Hi all!
With at least two important platform launches potentially imminent, crypto derivative products seem to be taking a big step towards a more diverse institutional offering.
And eyes and minds are still focusing on the macro narrative and bitcoin’s current and future role in a new financial order.
In THE BRIEFING, Josh Gnaizda of Crypto Fund Research shares insight and data on recent crypto fund performance, with some surprises. And, as usual, there are enough links to relevant opinions and information to keep you busy, even though sector activity seems to have quietened down a bit as movers and shakers head off for well-deserved summer breaks.
If you got forwarded this newsletter and would like to subscribe, you can do so here. And if you were sent it directly, how about forwarding to a colleague? It would be much appreciated. :)
Anyways, read on…
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Josh Gnaizda is the founder and CEO of Crypto Fund Research. The opinions expressed in this article are his, and do not reflect CoinDesk’s position.
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Crypto funds’ outperformance is not as surprising at it seems
It’s one of the worst-kept secrets in the alternative investment industry: net of fees, hedge funds struggle to outperform broad equity markets.
In 2007, before bitcoin was even a glimmer in Satoshi Nakamoto’s eye, Warren Buffet famously bet a prominent fund of hedge fund manager $1 million that over the subsequent decade, an S&P 500 index fund would outperform any basket of hedge funds he could put together. Buffet won handily.
It’s not that Buffet didn’t think there were capable investment managers out there; Buffet’s Berkshire Hathaway has often been described as a giant hedge fund. Instead, his confidence relied on his intuition that between fees and trading costs, even the best hedge fund managers would struggle to beat a low-cost index fund.
We might logically assume crypto hedge funds, which generally have a 2 and 20 fee structure similar to that of their traditional counterparts, would suffer a similar fate. But since the beginning of 2017, when reliable data became available, the result has been quite the opposite. An equal-weighted index of crypto funds significantly outperformed bitcoin and most other crypto assets.
The CFR Crypto Fund Index tracks more than 40 crypto funds, mostly hedge funds, across a variety of strategies. It shows that even as bitcoin climbed about 1,000% between January 2017 and June 2019, crypto funds gained more than 1,400%.
Despite these apparent headwinds, crypto funds did outperform. So let’s examine this trend a bit more.
Performance fees are too punitive in bull markets
Few investment assets have ever experienced a 12-month bull run like that of crypto assets in 2017. That’s fantastic for fund managers taking home 20% of profits, but certainly eats away at returns. Several crypto funds returned more than 1,000% in 2017 – meaning by year-end a fund manager could have taken home more in fees than the fund had assets to start the year.
Still, most crypto funds have a 2 and 20 fee structure similar to traditional hedge funds and many have high water marks (essentially to ensure managers don’t get paid for performance when a fund is below all-time high). So while crypto fund performance fees have been staggering in absolute terms, the fee structure is no more of a hindrance to crypto funds than to traditional hedge funds.
Diversified portfolios struggle to keep up with single assets
It’s hard to imagine any asset overshadowing bitcoin’s 12x performance in 2017. But that’s exactly what happened. Some other coins were up 100x or more. The Bitwise CCI 30 Index, which measures the performance of the top 30 cryptocurrencies by market cap, was up 42x.
So how exactly did crypto funds outperform during 2017? They didn’t. Not even close.
Crypto funds collectively returned a relatively underwhelming 1,000%. Sure, these funds returned more in 2017 than traditional hedge funds have in the past 20 years. But everything is relative. And relative to top cryptocurrencies, crypto funds had a disappointing year.
The story of crypto funds’ outperformance truly began when crypto winter cast a chill over the entire industry in 2018. Philanthropist and investor Shelby Cullom Davis said, “You make most of your money in a bear market, you just don’t realize it at the time.”
It was one heck of a bear market.
In 2018, bitcoin lost nearly 75% of its value. The CCI 30 Index lost 85%. The CFR Crypto Fund Index, however, was down “only” 33%. Or put another way, while crypto funds preserved 4/6 of their value, the CCI 30 maintained less than 1/6 of its value. As the chart above shows, this ability to preserve capital during 2018 propelled the crypto fund index ahead of bitcoin and other cryptocurrencies.
From Q1 2017 through Q2 2019, the CFR Crypto Fund Index has returned 1,430%. This easily bests bitcoin’s 1,022% return and narrowly surpasses the 1,413% of the CCI 30.
Crypto funds lack experience
After overcoming their fee structures and whipsawing crypto markets, crypto fund managers had a final hurdle to overcome: inexperience. It’s difficult to directly compare the total financial experience of managers across disciplines. However, we can look at the average age of funds.
A recent study published by Loyola Marymount University (LMU) found the median age of traditional hedge funds was 52 months. This is a lifetime in the crypto world. No crypto funds in the CFR index have been operational for 52 months and the median age is just 16 months.
This inexperience should hurt crypto fund returns, right? Not necessarily. Somewhat counterintuitively, the same LMU study found traditional hedge fund returns decrease with age. And not by a negligible margin. Hedge fund returns in year one were more than triple those in year five. After year five, the study found, “some funds become liquidated and the pattern is somewhat mixed.”
So inexperience, which would seem to be a significant headwind for crypto fund managers, may actually have been a tailwind propelling their performance past ahead of bitcoin and other benchmarks.
Reasons for caution
That crypto funds have outperformed various benchmarks is encouraging. But there’s also plenty of reason for institutions to remain cautious.
The index covers barely one market cycle. Buffet’s index fund didn’t take the lead over hedge funds until year four of the ten-year bet.
The index has less than 50 constituent funds. While the largest in the industry, it’s quite small compared to traditional hedge fund performance indices which can include thousands of funds.
There are potential biases. Since reporting is voluntary, and the index includes less than 20% of eligible funds, we can reasonably assume that poorly performing funds are less likely to report. Funds with particularly poor performance might have already closed, creating a potential survivorship bias. Though not unique to crypto fund indices, these biases shouldn’t be overlooked by investors.
Most crypto funds are quite small by traditional standards and it’s quite possible some strategies that perform well in illiquid markets will not support the same type of returns with more capital invested. Bridgewater Associates, the world’s largest hedge fund manages over $100 billion. Crypto funds manage less than $20 billion collectively.
Despite the potential issues, it’s encouraging that crypto hedge funds seem to have done more or less what they are supposed to, namely preserve capital in bear markets. And with the majority of crypto funds in the index now employing outside auditors, custodians and fund administrators, the industry is becoming less haphazard.
The crypto fund industry is still very much in a maturation phase, but with proper due diligence, crypto funds may present institutions, particularly those unwilling or unable to directly custody cryptoassets, an appealing way to get exposure to the sector.
Some decentralized architecture is said to have an “Oracle Problem”, but at least so far, crypto funds don’t seem to have an Oracle of Omaha problem.
– Joshua Gnaizda
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* six especially interesting entries - I'm all about saving you time, but do at least skim the rest.
BIG IDEAS
Two Libertarians, Two Views on Bitcoin’s Ability to Disrupt Fiat Money (CoinDesk) – An engrossing account of a live debate about one of bitcoin’s leading narratives: is it a viable substitute for fiat currency?
Crypto & Commodities: The Arc Seems to Rhyme More Everyday (CoinShares) – Parallels between product development and investor interest in the commodity and crypto asset worlds.
*How To Understand Bitcoin If You're Over 40 (Forbes) – Matt Hougan of Bitwise argues that we should think about it, not as a currency, but as a technology.
Electric Capital Developer Report: H1 2019 (Electric Capital) – The number of full-time blockchain developers increased over the past 12 months, while the number of part-time and infrequent developers fell, with most of the loss occurring in lower-cap blockchains; ethereum continues to have easily the largest developer network.
*Five reasons why the bitcoin wealth distribution is skewed (Decrypt) – The concentration figures don’t reveal what we think they reveal.
Nic Carter (@nic__carter) also rails against the concern that bitcoin is “too concentrated” to be a viable investment.
Investor Travis Kling (@Travis_Kling) tries to understand why bitcoin sometimes acts as a “safe haven” and sometimes not.
When Alt Season? (Eric Elliott) – If you’re not convinced that bitcoin will dominate market performance for at least a couple more cycles, here are some alternatives.
What is custody of digital assets? (Global Custodian, paywall) – Swen Werner of State Street points out that custody of crypto assets is not just about the safe-keeping of the private key.
Bitcoin’s Surging Dominance – Is This Time Really Different? (CoinDesk) – What bitcoin’s increasing dominance rate could mean for the sector.
Circle CEO Jeremy Allaire breaks down bitcoin's volatile week (CNBC, video) – A brief chat about the macro influences focusing global attention on crypto assets.
MARKETS
Bakkt Says It’s ‘Cleared to Launch’ Bitcoin Futures Next Month (CoinDesk) – The ICE-backed crypto exchange has acquired a New York state trust charter which clears the way for the offering of physically-delivered bitcoin futures contracts, with a target launch on September 23.
*Calling Bakkt a ‘crypto exchange’ misses the mark on what they’re actually doing (The Block) – It’s not about the futures: it’s about the custody.
Seed CX Begins Testing Swap Contracts Settled in Real Bitcoin (CoinDesk) – Depending on final regulatory approval, it could launch for institutional investors within the next few months.
Goldman Sachs Analysts’ Slide Suggests Now’s a Good Time to Buy Bitcoin (CoinDesk) – In a series of slides sent out to some institutional clients, the technical analysis team said the short-term target for bitcoin is $13,971 and that investors should consider buying on any dips in the current scenario.
World Bank Sells $33.8 Million More of Its Private Ethereum Blockchain Bonds (CoinDesk) – This is its second blockchain-based issuance.
Crypto custodian BitGo says Xapo clients are ‘extremely concerned’ about Coinbase deal (The Block) – The sector is getting competitive: BitGo will offer Xapo clients who move service 12 months of free custody.
Crypto Lenders Have Earned Just 2% on $4.7 Billion in Loans: Report (CoinDesk) – A new report by credit assessment startup Graychain suggests that the crypto lending industry has not been extremely lucrative thus far, although there is a strong demand for the business.
Silvergate Bank Eyes Crypto-Backed Loans for Institutions (CoinDesk) – According to an updated IPO filing, Silvergate, which banks many large crypto firms, is planning to offer institutional clients access to fiat loans collateralized with crypto.
Binance’s US Arm to Go Live ‘Within Two Months,’ CEO Says (CoinDesk) – The new platform will be run by BAM Trading Services but will use Binance’s wallet and matching engine technologies, and will not initially be available to residents in New York state.
PROFILES
Barclays Is No Longer Banking Coinbase (CoinDesk) – A detailed look at the complexity of banking relationships for UK-based crypto companies.
CRUNCHING NUMBERS
*Coin Metrics' State of the Network: Issue 12 (Coin Metrics) – A closer look at the data shows that bitcoin is not that correlated with gold, after all – so why do they sometimes move together?
*This Old Statistical Trick Might Help to Better Explain the Apparent Correlation Between Bitcoin and Gold (Jesus Rodriguez) – It’s not that they’re correlated with each other; it’s that they’re both influenced by the same macroeconomic factors.
Skew (@skew_markets) analyzed the recent sell-off – signs seem to point to expectations of a bounce, although the market’s “risk off” mode casts doubts on bitcoin’s “safe haven” status.
Skew also poked around bitcoin volatility in the options and spot markets.
The TIE (@TheTIEIO) created a Hype-to-Activity metric for cryptocurrencies that measures the number of tweets per $1 million in trading volume.
Vision Hill Crypto Hedge Fund Returns: Second Quarter 2019 (Vision Hill Research) – More information (see THE BRIEFING) on crypto funds performance.
REGULATORS AT WORK
New York Supreme Court Denies Bitfinex’s Lack-of-Jurisdiction Claim (CoinDesk) – The crypto exchange, which will appeal meanwhile, has to keep on handing over documents regarding their alleged cover-up of an $850 million shortfall earlier this year; whichever way it goes, this will end up being an interesting case of regulatory reach.
US Lawmakers to Discuss Facebook Libra on Swiss Visit: Report (CoinDesk) – According to reports, a six-member group from the U.S. House of Representatives’ Financial Services Committee plans to meet Adrian Lobsiger, the Swiss Federal Data Protection and Information Commissioner, to discuss Facebook’s plans for its stablecoin Libra.
BitMEX Times ad misled investors says UK watchdog (Decrypt) – Price charts in ads should not use logarithmic scale, that’s misleading.
SECURITY TOKENS
Crypto and Security Token Exchange INX to Raise $130 Million in Landmark IPO (CoinDesk) – This will be the first security token sale registered with the SEC, and one of the very few full-fledged IPOs, and the largest to date, in the blockchain industry (this is worth watching).
Security tokens aren’t yet worth the hype (Venture Beat) – So far they’re struggling with a lack of liquidity, an immature infrastructure, and murky regulatory waters.
Former Visa Exec Speaks on the Future of Security Tokens (Finance Magnates) – Roel Wolfert also talks about what’s holding security token issuances back, but if they’re handled with high standards, they could change company structure and financing.
Stephen McKeon Details The ‘Eight Key Features’ That Will Accelerate Security Token Adoption (The Tokenist) – Investor and associate professor Stephen McKeon highlights the main features of digital assets that will transform how capital markets work.
Breaking Down Tokenisation in Europe (Securities.io) – Where most activity is taking place, what’s happening in fund raising.
STABLECOINS
The State of Stablecoins, 2019 (ConsenSys) – What it says on the tin.
PODCASTS
THE SCOOP: Frank Chaparro chatted to R. Martin Chavez, Global Co-Head of Securities at Goldman Sachs, about software and finance, why Goldman is not diving into crypto services, the current settlement pain points that distributed ledgers could solve and why he thinks the Federal Reserve will issue a cryptocurrency.
CHAIN REACTION: Tom Shaughnessy interviewed Jeff Dorman of Arca Funds about different types of institution-friendly crypto fund structures, some common misconceptions about investing in crypto funds, how institutional involvement will take time and how bitcoin might weather a macro market meltdown.
UNCONFIRMED: Laura Shin spoke to Maria Shen, head of data science at Electric Capital, about the findings of their recent report on developer activity.
PAPERS
Practical Applications of Investments in Cryptocurrencies: Handle with Care! (Tobias N. Glas, paywall) – The investment performance of cryptocurrencies has little or no correlation with the performance of traditional markets and investments, or the macroeconomic environment in general.
The Benefits of Diversification between Bitcoin, Bonds, Equities and the US Dollar: A Matter of Portfolio Construction (Abdulnasser Hatemi-J, Mohamed A. Hajji, Elie Bouri, Rangan Gupta) – A combination of risk and return optimization shows a total return higher than that of the four asset types individually.
Practical Applications of Beyond Bitcoin: A Statistical Comparison of Leading Cryptocurrencies and Fiat Currencies and Their Impact on Portfolio Diversification (Stefan Ehlers and Kolja Gauer, paywall) – Cryptocurrencies have no correlation with fiat currencies, so combining them in a portfolio enhances diversification.
Bitcoin price prediction using machine learning: An approach to sample dimension engineering (Zheshi Chen, Chunhong Li, Wenjun Sun; paywall) – Apparently it is possible to improve price predictions with machine learning.
A-HA!
*America’s CEOs Seek a New Purpose for the Corporation (Fortune) – Whether it’s window dressing or not, the fact that business leaders coordinated to transmit the message that capitalism should not just be about profits is riveting, as is the build-up to this statement.
The new threat to capitalism (Axios) – Spoiler: it’s us getting older.
Why did we wait so long for the bicycle? (The Roots of Progress) – Innovation can seem so obvious in hindsight, but it’s staggering how rare it is when you consider the available resources and talent.
The Puzzle of Economic Progress (Project Syndicate) – On the need for interdisciplinary research on “progress”, and how hard that is to achieve with today’s academic and regulatory structure.
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FUNDING
Cryptocurrency derivatives exchange Blade, which plans to launch in a few weeks with a focus on perpetual swaps (not available to U.S. investors), has closed a $4.3 million seed round from Coinbase, SV Angel, A.Capital, Slow Ventures, Twitch.tv co-founder Justin Kan and Quora co-founder Adam D’Angelo.
FIRMS
Cryptocurrency exchange Coinbase has acquired the institutional business of cryptocurrency wallet and custody service provider Xapo.
Bitcoin derivatives exchange BitMEX has restricted access to its platform for users based in Seychelles, Hong Kong, and Bermuda – jurisdictions in which it has offices and employees – for regulatory reasons.
PEOPLE
Martin Halblaub, the CEO of Switzerland’s SIX stock exchange SDX, has resigned just eight months after taking on the role, reportedly over a disagreement over the future direction of the in-development exchange.
David Damato, formerly at cybersecurity firm Tanium, will join crypto exchange Gemini as Chief Security Officer.
Pete Najarian, formerly senior vice president of institutions at bitcoin service provider Xapo, will join crypto asset custodian BitGo as Chief Revenue Officer.
Have a tip? Drop me a line at noelle@coindesk.com. |
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| Whether you're based in San Francisco or Singapore, there is no escaping how big a role Asia plays in today's crypto markets. Whether it's the advent of exchange tokens, the importance of Asian OTC desks or the unusually clear-eyed regulatory regimes, there is a strong argument that, when it comes to crypto, in many ways East is leading West.
Our upcoming event in Singapore, Invest: Asia, is an exploration of the people and topics driving this market. CoinDesk is thrilled to be returning as a partner to TechXLR8 Asia by co-locating Invest: Asia with 5G Asia, IoT World Asia, NV&SDN, the AI Summit and Project Kairos Asia September 11-12, 2019 at the Marina Bay Sands Convention Center. With a dynamic expo floor, a special Asia edition of CoinDesk Live and plenty of networking opportunities, Invest: Asia will further explore how crypto markets function and impact the world at large.
You can see our evolving agenda here.
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Previous newsletters: 35, 36, 37, 38, 39, 40, 41, 42, 43, 44, 45, 46
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CoinDesk is not an investment advisor. This newsletter is for informational purposes only, and any comments here do not constitute investment advice. |
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