Understanding Crypto Vaults: A Guide for Advisors

Understanding crypto vaults: Explore risk layers (smart contract, redemption), composability, and the impact of RWAs on DeFi yields.

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In this edition, Nassim Alexandre from RockawayX discusses crypto vaults, their functionality, and risk assessment.

Lucas Kozinski from Renzo Protocol follows up with insights on decentralized finance in the Ask an Expert segment.

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Understanding vaults: exploring yields and beyond

Investment in crypto vaults exceeded $6 billion last year, with estimates suggesting it could reach $12 billion by the end of 2026.

As this sector expands, a notable differentiation has arisen between vaults characterized by strong engineering and oversight and those that merely focus on yield generation.

A crypto vault represents a managed fund structure implemented on-chain. Investors contribute funds, receive a token that signifies their ownership stake, and a curator manages the allocation of those funds according to a specified mandate. This structure may be either custodial or non-custodial, and the redemption conditions depend on the liquidity of the underlying assets, with portfolio rules typically encoded within smart contracts.

The primary concern regarding vaults is exposure: what risks are present, and could they exceed what is communicated? A clear understanding of yield sources, asset custodianship, parameter modification authority, and potential scenarios during stress events is essential for grasping the product. Without this understanding, the advertised returns become irrelevant.

There are three significant risk layers to consider.

The first is smart contract risk: the possibility that the underlying code may fail. When was the last audit conducted? Has there been any alteration to the code since? Additionally, allocation controls are part of this risk layer. Incorporating new collateral into a well-structured vault should necessitate a timelock to allow depositors to assess the change and withdraw before it becomes effective. Strategy modifications should require multi-signature consent.

The second layer is the risk associated with the underlying assets: the quality, structure, and liquidity of what the vault actually holds.

The third, often overlooked risk is related to redemption: under what circumstances can capital be retrieved, and what is the speed of recovery? It is crucial to know who manages liquidations during market downturns, their level of discretion, and whether the manager is committing capital to support them. This distinction is particularly important during the moments when you would prefer to exit.

The overall quality of a vault relies heavily on the caliber of its curation. A curator is responsible for determining which assets are eligible, setting parameters, and perpetually monitoring the portfolio.

For instance, the majority of real-world asset strategies currently on-chain are single-issuer, single-rate products. In contrast, a curated vault integrates multiple vetted issuers under active management, providing diverse exposure while relieving the investor from managing individual credit risk.

Continuous monitoring is also vital. Default rates can fluctuate, regulations may evolve, and counterparty events can occur. A curator that views risk assessment as a one-time task is not effectively managing risk.

What distinguishes crypto vaults from traditional funds is their transparency; investors do not need to rely solely on the curator’s assurances. All allocations, positions, and parameter modifications occur on-chain and can be verified instantaneously. For advisors with experience in private credit, the underlying collateral may be familiar. However, attention must be paid to the on-chain structuring surrounding it: whether genuine recourse exists, in which jurisdiction, and against whom. This is where curator expertise is crucial. A curator acts as the risk manager for a vault, determining eligible assets, setting operational rules, and actively overseeing the portfolio.

Curated vault strategies typically aim for annual returns of 9-15%, contingent on the mandate and assets involved. This range reflects risk-adjusted return generation within established parameters.

Vaults also present a more efficient method to access assets you are already invested in, offering functionalities that traditional structures do not provide. For family offices managing liquidity across various positions, this represents a significant operational enhancement.

The key advantage is composability. On-chain, a vault can enable you to borrow against a collateral position directly, circumventing the documentation burden of a traditional loan facility. For family offices managing liquidity across various positions, this represents a significant operational enhancement.

Additionally, permissioned vault structures are significant as they allow multiple family offices or trustees to deposit into a single managed mandate without commingling, preserving separate legal ownership while utilizing the same risk management framework.

The vaults that withstand scrutiny will be those whose engineering, mandates, and the curator’s judgment are designed to endure under pressure.

– Nassim Alexandre, vaults partner, RockawayX

Ask an Expert

Q: With “yield-stacking” and numerous layers of decentralized finance (DeFi) protocols, what measures are necessary to mitigate risks in vaults?

The primary approach is to reduce complexity. Each additional protocol in the stack introduces another potential vulnerability. Therefore, if it is not essential, eliminate it. We avoid depositing into protocols that have discretionary control over funds, meaning they can relocate capital without user consent. We seek transparency regarding how other protocols utilize our capital, while maintaining privacy around our strategies to protect proprietary information.

Furthermore, it fundamentally relies on transparency and time. Users should consistently have visibility into the exact location of their funds and their activities. Moreover, any changes to parameters — such as fees, strategies, or risk limits — should undergo a timelock to provide individuals with a chance to review and respond before implementation. Smart contract audits are also important, but they serve as a baseline rather than a guarantee of safety. The architecture must be robust before an auditor even reviews it.

Q: At what stage will institutional capital inflow compress DeFi yields to align with traditional risk-free rates, and where will the next source of “alpha” emerge?

Eventually, this will occur in the most liquid and straightforward strategies. However, traditional finance (TradFi) cannot replicate composability. The underlying instruments may be the same — for example, the USCC carry trade — but in DeFi, you can integrate that position into a lending market, use it as collateral, provide liquidity to a DEX pool, and execute all these actions simultaneously. Such a capability is not feasible in TradFi without incurring substantial infrastructure costs.

The alpha will not vanish; it will merely transition to those who establish the most efficient capital pathways among strategies. The individuals who identify ways to stack yields across composable layers while effectively managing risk will consistently outperform. Additionally, the disparity in infrastructure costs between DeFi and TradFi will maintain a wide spread for an extended period.

Q: How will the integration of Real World Assets (RWAs) into automated vaults affect the correlation between crypto yields and global macro interest rate cycles?

Indeed, crypto yields will increasingly correlate with macro rates as RWAs are adopted. This is an inherent consequence of bringing rate-sensitive assets on-chain. However, I believe people often underestimate the alternative side of this tradeoff.

Prior to RWAs, crypto holders faced a binary decision: retain stablecoins on-chain and earn crypto-native yields or withdraw everything to deposit in a brokerage. Now, holders can maintain stablecoins on-chain while accessing the same strategies available in TradFi, without exiting the ecosystem. Importantly, they can also layer additional strategies — borrowing against RWA positions, deploying that capital into lending markets, and providing liquidity against pools that utilize these assets as collateral. The capital efficiency offered by this arrangement is simply not attainable in traditional finance. So yes, greater macro correlation is expected, but also increased options for capital deployment, which should elevate rates as liquidity grows.

– Lucas Kozinski, co-founder, Renzo Protocol

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