Series Introduction
In this series, we will look at the practical implications that Ethereum Layer 2 solutions can bring to the financial services industry, i.e. faster and cheaper trading and settlement, payments, investing, lending and borrowing, etc. In part 1, we explored the impact of Layer 2 on crypto brokers & exchanges. Now we will look at its effects on institutional investors.
Part 2 - Institutional Investors - Investment Managers and Funds
With Gas Fees This High, Who's Still Trading?
Trading Digital Assets on Ethereum is becoming cost-prohibitive for most investors. Gas fees on Ethereum have been reaching historic highs with alarming regularity. With Uniswap fees of $300, for instance, it begs the question of who is still using Ethereum for trading. Retail investors are moving away from Ethereum to Layer 2 solutions and other Layer 1 networks.
SushiSwap, an alternative DEX (decentralised exchange) to UniSwap, reported that it had over 15,000 active wallets on Polygon compared to its Ethereum based deployment, which only has 4,194 active wallets.
While retail investors are moving to Layer 2 solutions in droves, until recently, the ‘whales’ and large funds have stuck with Ethereum as they actually benefited from the high fees. The value of Ethereum continues to rise, the APY offered in yield continues to rise, and the only entities able to profit on the network are those high-volume, low frequency block traders.
Long funds rarely rebalance their asset baskets so the fees can be absorbed easily, especially as they hold on to a crypto asset typically from 3+ months. For new DeFi yield farming and index funds, though, the appeal of layer 2 DeFi trading is catching their attention.
Why Move To Layer 2?
In the early stages, there weren’t enough DeFi protocols on Layer 2 to make the move interesting to institutional investors. Now though Uniswap, SushiSwap, Aave, and more DeFi protocols have migrated to Layer 2 bringing with them a majority of retail investors and traders.
The benefits of moving to a Layer 2 solution depend on the type of fund being managed, but one benefit they can all enjoy is the return yield from deploying capital on Layer 2 protocols. With retail traders taking advantage of micro-lending, yield farming and token swaps, there is a demand for liquidity providers and the yield generated from that is a high growth opportunity.
The protocols themselves are also adding incentives to bring investors across. As an example earlier in this year, Polygon Matic launched a $40 Million liquidity mining program with Aave distributing the additional rewards to providers.
For certain types of institutional investors like index funds or hedge funds with the need for high-frequency re-balancing, Layer 2 solutions will be required, eventually. The high fees on Ethereum’s main network will affect the funds' margins and profitability. If the trading fees are passed on to the clients rather than absorbed by the management fee, then it reduces the returns on investment and may drive clients to other options. This is one reason Polygon has seen rising demand from Institutional Investors over the past year.
Long funds, however, that re-balance their assets infrequently won’t see much utility in the Layer 2 ecosystem other than from capital deployment. It will be these funds that remain on Ethereum’s main network being able to absorb those fees without it impacting the margins significantly.
How To Access Layer 2 DeFi
If you are an Institutional Investor, a fund, or Investment manager, Layer 2 solutions offer some new high growth opportunities, but accessing them whilst maintaining security and accountability can be a challenge.
Not all digital asset & crypto custodians have Layer 2 compatibility and choosing the right custodian wallet can reduce the risks associated with DeFi trading. Trustology’s TrustVault platform has bank grade security, private key insurance and the ability to set custom rules and policies with our DeFi Firewall technology, we are also fully FCA registered. Our MetaMask extension allows for fast access to hundreds of DeFi protocols and we are piloting access to Layer 2 solutions like Polygon matic, Arbitrum, and Optimism, right now. If you would like to find out more, why not talk to us.
Related readings
The DeFi upgrade you can’t afford to miss
TrustVault the safest crypto account for institutional investors
How to earn interest in DeFi with TrustVault & MetaMask
How to send transactions using MetaMask & TrustVault
Decoding an Ethereum Transaction
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