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Market View:

Bitcoin (BTC) prices are struggling as the 10-year Treasury yields have climbed above the critical 3.5% level — previously we had identified this level as the make-or-break level for Bitcoin, and prefer to be neutral or even short Bitcoin IF the Treasury yield climbs above that level. As prices are now at 3.7%, we are not surprised that Bitcoin is selling off.

Most Crypto Hedge Funds SUCK - Where has all the (Crypto) Alpha Gone?

👇 1) According to the Eurekahedge Cryptocurrency Index, a benchmark index with 14 equal-weighted constituents, crypto hedge funds are underperforming Bitcoin for the fifth year out of the last eight years. This is a very poor representation of crypto fund managers. Even in 2023, crypto fund managers have underperformed in January and March — both months saw Bitcoin returns of +39% and +23% returns respectively.

Exhibit 1: Eureka Crypto Hedge Fund Index minus Bitcoin performance (Jan 2016 to current)

👇 2) Investors in those funds certainly demand stronger performance as the managers appear to underperform even the most straightforward crypto investment — namely Bitcoin itself. Why should investors allocate to crypto fund managers if they consistently underperform the benchmark?

Exhibit 2: Normalised returns for Eureka Crypto Hedge Fund Index vs. Bitcoin (Jan 2017 to current)

👇 3) It seems that managers are simply tracking the price of Bitcoin; adding management costs and performance fees on top, et voila, the underperformance can easily be explained. In addition, as regulatory requirements increase, operating costs will increase and could hurt fund performance even more.

👇 4) But understanding the cyclicality of digital assets, combined with a flexible mindset of riding the winners and selling the losers, investors could make sizable returns — not even in bull markets, but also in bear markets. True, the ‘Alpha’ has decreased over time, and this has made active, discretionary crypto fund management more difficult. 

👇 5) For example, running a strategy with the top 10 market capitalisation weighted tokens, the difference (dispersion) between the average return of the top 5 vs. the bottom 5 cryptocurrencies has continued to drop. However, it still offers 10-20% monthly returns IF the manager is able to buy the strongest performing 5 tokens ahead of the month and sell the 5 worst performing ones — before any costs etc. of course. While this seems impossible, a skilled fund manager might be able to generate 2-5% per month with relatively low delta exposure (market neutral).

Exhibit 3: Dispersion between the top 5 and bottom 5, monthly performance of top 10 cryptocurrencies

👇 6) This requires the implementation of a Long / Short Crypto Hedge Fund strategy where the manager and his team are buying the winners and shorting the losers. Instead of a long only strategy that is at the mercy of the price of Bitcoin, the Long / Short Strategy would limit the fund’s direct exposure to the price of Bitcoin because one long position would be paired with one short position simultaneously.

👇 7) The Eurekahedge performance data indicates that crypto hedge funds are too dependent on the direction of the price of Bitcoin and are not managing their downside well. Shadowing the large drawdowns of 60-80% that Bitcoin tends to experience every 3-4 years is simply unacceptable for institutional investors. It is time for the crypto hedge fund industry to mature and implement stricter risk management with a more active trading strategy.

👇 8) While this requires an active investment management process instead of buying and holding for a 10x return that might not occur, it also demands that crypto hedge fund managers incorporate all price-impacting variables into their decision-making process. Interest rate and liquidity considerations have become an important part in predicting where crypto prices are going and correctly predicting those variables could determine if the fund should be market neutral, slightly bearish, or slightly bullish positioned tactically. This could be another source of ‘Alpha’.

👇 9) The disappearance of ‘Alpha’ appears to be a shifting market structure narrative whereas macro factors have become more important as the liquidity within the crypto universe fails to expand. This itself is due to the regulatory overhang and the lack of sizable capital that institutions were expected to provide.

👇 10) In that environment, there should be a focus more on winners and losers, instead of broad exposure that depends on a rally in the Bitcoin price. This is the time for active crypto fund management.

Crypto Titans: How trillions were made and billions lost in the cryptocurrency markets → Amazon