Arca Chief Investment Officer: Nine key takeaways from managing crypto funds over the past five years
Original author:Jeff Dorman,Arca Chief Investment Officer
Original compilation: Felix, PANews
Jeff Dorman, chief investment officer of crypto investment firm Arca, has been running a cryptocurrency fund for 1,825 days. Arca has just achieved a major milestone, breaking a five-year record for external capital under management in liquid hedge funds.
Five years may not seem like a long time frame in any other industry, but in crypto, five years is a relatively long time. Because of round-the-clock trading, one year in the crypto industry can be said to be equivalent to five years in the traditional industry. After seeing many of his peers come and go over the past five years, Jeff Dorman left behind some survival insights when it comes to crypto asset management.
CoinDesk columnist Jeff Dorman is Arca’s chief investment officer, leading the investment committee and responsible for portfolio sizing and risk management. He has more than 20 years of trading and asset management experience at firms including Merrill Lynch and Citadel Securities.
As chief investment officer overseeing this fund and three other Arca funds, Jeff Dorman has experienced firsthand the evolution of the industry, including good times, bad times and constant innovation. Here are the most important takeaways from the past five years of managing a cryptocurrency portfolio.
In short: the crypto investing market is very challenging.
Adjust assumptions and risk models
Adjusting assumptions and risk models is self-evident to anyone who has invested in this market, but cryptoassets are not an easy category to invest in. For newcomers, frequent booms and busts can create a false sense of liquidity and an inaccurate depiction of expected beta and returns. All risk models, expected loss reserves and sizing parameters are based on historical data and correlations, which can change very quickly. For those who manage liquidity, its a constant game of adjusting assumptions and risk models.
Interpretation beats speed
Contrary to popular belief in the market, crypto markets can be traded 24* 7 globally but do not require round-the-clock trading coverage. Overtrading on every price move is costly in any asset class, and the 24/7 nature of cryptocurrency trading will often try to lure you into more trading activity. But the reality is that a fragmented global investing landscape actually gives you more time to react to news and information. While there will always be bots and algorithms that react immediately to news, these initial knee-jerk reactions are often wrong. With one-third of the world asleep at all times due to jet lag, it often takes a few days for the true market reaction to show up. Correct interpretation of information is much more important than reaction speed.
Detailed documentation is critical
Trading around the clock does create difficulties not found in traditional markets. In traditional financial markets, even the worst day/week eventually ends, giving you plenty of time to recalibrate and think through decisions while the markets are closed, without price fluctuations clouding or affecting your thought process. But in the crypto world, these don’t exist.
Take the Terra/Luna incident, for example, where an ecosystem worth $30 billion collapsed in three days. There is a constant flow of transactions and new information during these 72 hours. The decisions traders made during this time don’t look back on much deadlines now, and crypto folks are gradually learning how to better implement risk management against such tight deadlines in the future.
In hospitals, errors often occur not because doctors are overworked or tired, but because information is incorrectly passed on to the next doctor, who lacks complete information because the previous doctor did not provide complete records. . Cryptoasset management requires similar knowledge transfer and documentation.
Balance between short and long
In debt and equity markets, quiet periods (summer, holidays) often lead to slow price increases. The cost of shorting is high, and dividends and coupons accumulate, adding more buying interest to the market. The opposite is true for cryptoassets. Since most crypto projects accumulate value through network activity, flat periods tend to slow an asset’s upward momentum. Since most assets have no cash flow distributions, the cost of shorting is minimal. When markets are down, negative price movements tend to be more prevalent, making decisions difficult to make when it comes to hedging and long exposure.
Therefore, active management is better than passive indexing. Passive, rules-based index strategies simply cannot keep up with innovation and changes in the crypto market. Likewise, passive indices are unable to take advantage of market volatility and generate considerable alpha. Over time, this may change as the market matures. But the crypto space hasn’t reached that point yet.
Hire people who are passionate about the industry
Building a great team is the foundation of success and can be extremely challenging.
Jeff Dorman has worked at seven different financial firms over the past 25 years. Jeff Dorman has looked at thousands of resumes and interviewed hundreds of people. Jeff Dorman has worked hands-on in nearly every financial sector (banking, trading, research, sales, business development). If a traditional Wall Street financial firm came to Jeff Dorman looking for a candidate, Jeff Dorman could easily find the candidate that best suited their needs.
What are the best attributes and qualifications for a cryptocurrency research analyst? What makes the best trading operators? Who is best suited to handle investor relations? These are still not easy questions to answer in the crypto space. In the early years of the Arca Foundation, Arca found anyone who wanted a job. The wages are low, the hours are long, and the future is uncertain. Anyone who wants to find a job in the crypto industry in 2018 has a genuine passion for blockchain success and is willing to learn whatever knowledge and skills are required for the job. Most people who joined the industry before 2020 are still working in the industry, and their job responsibilities are changing in real time. Come 2021, Arca can hand-pick anyone it wants from major banks, brokerages, and hedge funds, with resumes pouring in who have no crypto experience but see big fortunes ahead. But in 2023, only those who are passionate about the industry will be there.
Everyone wears many hats
This is a very hands-on business, and research analysts must test the functionality of applications, challenge existing financial models, and communicate in real time with other industry veterans at conferences. Traders must switch back and forth between US macro, Asian currency markets, and specific on-chain wallet trends based on current correlations. Back-office staff must test new service providers every three weeks to keep up with changing regulations, best paths and LP requirements, while dealing with constant bankruptcies, closures and hacks.
What they all seem to have in common is a genuine willingness to test new ideas. If you gave 10 stock analysts the same information, they would give you roughly the same answer and provide homogeneity modeling to arrive at that answer. If you provide the same information to 10 crypto analysts and traders, chances are they will provide 10 different answers using completely different modes of analysis. This is refreshing and often leads to huge alpha, but also creates challenges when it comes to creating a repeatable model of success.
Trading operations is the most important department
When Jeff Dorman was working at a credit and equity fund firm, he discovered that back-office work was being neglected. These employees are often young kids eager to move into a real trading role as quickly as possible. The back-office work is basically making sure trades settle, making sure brokerage statements are accurate, and making sure fund administrators are doing their jobs.
But you should be lucky in the crypto space.
Trading operations is the most important job in the cryptocurrency space. You have to touch these assets every day, and a single mistake can cost a company millions of dollars. So not only do these people need to be the most trustworthy people in the company, but they may also be laid off, but the company can still function even if they leave. It is more attractive to enter a trading operations role than to exit, as those working in this department will learn the most about blockchain.
Likewise, in the crypto space, compliance is not an afterthought. Unlike traditional financial markets, it cannot be assumed that your employees understand the rules, as most employees come from backgrounds completely different from those on Wall Street. Ongoing education and supervision are required. Furthermore, compliance officers cannot just read the rules and assume compliance, since there are few clear rules to follow (although Gary Gensler says otherwise). Being both a trustee and a law-abiding company is a difficult task.
Things are getting better for sellers
In traditional finance, the seller plays a very important role. They underwrite new transactions, create novel financing ideas, advise companies on how best to participate in capital markets, facilitate transactions in existing securities, and write research reports on new and existing securities. Full-service investment banks and broker/dealers exist, but whether you use a one-stop shop or work piecemeal for multiple firms, the services themselves are covered.
While the sellers in the crypto space are getting better, it is still very fragmented and many of these services are still non-existent. As a result, fund managers often sit on siled islands, forced to source their own deals, structure their own financing, and do their own research from scratch. Although the number and quality of research reports published by OTC platforms has greatly increased, the trading itself is still very dependent on the exchange (it can be said to be the black box of the aircraft). There are currently no full-service investment banks. In fact, providing underwriting and advisory services for token issuance may be the biggest market gap in the future.
Jeff Dorman has been struck by how little well-known capital markets tools are used in the crypto space. Most coin offerings are doomed from the start. From low float/high fully diluted valuation (FDV) token offerings, to direct listings at crazy prices, to poorly written token economics, token issuers (often developers and lacking financial literacy) Having to enter the market without third party assistance. This would subsequently lead to worse investment returns for the asset management company.
Some service providers are getting better, such as custody solutions, OTC trading, and options liquidity. Still, things are getting worse for others, such as fund managers and auditors, who are pulling out of the products in the wake of FTXs collapse.
In terms of technology and research, Bloomberg’s crypto services still fall short. Coverage lists, indexes and all functionality are still as of 2017 and do not take into account how far the industry has grown and evolved. Fortunately, new companies like Nansen, Messari, Glassnode, Dune Analytics, Telegram, etc. are innovating fast enough to capture this market, and I would like to express my gratitude to these companies. By 2023, it will be entirely possible to run a cryptocurrency fund without logging into a Bloomberg terminal.
Overall, fund management continues to face challenges from a lack of sell-side tools. As the sell-side improves, so does the size and breadth of the fund.
The investor community is getting smarter
When it started setting up the Arca Fund five years ago, Arca believed that the educational journey for future investors would be a long one. Arca is constantly learning as they invest and does its best to educate interested investors in real time, but it’s unrealistic to expect those who don’t follow the industry full-time to keep up.
Today, the script has completely flipped. Investors are becoming more knowledgeable about asset classes and investment areas, allowing them to ask better questions. In some cases, investors now know more than fund companies because they are exposed to different areas that may not be the day-to-day focus of fund companies. That is to say, a large amount of bad information continues to be spread to investors through media and KOL accounts, which often makes fund companies surprised by certain topics that are not considered relevant but that investors consider to be hot topics.
As investors become more knowledgeable about crypto assets, they want more control over their investments and personalization increases. Asset management companies in this field have launched highly specialized funds based on investor needs, including DeFi-focused funds, NFT funds, etc. Many asset managers, including Arca, have begun creating “Funds of 1” that allow for more targeting but provide a team of professionals to manage investments.
As information becomes easier to obtain and the UI/UX of the project becomes better, it goes from requiring the guidance of professional fund managers to gradually encouraging retail investors to research and invest on their own. However, to generate alpha in the presence of information asymmetries, it is still valuable to have professional fund managers who can take advantage of around-the-clock news, market volatility, and ambiguous regulatory environments.
in conclusion
Overall, it has been very rewarding to run a fund in this new and innovative area and look forward to the next five years. Fund managers will continue to look for new blue oceans of investment, rather than limiting themselves to liquidity mining, airdrops, testing new applications and other crypto-only opportunities.
The most important factor for success in the crypto asset space is confidence in the future. It must be believed that the crypto industry is at the forefront of building a new financial system that has the power to transform society. While there will be bumps in the road and pushback from some businesses, as long as we keep moving forward, fight for necessary changes, and adjust as needed, the industry will succeed.
