Does the World Need a Cryptocurrency Robo Advisor?
Michal is CEO at Empirica that provides software for insitutional crypto investors
What is a Robo Advisor?
First and foremost let’s get our definitions together. Robo Advisors a.k.a automated investment advice tools are online platforms that through a digital risk assessment questionnaire determines the risk suitability of investors and based on that risk category, they propose an appropriate investment portfolio.
These investment portfolios are for example constructed using mean-variance
, a Nobel prize-winning method introduced by Harry Markowitz. Then via online portals or mobile apps, investors get to receive a real-time valuation of investment portfolios.
Most Robo Advisors charge based on a percentage of the assets they are managing, i.e. 0.75% of portfolio value. This practice is regulated and requires a license.
The first Robo Advisor was introduced by John Stein, the CEO and co-founder of Betterment
. The firm is one of the most successful and well-known Robo Advisors up to this day.
Initially, Robo Advisors were designed to automate the process of investment management with a passive approach to it. Robo Advisors aims to reduce the operational costs hence the fees investors pay for portfolio management.
They did successfully accomplish that. According to reports Robo Advisors’ market share by 2020 is expected to be USD 2.2 trillion.
What is the current situation worldwide?
Robo Advisors as a service has been used on a global scale. Though, there is definitely a different scene running in different parts of the world, for instance comparing the US market with Europe.
The US retail market has shown much more interest and trust in using these computer programs to manage their money. This has alone made the US the source of innovation for Robo Advisors considering the competition between some heavyweight financial institutions trying to take a bite from the market share such as Vanguard or Charles Schwab and very bright startups such as Betterment, Wealthfront and Acorns.
In Europe, not so much, yet. The UK is perhaps the leading market with the presence of Nutmeg, Moneyfarm and Wealthsimple.
Across other countries in Europe, German’s Scalable Capital is the biggest player, with EUR 1 billion in assets under management compared to USD 16.1 billion (EUR 14.47 billion) managed by Betterment.
Industry experts speculate that 2020 is to be the year when there will be more launches of hybrid and fully automated Robo Advisors in Europe.
Whether they will be successful really depends on their go-to-market plan and learn the hard reality from the Robo Advisors graveyard that customer acquisition COSTS.
Startups vs Incumbents
Though we have witnessed more retails banks getting involved and launching an automated investment management service for mass affluent investors (customers with having less than USD 100K of investable funds). The service is being delivered as part of the online/mobile banking app.
Another entry channel that can be seen with the market is the joint cooperation between some of the neobanks with online advice tools. N26 customers can integrate their accounts with Ovalmoney and invest their funds into some Exchange Traded Funds (ETFs).
Although Ovalmoney is not providing financial advice per se, it makes investment portfolios (ETFs) available for its users, but the concept of such collaboration potentially could be seen more across the market.
Robo Advisor for Cryptocurrencies?
The past, present and future of Robo Advisors are analyzed by research institutes and there are already many research papers and market analyses available.
We want to answer a more challenging question: does the Cryptocurrency market also need a Robo Advisor?
One common attribute amongst all Robo Advisors is the passive nature of them, they are meant to be managing investors’ assets very cautiously with minimizing the risk to maintain a solid, continuous and long term returns for investors.
This statement alone could reject the idea of having Robo Advisors in the crypto world, considering the wild nature of Cryptocurrencies with high volatility and unexpected fluctuations.
But hold on, there is more to it.
Robo Advisors in the capital market are hugely bundled with ETFs. All ETFs contain a basket of investments that can include stocks and bonds. An ETF typically tracks an underlying index such as the S&P 500 but can follow an industry, sector, commodities, or even currency.
An ETF price can increase and decrease just like other investments. These products trade throughout the day just as a stock would trade.
ETFs are put together to have controlled risk and provide underlying shares to investors with lower costs and lower fees than the assets included in the basket.
All together, Robo Advisors and ETFs were a match made in heaven and each contributes to one another’s growth.
So you are probably thinking about it already, we need to wait until we have ETFs-like investment vehicles in the Cryptocurrency market and then we can say Robo Advisors can enter the Cryptocurrency world. No, this is not when we end this article.
What if there are ETFs-like instruments in the Cryptocurrency market?
Digital Asset tracking instruments
There are very similar products to ETFs that are called Exchange Traded Products
(ETPs). These instruments track underlying securities, an index, or other financial instruments. ETPs also trade across exchanges like stocks meaning their prices can fluctuate from day-to-day and intraday.
ETPs can be benchmarked to myriad investments including commodities, stocks, bonds or Cryptocurrencies. However, the prices of ETPs are derived from the underlying investments that they track. The low-cost structure of ETPs has contributed to their popularity.
In December 2019 a series of regulated cryptocurrency ETPs have been listed for investors. Amun technology a company focused on creating digital asset tracking has received the required license to list their cryptocurrency-based ETPs.
Investors can invest in crypto ETPs easily, safely and in a regulated framework. EU member state regulator has cleared a base prospectus filed by the firm.
With that, EU retailers who have access to the Swiss SIX and Germany’s Boerse Stuttgart exchanges can now trade various crypto-based ETPs offered by Amun.
One challenge that remains for the market and the ETP providers is to keep liquidity for the indices they launch. Market liquidity across Cryptocurrencies, especially alternative coins (all non-bitcoin coins).
There are specialized parties, called market makers using sophisticated tools for providing offers for both sides of order book. The tool, called also market making bot
makes sure make sure such coins or indices have sufficient liquidity to attract investors or financial advisors.
Regarding the trading automation in crypto space this is developing very rapidly with many different crypto trading bots
that improve the trading operations of this alternative asset class.
What about technology?
A well-integrated, modular platform that has an open mechanism for further integration and customization might be needed to finally push this idea of crypto Robo Advisor. It sounds complicated, but the solutions already exists.
The integration to the market as well as the ability to include a variety of financial instruments within the custom made portfolios are what is required to deliver cryptocurrency-based instruments.
With the likes of Empirica’s white-label Robo Advisory solution that is built on top of algorithmic trading platform that plays the role of a bridge that connects our Robo Advisory solution to broker/custodian and market data providers.
Technically all portfolio management configuration, risk assessments and rebalancing are done through the Robo Advisor components and through the algorithmic trading software
it automatically sends the orders for designated investors and once successfully executed. Then the algorithmic trading platform sends the information back through our APIs and portfolios are updated.
Price measures(a sale above the bid price, or a buy below the offer price) is also very important for automated portfolio management.
Robo Advisor technologies that are equipped with smart order routing
monitor execution of all orders across different trading venues and determine whether investors receive the best possible price at the time the trade is placed.
What about custody?
Each Robo advisors have a custodian bank that actually holds investors’ money. Custodians add an extra level of security and regulation.
Custodians are specialized financial institutions responsible for safeguarding a firm's or individual's financial assets.
Is there any custodian that supports Cryptocurrency?
There are cold storage custody services in the Cryptocurrency market. Most famous ones are offered by rather bigger Cryptocurrency exchanges such as Coinbase and Gemini.
There are two main issues with such custody services, one is that within the traditional market custody services providers allow third-party systems like Robo Advisors to create custody accounts for investors via API and Custodies like Gemini and Coinbase do not.
The second issue comes with API enabled executions which cold storages at this point do not provide that access, yet.
With the news of crypto ETPs on Six Group from Switzerland, we know the custody service from here is also sorted out. SIX SIS is the central securities depository for the Swiss financial market, while also acting as a depository for international securities.
It also offers issuer, clearing and settlement services as well as asset servicing in a variety of combinations.
On the other side of the world, the Japanese bank Nomura has also been preparing to launch a custody service for digital assets in partnership with Ledger.
Their solution is predicted to launch next year. Germany also recently passed a law, effective Jan. 1, 2020, which would allow authorized companies to offer crypto services, including custody.
The three main criteria for Cryptocurrency Robo Advisors to operate are listed in this article:
- risk-controlled and low cost instruments like the ETPs,
- the technology with an open mechanism for integration and portfolio construction and
- custodial service to run secure and regulatory-friendly operations.
Seems like the pieces are there to complete the puzzle.
Ideally, a combination of digital ETPs and traditional ETFs into a single portfolio would be the goal to balance out the risk as well as not missing the opportunity on the exciting Cryptocurrency market.
We do think the crypto market needs a Robo Advisor, perhaps the entrance could be either a new launch with a combination of assets with non-digital assets or the current Robo Advisors will start including Cryptocurrencies as part of their portfolio offerings.
(Disclaimer: The authors, Hanif and Michal, are working at Empirica)
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