Passive investment in the world of traditional finance is, well … passive. And it’s not just the fact that passive indices give investors access to stocks without having to do anything about the composition of the index. It is also true that holding shares is fundamentally a passive game.
No obligation as a shareholder
Having a share entitles the investor to economic and administrative rights within a company, but there are no performance obligations as a shareholder. As a shareholder, it is perfectly fine to simply hold a share forever, collect dividends and over time enjoy capital growth by holding shares in a company.
Even if a shareholder were to exercise his administrative rights, there are limits to what he can do. Of course, shareholders can do things like vote for new board members, adjust management remuneration and approve or reject important financial transactions, such as mergers and acquisitions.
But shareholders do not manage companies directly. Apple shareholders do not set prices for Apple’s newest iPhones, nor do Amazon shareholders determine which new markets Amazon should enter. Usually, apart from activist situations, shareholders are absent when it comes to a company’s activities. And the same can be said for index funds which, although they own a significant proportion of most listed companies, cannot exercise power.
Crypto is another story.
Keeping tokens is active
Holding tokens like Ethereum Code is an active game. In many cases, token holders directly control the protocols and take the risks. In Synthetix, token holders actively store synthetic assets and manage the debt of the protocols. In Aave, token holders actively determine the risk parameters of their credit markets and insure the protocol in case of insolvency events.
And at Nexus Mutual, token holders arrange the transactions between them and determine which claims are paid out. To perform these activities, active token holders receive protocol rewards in the form of fees (tokens), while passive token holders often receive nothing.
In general, indices are a game of collecting capital in which index providers compete for trillions of dollars of capital from investors. The way to attract investors is by offering them incentives that meet their needs in terms of asset exposure and diversification (i.e., what is in an index).
But the composition of an index is only half the game in the crypto world. The other half is what the tokens in an index do for an investor’s assets, because crypto assets are meant to be productive.
Most crypto projects acknowledge the fact that holding tokens is an active game. Many index products, such as those from PowerPool and PieDAO, are implemented as forks from Balancer liquidity pools, which means that assets in the pool are made available to trade against. But now protocols go a step further by adding features such as meta-governance and fund management strategies. The combined features provide index investors with a combination of board delegation and return strategies on their tokens, which form the basis to entice investors to buy these indices for reasons beyond the composition of the index.
This is just the beginning. The next development is when passive investment turns into passive participation. Ryan Watkins explains this well in the wire below.