or procedure, this diversity can help to lower overall risk.

The use of data analytics and risk management tools to assist clients in evaluating and controlling risk is another critical component. For example, DeFi systems can provide real-time market tracking and analysis, risk rating, and other measures to aid buyers in making educated financial choices.

Can you discuss the recent failures in the blockchain industry and why they were not due to issues with the underlying blockchain or DeFi infrastructure?

There are plenty of examples, but let me speak on my favorite: LUNA. I participate in the LUNA craze by shorting UST, their synthetic stablecoin, which, by logic, would never trade above $1: Making it a strong sell-side asset. 

Why was LUNA unsustainable, you might ask? The simple fact is that LUNA had ballooned to a size much larger than the potential "exit gateway." Whenever you find yourself in a scenario where $100 in assets is being "protected" in value by a gateway the size of only $10: One can safely assume that at the slightest sight of uncertainty, the system collapses.

What advice would you give investors looking to enter the DeFi market for the first time, and how can they manage their risk effectively?

It is recommended that individuals new to the industry conduct thorough research and acquire extensive knowledge about the field. Comprehending the fundamental principles and concepts of DeFi and its distinctions from conventional finance is of utmost significance. In addition, acquiring knowledge about various DeFi protocols and their respective functionalities is imperative.

When it comes to risk management, it is crucial to begin with, modest investments and refrain from committing funds beyond one's capacity to absorb potential losses. In addition, it is crucial to ensure portfolio diversification and avoid concentration risk. The DeFi market is characterized by volatility and rapid changes, necessitating the need to stay abreast of industry news and developments and to be ready to make investment adjustments as necessary.

Thoroughly scrutinizing the DeFi projects under consideration for investment is a crucial aspect of risk management. Therefore, it is advisable to seek out undertakings with robust teams, established track records, and a well-defined outlook for the future. In addition, it is imperative to consider variables such as liquidity, security, and regulatory compliance.

What are the biggest regulatory challenges facing the DeFi industry, and how can they be addressed to promote more widespread adoption?

The first and foremost "challenge" seems to be avoiding the securitization of every "real yield" generating asset, which is less so a challenge that requires addressing and more so a challenge that will be solved through free market competition. 

Any government that stands against that logic will effectively nullify its ability to become a "Crypto Hub," which, given the growth we have seen in the industry, is more so a problem for said government than it is for us directly.

Looking to the future, how do you see the DeFi landscape evolving in the next 5-10 years, and what role will risk management play in this evolution?

DeFi will slowly take the role of "unbanking the bank" when I get around to purchasing my first real-life property. I never had to sell a single dollar of my crypto holdings. Instead, I spread out my holdings in various DeFi lending protocols, borrowed stablecoins against my crypto, and off-ramped the stablecoins. 

A prime example of how DeFi can be used without the interference of a counterparty (the exception being the off-ramp in my example) to hold a certain degree of exposure while still facilitating the ability to 'live your life unbanked.'