Thoughts on the Prism portfolios product

The makers of ShapeShift have a new product in beta, called Prism, that sets out to address a number of challenges to investing in a diversified portfolio of cryptocurrencies. Such challenges include:

  • Acquiring the coins you want to you may require creating accounts on several exchanges, and going through the tedious KYC/AML processes for each.

  • Given that it’s a bad idea to leave your coins on exchanges as part of a long-term hold strategy, self-custody of your coins, especially obscure ones, can present technical difficulties around identifying and installing multiple wallets, and securing them.

  • Most of the services that offer investible indexed or managed baskets of cryptocurrencies require SEC accreditation for access, or are geographically restricted. These include Grayscale, Bitwise, MetaStable and Iconomi.

Prism solves the problems in the following way: The product (when launched) will be accessible to anyone holding Ethereum. Users of the platform will be able to create portfolios of cryptocurrencies—i.e. a list of currencies and the percentage allocation to each—and then fund those portfolios with a deposit of Ethereum, which is then used as collateral to back the contract.

(Interesting, ShapeShift will initially take on the risk of matching your collateral, although they plan to make collateral matching its own investment opportunity for liquidity providers in the future.)

Upon funding of the contract, Prism will deploy a smart contract on the Ethereum network that tracks the performance of the coins and allocation defined in the contract. At any time, the contract owner can “rebalance” the portfolio and/or cancel it. Upon cancellation, the contract owner will have their Ethereum collateral returned, plus or minus the gains or losses that the portfolio realized with respect to Ethereum, minus a fee charged by the Prism platform for providing the service (currently anticipated to be around 2.5%.)

This is a fascinating and exciting product, and following are some random thoughts having read the announcements (but not yet having received access to the beta):

Convenience. The Prism product makes it extremely convenient to invest in a basket of currencies. No more having to install wallets like Monero, that require downloading and syncing the entire blockchain.

Security. It seems there are both pros and cons here. On the one hand, there’s less for the individual user to secure. Instead of securing coins held in local wallets (hardware or software), you only need to secure access to your Prism account and the source wallet of the funding Ethereum, which is where Ethereum would be returned upon contract cancellation. On the other hand, you’re at the risk of the quality of contract implementation and the security of the Ethereum network. As we discovered in the DAO hacking, this is a real concern.

Ethereum denomination. One should keep in mind that the portfolio performance is referenced to Ethereum, and not USD. If the portfolio increases in value with respect to USD, but not Ethereum, you’ll receive back less Ethereum than you provided in funding. That’s to be expected, of course, but might come as a surprise to people who think of everything in terms of USD.

Taxation. If tax authorities (at least in the United States) are already behind in terms of clarifying issues around crypto taxation, who known when it would become clear how participating in something like a Prism will be taxed. Will funding a Prism contract be considered a taxable event, i.e. as if you sold Ether for USD and then virtually purchased the underlying coins? Will rebalancing of a Prism be taxable, i.e. the selling of certain coins in the portfolio to buy others? Or will the taxable event simply be the gain or loss of Ether when terminating a contract?

In my experience, first movers in a space like this often bear a disproportional amount of the pain when it comes to frontier taxation issues. The cost of having a tax advisor figure out how something should best be declared, and then potentially having to defend that position to the IRS can easily consumer any gains that one earns.

Having said that, though, I’m sure I’ll anyway give it a try when getting access to the product, as I always do. You later movers can thank my sacrifice in paving the way. 🙂

Social opportunities. Given that Prism already publishes a leaderboard, one can easily imagine a future when it will be possible to “follow” the portfolio managed by another user, such that anyone in the world, based only on their merits, can become a successful “fund manager”.

Tokenization of all securities. Looking further out, one can imagine a day when through a platform like Prism, it will be possible to invest in portfolios constructed of both crypto assets, and traditional assets like stocks, bonds, ETFs, real estate and precious metals. That would certainly be disruptive to the brokerage and financial industries.

Regulation. This is another in a long-line of frontier products created by ShapeShift founder and libertarian advocate Erik Voorhees, and he’s no stranger to having to deal with behind-the-times regulators after-the-fact. It’s hard to imagine a platform like Prism growing too much before catching the attention of the SEC, and it’s hard to imagine them not wanting to regulate the service somehow in the interest of investor protection. It will be interesting to see how that plays out. I would guess at minimum we might expect to see KYC/AML processes for user accounts.

So those are my initial thoughts about Prism, and I’m really looking forward to giving it try, and will post a review as soon as I have direct experience.