Modular Asset Management, a licensed, $1 billion macro hedge fund in Singapore, is pursuing an investment strategy into blockchain smart-contract protocols that is organized around principles of sustainability.
Matthew Cannon, COO and co-founder of Modular (pictured, left), says the ultimate goal is to establish a fund that can take third-party money from conservative institutions such as sovereign wealth funds and pension funds.
“We feel we can apply our institutional knowledge and bring in our crypto expertise to ride two trends: blockchain and ESG,” Cannon told DigFin. “That confluence has yet to be widely recognized.”
Although Cannon and his partner, investor Jimmy Lim, have made personal investments into crypto, the expertise he cites for the strategy Modular is developing comes from Lightbulb Capital.
Dan Liebau (pictured, right) founded Lightbulb as an investment and advisory firm looking at innovative startups in financial technology; Lightbulb soon gravitated to blockchain.
A former COO at HSBC Securities in Singapore, Liebau was familiar with electronic trading technology but found banks were not innovating. This inspired him to launch Lightbulb. But his time at the bank did give him a grounding in ESG – investment risks based on environmental, social, and governance factors. As Lightbulb got involved in crypto projects, he saw a need to bring an ESG-style approach.
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Cannon had been Liebau’s colleague at HSBC, having headed the bank’s global markets activities in Singapore. He joined Lightbulb as an advisor and then joined hedge fund Millennium in Singapore. There he worked with Jimmy Lim, who was a portfolio manager (Lim also ran portfolios at fixed-income specialist BlueCrest Capital Management, as well as at J.P. Morgan’s CIO office).
The two spun out Modular as a macro fund focused on investing in Asian sovereign markets.
They share an interest in sustainability, and Modular signed the United Nations Principles for Responsible Investment in January 2021. It’s not easy for a macro fund to pursue an ESG mandate. “But we do what we can,” Cannon said.
ESG for crypto
Liebau, Cannon, and Lim found a way to translate ESG-style investing into crypto-speak; another way to put it is they developed an investment strategy to incorporate ESG into decentralized protocols.
Traditional ESG is about portfolio management decisions. Investors rely on company disclosures and risk analytics to factor in environmental, social, and governance risk factors.
From an environmental point of view, they would favor “green” bonds in which proceeds are aimed at activities that don’t leave a carbon impact, or mitigate other emissions activities – while avoiding companies that are big carbon emitters and which show little sign of changing their ways.
In blockchain, Liebau’s strategy is to invest in blockchain systems that should be sustainable over time in terms of energy consumption and good governance. But it’s an investment into technology, “tokenomics” (incentive designs), and user communities.
“Our first version of the strategy is to invest in smart-contract platforms with a sustainability overlay,” Liebau told DigFin.
Thinking macro for blockchain
Therefore the strategy only invests in “layer 1” blockchains, such as Ethereum, Polkadot, and Solana – the operating systems. The strategy does not invest in tokens or teams building applications on top of those base layers.
This mimics Modular’s macro strategy. Liebau says layer-1 blockchains are the equivalent of sovereign issuers in traditional bond markets: their software provides the rules that govern their smart contracts and how users interact. “They are the operating systems of the future of commerce,” he said.
The apps, from games to lending programs to NFT projects, are the individual “stocks” or securities of traditional finance – which Modular, as a macro fund, does not look at.
For now the ESG strategy is straightforward: it avoids blockchains such as Bitcoin that operate on the basis of Proof of Work consensus, in which miners chase new blocks by massive computations that burn electricity; the energy consumption is itself the “coin” that gives them the privilege of minting bitcoins.
Applying ESG principles
Just as traditional ESG fund managers will continue to invest in companies that are polluters but which are making an honest attempt to transition to sustainable activities, Liebau says the strategy will stick with blockchains such as Ethereum that are still using Proof of Work but are trying to move to Proof of Stake consensus (in which mining and validation is based on the value of a user’s horde of tokens).
There is also a governance angle to Lightbulb’s strategy. For example, not all blockchain tokenomics are transparent. Some are vulnerable to collusion, as in the case of a platform he didn’t name that has only 21 validators (but which sounds to DigFin a lot like this).
Other factors that will be relevant to Proof of Stake platforms will be social issues such as equality – are tokens fairly distributed or do a few whales dominate the supply?
Liebau argues that such questions should have a direct bearing on the blockchain’s long-term success, although this is not yet a hot topic in the blockchain world. “It’s early for ESG and platform tokens,” Liebau said. “Few understand the relevance.”
But crypto is now a $3 trillion industry, and more scrutiny is coming from non-profits, regulators, and others who will be asking questions about the emissions from a given transaction on, say, Ethereum: “gas” prices are about more than just the price.
Cannon says the fund structure is meant to be as conservative as possible so it can eventually appeal to third-party institutional investors. That also means the fund needs to be able to scale. Liebau said the strategy today has a capacity of $2 billion, but Cannon wants it to have the flexibility to go bigger as crypto’s market cap expands.
Before Modular can turn Liebau’s strategy into a fund, it has a few important operational requirements to meet.
It is still searching for custodians it views as operationally sound, for starters.
Second: putting the necessary controls in place.
Cannon says a crypto fund would not fall under the regulation of Modular’s Capital Markets Services license. In theory it could operate more freely. But institutions will demand the kind of tight operations and controls that they expect in the traditional world. Modular already has those policies and controls in place, so it would adapt those to a crypto ESG fund.
The fund would not report to the Monetary Authority of Singapore, as it would not be regulated, but the managers would prefer authorities and clients to be comfortable with it. The hedge fund must also prove to the regulator that a side hustle like a crypto fund won’t impact its obligations around staffing and operations in the regulated world.