The Rise and Fall of DeFi Fund Managers: Lessons from Stream Finance

Key Takeaways

• DeFi fund managers have emerged as new financial intermediaries, managing billions without regulatory oversight.
• The collapse of Stream Finance highlighted the systemic risks inherent in the DeFi ecosystem.
• Traditional financial accountability mechanisms are largely absent in the DeFi space, leading to unmitigated risks.
• The DeFi model encourages high-yield but high-risk strategies, often at the expense of careful risk management.
• Suggestions for reform include mandatory identity disclosure, capital requirements, and reserve proof.

Introduction to DeFi Fund Managers

In the last 18 months or so, the decentralized finance (DeFi) landscape has seen the emergence of a new class of financial intermediaries. These entities, known by titles such as “risk managers,” “vault managers,” or “strategy operators,” exert considerable influence within DeFi ecosystems. They manage substantial sums on protocols like Morpho and Euler, implementing risk parameters, selecting collateral types, and deploying yield strategies. For managing these assets, they extract performance fees ranging from 5% to 15%. However, these roles operate without the licenses, regulatory oversight, or mandatory disclosure of credentials that traditional financial institutions are subject to.

Stream Finance Collapse: A DeFi Debacle

In November 2025, the collapse of Stream Finance exposed the vulnerabilities and risks inherent in the DeFi architecture. The incident resulted in significant financial losses across the ecosystem, with estimated ripple effects causing around $285 million in total damages. Several managers, including TelosC, Elixir, MEV Capital, and Re7 Labs, had excessively concentrated user deposits with a single counterparty, who operated with a collateral of only $1.9 million against the leveraged position reaching up to 7.6 times this amount. Despite clear warning signals from figures like KOLCBB and Yearn Finance months before the crash, prevailing incentives deterred fund managers from taking preventive actions.

Comparing DeFi and Traditional Financial Intermediaries

The operational model of DeFi fund managers borrows from traditional finance but eschews the accountability mechanisms that have been honed over centuries. In contrast to the capital requirements, fiduciary duties, and regulatory scrutiny that banks or brokerage firms face, DeFi fund managers rely mainly on market incentives. These incentives prioritize asset accumulation and yield maximization over risk mitigation, while protocols claim to be “neutral infrastructure,” profiting without accountability for the ensuing risks—a stance long rejected in traditional finance due to past catastrophic failures.

The Double-Edged Sword of Permissionless Architecture

Platforms like Morpho and Euler function as permissionless lending infrastructures, allowing anyone to create vaults, set risk parameters, and gather deposits freely. While such architecture promotes innovation and broadens access to underserved participants, it also introduces fundamental problems, as highlighted by the 2025 crisis. There are no entry checks to ensure the quality of managers, no registration to hold failed managers accountable, anonymity that allows managers to walk away from losses, and no capital requirements ensuring managers have skin in the game beyond fickle reputations.

Case Study: Stream Finance’s Path to Collapse

Stream Finance exemplified a specific failure pattern within DeFi’s permissionless framework. The absence of barriers allowed anyone to compete for deposits by offering high yields—either through genuine alpha (rare and hard to sustain) or through heightened risks (common and potentially disastrous). Users attracted by promises of high annual returns often placed undue trust in so-called risk managers, assuming their due diligence. In contrast, fund managers, driven by fee opportunities, accepted risks that prudent risk management would typically reject.

Inherent Conflicts of Interest and Incentive Failures

The operational model of fund managers inherently engenders conflicts of interest, where the financial incentives of users and managers diverge. Users seek safety and reasonable returns, whereas managers focus on maximizing fee income. The most dangerous conflict arises when yield opportunities necessitate risks that users themselves would usually avoid. An instructive case involves RE7 Labs, which identified counterparty risk before integrating xUSD but proceeded, swayed by the prospect of demand. This dynamic penalizes caution: prudent managers earn less, while reckless ones prosper—until disaster exposes their unhedged positions.

Asymmetrical Fee Structures

Fund managers commonly extract performance fees of 5%-15% from user yields, a model favoring profit-sharing without equivalent loss sharing. For instance, in a scenario where a $100 million vault generates a 10% return, a manager might earn $1 million in fees. However, if by doubling the risk, the return reaches 20%, their earnings double to $2 million, even if subsequent losses wipe out half the deposit, affecting only future earnings without reclaiming past fees.

Protocol Conflicts

Protocols like Morpho and Euler face their own conflicts of interest, earning fees from vault activities, which incentivizes maximizing activity—even if it requires permitting high-risk vaults to attract deposits. While protocols present themselves as neutral, they profit from transactions like brokers do, and as history shows, entities profiting from mediation should not be fully shielded from the risks they create.

Accountability Vacuum in DeFi

While traditional finance punishes customer fund losses through regulatory investigations, license revocations, and legal liabilities, DeFi fund managers face mainly reputational damage and can often restart under a new identity. The March 2024 Morpho incident, where a minor oracle price deviation led to losses, established a precedent of shared responsibility evasion—a deliberate design that capitalizes profits while society bears the losses.

Anonymity and the Lack of Accountability

Many DeFi managers maintain anonymity, purportedly for security and privacy, yet this undermines accountability, enabling malfeasance without repercussions. Unlike in traditional finance, where civil liabilities and reputation tracking impose deterrence, DeFi lacks such checks.

Opaque Strategies and the Risks of Authority

Fund managers bill themselves as risk experts but often lack the necessary infrastructure or expertise, as demonstrated in November 2025. Traditional institutions invest significantly in risk management, unlike DeFi managers, who tend to focus on yield generation and asset gathering. The opaqueness in strategy disclosures allows fraudulent or reckless behavior to flourish unnoticed.

Reserve Proof: An Underutilized Solution

Despite the availability of efficiently privacy-preserving reserve proof technologies like Merkle trees, Stream Finance lacked any form of reserve verification, choosing opacity. Protocols managing significant funds should require reserve proofs, much like demanding external audits from banks.

Stream Finance: An Exemplary DeFi Failure Case

Stream Finance’s demise showcased the systemic issues plaguing DeFi fund management—a convergence of inadequate diligence, conflicted interests, ignored warnings, opacity, and lack of accountability. Warnings from industry analysts were disregarded as managers continued risky practices.

Recommendations for Improvement

While the current model presents a vacuum of accountability, its advantages in capital efficiency and professional fund management can persist alongside necessary reforms:

• Identity Disclosure: Compulsory identity disclosure for managing substantial funds can ensure accountability without compromising privacy.

• Capital Requirements: Managers should be required to hold risk capital, aligning their interests with those of users.

• Transparency: Mandating a standardized disclosure of strategies can mitigate the risks associated with opaque practices.

• Reserve Proof: Enforcing reserve proof requirements can safeguard against the unchecked management of off-chain assets.

• Concentration Limits: Imposing limits on exposure will curb the dangerous trend of excessive risk concentration.

• Protocol Accountability: Protocols must share in the responsibility and offer safeguards like insurance funds to protect user investments.

Conclusion

The existing DeFi fund management model harbors systemic failures, entrusting vast amounts of user funds to unregulated entities. While not a wholesale rejection of the model, given its potential benefits, there’s a clear need to incorporate accountability mechanisms honed in traditional finance settings. Only when the industry acknowledges the necessary balance between profiteering and responsibility will it avert repeating past failures.

FAQs

What caused the collapse of Stream Finance?

Stream Finance’s collapse was chiefly due to excessive leverage and risk concentration in a single counterparty, compounded by ignored warnings and systemic incentive flaws within the DeFi ecosystem.

How does DeFi lack traditional financial accountability?

Unlike traditional finance, DeFi lacks regulatory oversight, capital requirements, and identity disclosure, making fund managers operate in a largely unregulated environment.

Can DeFi reconcile innovation with accountability?

Yes, by integrating identity disclosure, capital requirements, and transparency measures, DeFi can maintain its innovative edge while ensuring greater accountability.

What lessons does the Stream Finance collapse offer?

Stream Finance underscores the risks of opaque practices, unchecked leverage, and the failure of relying solely on reputational accountability in DeFi.

How can reserve proof enhance DeFi safety?

By mandating reserve proof, DeFi protocols can bolster transparency and verify asset backing, preventing fraudulent activities and reinforcing trust.