Financial advice — wait, really? • Letter #92

Hedgehog Admin -

Hi, Colton here again. In case you missed it, I introduced myself last week:

I'm Colton Dillion, cofounder of Hedgehog alongside Taylor and my brother Jason. My main job title is CTO, but I'm also Chief Compliance Officer, CFO, and our Registered Investment Adviser Representative (or registered rep). That's a lot of jargon but to put it simply, I'm responsible for all the infrastructure at Hedgehog: technical, regulatory, and financial.

As the company's registered rep, I'm stepping in for Taylor so the newsletter can evolve as Hedgehog-the-product evolves. Don't worry, we're not going full promotional — there will still be crypto news to discuss (because there is always crypto news to discuss), but since we're giving financial advice, it's helpful to have the right registrations to talk about the nitty-gritty.

It might feel disconcerting for someone to waltz in and say, actually I am offering financial advice; usually you hear the opposite! And for very good reason, because the legal ramifications can be brutal (yes, that's almost 30 years of people who have had their pants sued off them, or an orange jumpsuit sued onto them).

Which reminds me, an obligatory disclaimer: I’m not offering financial advice to you per se, but more of a general, non-specific financial advice for large audiences. YMMV and you should really hire us if you want financial advice tailored to your goals. To get a broader sense of the legal guidelines, you can read a brief description of what it means to be a registered rep on FINRA's website or a longer one from the North American Securities Administrators Association.

Now that we've taken care of that, let's discuss how financial advice is integrated into Hedgehog's product.

Bona fide tips

To be clear, I'm not sitting down with people individually to give them suggestions based on my own opinions. Of course, I think my opinions are pretty good — if I didn't, I would change my mind! But an opinion ain't enough to go on when it comes to other people's money. I would rather use a combination of reliable data and long-standing best practices to guide the suggestions we make to clients. Sounds boring, but this is an area where boring is good; we can leave the excitement to the headlines.

We used to describe Hedgehog as a portfolio manager, because that's what we created our tools do — manage your portfolio. In other words, we made it convenient for you to act on your investment decisions. That aspect of Hedgehog isn't going away, but with v2 we're layering on advisory services that hit the trade button for you, even while you're sipping on mojitos or catching up on YouTube. We're becoming your crypto concierge.

Specifically, Hedgehog 2.0 is a roboadviser, which is what it sounds like: a robot that gives you investing advice. Crucially, the robot doesn't make up advice out of thin air; we programmed our algorithms to follow the principles of modern portfolio theory, which is the investing paradigm pioneered by Nobel Prize-winning economist Harry Markowitz (whom I had the pleasure to work with at Acorns), and operationalized by index fund creator John Bogle. His firm Vanguard revolutionized retail investing, thus the entire finance industry, and is still thriving today.

A central tenet of modern portfolio theory is that you can get higher quality returns with lower risk by mixing the types of assets you buy. Sometimes this looks like "buying the market," for example by investing in an index fund that tracks the S&P 500. You can own a piece of all the most successful companies, in accordance with how successful each one is. You can grow with the small guys who still have a lot of room to win hearts and minds, while still sheltering under the stability of the big guys who are unlikely to suddenly go bust. Buying the market is usually simpler, easier, and less expensive than active investing (though of course you can still do both).

Trying to pick and choose winners is risky, and requires dealing with larger losses and more volatility than most people can stomach, unless you're in a specialized field like venture capital. If you choose five projects that you think are promising, and three go the way of the dinosaur, such a loss can tank your whole portfolio even if the other two are fairly successful. The problem is too few eggs, not enough baskets. Solution? Diversify, with index-style investing being one of the best methods for most non-pros.

We designed the Hedgehog roboadviser to bring modern portfolio theory to crypto, without the hassle of cumbersome and tedious spreadsheets. Bonus: instead of getting a piece of something like an exchange-traded fund (commonly just "ETF"), we help you automate the balance of your portfolio so that you still own the underlying assets directly. In other words, you have your own BTC, ETH, or [insert latest DeFi hotness here], that you can withdraw at any time to a wallet you own, rather than getting it stuck in some fund of which you own a fraction.

Hedgehog offers the best of both worlds, taking the parts of TradFi that work well and applying them to DeFi. To give this a whirl, sign up to beta test the app. In the meantime, you can whet your whistle with some interesting tidbits about other roboadvisers…

Helpful moneybots

Who is using them?

According to the latest MagnifyMoney survey [in 2022] of nearly 1,600 Americans, nearly two-thirds (63%) of consumers are open to using a robo-advisor to manage their investments. Perhaps because they grew up at the onset of the digital age, Millennials are the most open of all the generations at 75% of respondents, compared to just 43% of Baby Boomers.

Additionally, men (69%) are more likely to consider using a robo-advisor than women (58%). Also, the higher one's income, the more open they are to using a robo-advisor. In this case, six-figure earners (56%) and Baby Boomers (50%) are most likely to have one. Only 32% of those who make $100,000 or more say they are not open to using one. Robo-advisor services are generally less personalized, so it’s interesting that the highest earners — likely those who can invest the most — are more open to it, the authors observe. Yet, despite this willingness, the survey also found that just 1% of respondents with investments say they use a robo-advisor.

Should roboadvisors use AI? Not necessarily:

"We haven't used machine learning [in our consumer-facing robo-advisor product] for a very specific purpose, because it hasn't really addressed a core problem that we felt like machine learning could directly address in effective ways," Mychal Campos, Betterment's senior director of investing, told us in an interview. "Us not using it doesn't mean we didn’t put the research into it. We did, and we found that, actually, we have much simpler approaches, which actually are more effective." [...] AI-based portfolio optimization resulted in lower expected returns.

Lastly — for now — an intriguing question from the Brookings Institute: "Robo-advice: An effective tool to reduce inequalities?" Maybe:

Robo-advisors collect and analyze large amounts of transactional data and provide individuals with suggestions on how to improve their choices. Depending on the soundness and appropriateness of the algorithms they employ, robo-advisors have the potential to improve households' decisionmaking considerably.

Quick hits

Recently the DeFi project Euler Finance was hacked for $197 million. After a delicate combination of pleading and threatening the hacker, 90% of funds were returned, in installments. The last chunk was just delivered back.

This would never happen in TradFi — not least because, while it would be an overstatement to say it's impossible to hack a bank, doing so is not as straightforward as pwning even a complex smart contract. (Arguably, the more complex the more pwnable.) But what's really astounding is that Euler's recovery strategy worked:

To retrieve the stolen funds, Euler Finance offered the attacker a 10% bounty worth $19.7 million, with a warning to initiate a $1 million reward for information on the attacker if the remaining 90% of the funds were not returned.

As Taylor has said before, another day, another digital dollar, another DeFi hack. It's nice that this one got a happy ending (relatively speaking).

Investor Li Jin writes that emotional ownership is the missing ingredient for many crypto projects, and the secret to the ones that do take off. That feeling of "mineness," of not just financial but personal investment, is what makes people decide a .jpeg or .png file is worth millions. Sure, the cryptographically provable ownership of a scarce instantiation of that image is the tangible asset being sold — but without the image's symbolic link to a culture of recognition and participation, there's no point. It's memes all the way down, baby.

Eugene Wei:

A lot of crypto projects have established ownership de jure (via tokens) before de facto ownership. It's structurally simpler in many ways, it's an engineering problem. But it leaves a huge door open for speculation to overrun everything.

On the flip side, when people do genuinely care about a project, magic happens.

Giveaway

Look at this beautiful merch snapshot kindly sent to us by a winner. That could be you! Reply to this email with your answer to the question below to enter the giveaway.

Question of the week: What's a project, community, or business that you genuinely care about? Doesn't have to be crypto.

Keep hedging,
Colton

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