How Two Asset Managers Handle 2022’s Crypto Volatility
The key to long-term investment success in cryptocurrencies is really no different than it is to investing in any other growth-oriented, volatile asset class: Timing the market beats timing the market.
The problem is that severe downturns, characteristic of cryptocurrencies, can cause many investors to lose faith in buy-and-hold strategies. And the challenge, from an advisor perspective, is to get clients to stay invested.
The reason advisors should encourage their clients to stay invested is that the recent selloff offers an abundance of opportunities for investors.
Brad Roth, chief investment officer at Thor Financial Technologies, emphasized the importance of not only staying invested, but adding to investments in the current market climate: “We’ve seen a 60% decline in bitcoin this year. Now is not the time to jump in the towel. It’s time to look for opportunities. We don’t want clients making the wrong decisions at the wrong times because history repeats itself.”
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However, investors who cannot bear the full brunt of the volatility of crypto prices may consider risk-managed trading strategies.
Although risk management comes at a price, that price may be worth getting clients some exposure to the growth that cryptocurrencies offer.
After the ups and downs of the past seven months, it feels like a good time to revisit how professionals are reducing the volatility of digital assets.
Two strategies for managing risk in crypto
Thor Financial Technologies offers a couple of such strategies designed to trade in and out of bitcoin and ethereum to avoid downside volatility.
“Our two main strategies are risk-managed spot bitcoin and risk-managed spot ethereum,” Roth said. “In terms of the amount of moves, we have done exceptionally well. These strategies go into a risk-off mode or safe mode. Instead of investing in an altcoin or a stablecoin, we prefer to just put them into cash .”
At the beginning of the recent drawdown, Thor’s strategies traded out of bitcoin and ethereum and into cash where they are today. Roth said his strategies are designed to avoid trading as crypto prices move sideways, and that he likely won’t re-enter the market until bitcoin prices break above $24,000 or $25,000. At that point, Thor’s strategies will begin to increase in value again from the lower price without having taken the 50% to 60% hit that most tokens have suffered in 2022.
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ZX Squared Capital, a digital hedge fund, also invests in bitcoin and ethereum. However, it manages risk by using options and futures to achieve a higher Sharpe ratio, which means better risk-adjusted returns.
“People are observing right now and trying to figure out how to get some exposure to this asset class. We believe there is an opportunity going forward, especially as this asset class goes through successive market cycles,” said CK Zheng, co-founder of ZX Squared. “This cycle is not unique – we’ve had three to four cycles before, and each time a token like bitcoin can drop 80% – but they all come back.”
ZX Squared uses options to express short, medium, and long-term views on the bitcoin and ethereum marketplaces, helping Zheng and his partners strike a better balance between risk and return in the crypto market.
“In equity you get around 20% to 30% volatility, but in bitcoin you get somewhere around 80% to 100% volatility,” Zheng said. “So step one for us is to reduce the volatility – essentially 50% of the volatility will be reduced.”
Unlike Three Arrows Capital — the hedge fund that collapsed last month, triggering a series of failures with decentralized finance (DeFi) and stablecoin strategies and knocking out some prominent crypto exchanges — ZX Squared does not use leverage, according to Zheng.
Over the past 12 months, ZX Squared’s strategy has experienced volatility of around 30-35%, similar to a Nasdaq 100 stock, while targeting a Sharpe ratio of 2.0, double bitcoin’s Sharpe ratio of 1.0.
By comparison, US stocks have a Sharpe ratio of 0.5, so on a risk-adjusted basis, bitcoin has outperformed, Zheng said.
Sticking to the big guns
ZX Squared and Thor run different strategies using the same two assets – bitcoin and ethereum. As a result, they naturally reduce some of the risk in the crypto market by avoiding new, esoteric, small and illiquid altcoins.
“I would say that as technological innovations, bitcoin and ethereum have first-mover advantage in the digitization process,” Zheng said. “Whether they can be overcome or replaced by another coin or not is very difficult to say at this stage.”
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Both Zheng and Roth argue that bitcoin is unique in its design and should become more of a currency in the future.
“We believe that at some point bitcoin could become another form of money,” Roth said. “The long-term upside potential is significant.”
In recent months, however, bitcoin has traded more like a technology stock and has correlated closely with stocks. Until that correlation is broken, Roth said bitcoin is more of a growth investment than anything else.
Both agree that ethereum is also more of a growth play.
“We view ethereum more as a security than another form of money,” Roth said. “A lot of platforms are built on it. That’s not going to change. There’s a huge growth opportunity in ethereum. It’s more like a high-growth stock.”