Smart contract account abstraction and vaults are a useful and very logical path for many projects offering web3 investment (inc fund/asset) management tools.
It is something which we considered but dismissed very early on. Here's why.
Despite first appearances, we don't consider Account Abstraction and Vaults to be a digitally primitive product in the context of investment management. It does not remove the need for a management layer, which almost certainly requires regulation. This tends to skeuomorphism and the resulting businesses and products are the same as their traditional predecessors with a variation on technical implementation.
When one party manages someone else's money or makes investment decisions on behalf of an investor, that party needs to be regulated. There is simply no getting around this. Regardless of what technology is used, if it is clear that investment decisions are being made and applied to someone else's funds, this is discretionary investment management and this is a regulated activity.
In Account Abstraction, the investor deposits funds into a smart contract account that they are the owner of. In the context of a vault, they then delegate the ability to operate to another account or smart contract. This is effectively a programmatic Power of Attorney and it saves the investor having to sign (authorise) every transaction.
However, it means that the investors do not decide how their funds are invested and do not originate the execution of any trades themselves. While technically the transaction is issued from their account, it is done so by an authorised agent, not themselves.
Responsibility for the strategy application (management) and the origination of the execution lies with a manager whether that role is fulfilled by code or real person(s).
There are three key tests:
- who/what role makes the investment decision?
- who/what role determines the value of the investment decision?
- who/what role originates the trade execution instruction?
If the answer to any of these questions is not the Investor, then regulation of the party that does is highly likely.
Account Abstraction/Vault Roles and Responsibilities
| Strategy Provider* | Vault Manager* | Investor |
| - Provide the investment strategy to the manager - Independent of and with no awareness of the end investor | - Overall responsibility for strategy performance - Determine the size (allocation) of a trade that should be applied to an investor's funds - Initiate the trade on the client's funds | - Deposit and/or withdraw funds - Delegate authorization |
| Regulation not required | Regulation Required | Regulation not required |
* These roles are often combined
Often there is no intention at all to hide that investment management is taking place, despite a lack of regulation. Here are two examples where the intent to manage investments and to profit from doing so is very clear:
- https://tradingstrategy.ai/strategies/enzyme-polygon-matic-eth-usdc/fees - note the reference to 'management fees'
- https://flagship.fyi/ - “No time to manage your crypto….someone is watching your positions…”
Investment management is a regulated activity. Any service that manages money, makes investment decisions, applies strategies or initiates trades on behalf of users will almost certainly need to be regulated.
Is being regulated so bad?
Regulation has an important role to play and is absolutely necessary to protect investors investing in traditional investment products.
It's also important to note that we are excited about the possibilities of Account Abstraction & Vaults.
Our concern is that because regulation is a likely outcome for investment products using Account Abstraction & Vaults, these products will either be only run by regulated and traditional firms or the regulatory burden will limit otherwise innovative startups.
If regulation is indeed required, then the following is likely:
- Investors will need to be KYC'd, together with AML, PEP checks etc run by a centralised party
- this is likely to result in products being made available to only investors in certain jurisdictions
- there will be no anonymity
- Strategy providers and strategies will need to be vetted and approved by a centralised party
- no longer is the service permissionless
- investors may need to pass suitability checks before being able to access a strategy
- The increased costs of operating this service are likely to result in a minimum investable balance
- this restricts who can access
- it becomes more cost effective to have fewer investors with larger balances
So if a DeFi product is skeuomorphic and requires regulation, then a traditional business will result.
The 'new' web3 investment management will look very similar to 'old' investment management and the opportunity to genuinely change the system will be lost.
And the only way to create that new system, a fully decentralised web3 native system, is to completely remove the need for a management layer which in turn removes the need for regulation.