Up, down and all around: the future of quant and cryptocurrency

If there is one certainty about cryptocurrencies, it’s their volatility.

Yet despite the industry being in its infancy and still evolving, interest in crypto as an asset class remains high.

The fact that it is now under such regulatory scrutiny indicates that its acceptance is growing. Lawmakers in the US and elsewhere in the world are currently pushing for better laws and guidelines to make cryptocurrency safer for investors. More regulation is likely to mean more stability and to encourage greater confidence.

It may well also mean that big institutions and mainstream banks increase their adoption of it. Already Fintech companies, including PayPal and Square, have endorsed crypto by allowing users to buy on their platforms and Tesla accepts Dogecoin payments, while the company itself holds billions in other crypto assets.

At the time of writing, the top cryptocurrencies based on their market capitalisation include:

• Bitcoin: The original crypto, it has a market cap of over £342 billion. Its price has soared as it has become so widely known. In May 2016, a Bitcoin was worth £370 but as of 2 November, 2022, a single Bitcoin’s price was roughly £17,800.
• Ethereum: This is both a cryptocurrency and a blockchain platform, with a market cap of over £167 billion. From April 2016 to November 2022, its price went from about £8 to over £1,369.
• Tether: A different type of crypto, Tether is a stablecoin, with a market cap of over £60 billion. That implies it is backed by fiat currencies like UK pounds, US dollars and the Euro. It is viewed as safer as hypothetically it keeps a value equal to one of those denominations.

As crypto’s acceptance is growing, so is its uptake with investors.

This is despite the known volatility in the sector and that crypto is still a new asset class with little to no industry-wide regulation or standardization. Yet a growing number of traditional hedge funds are investing in crypto and more specialist crypto funds are being created as the digital asset class gains acceptance.

Total assets under management (AUM) of crypto hedge funds surveyed was US$4.1bn in 2021, up 8% from the year prior according to PwC’s 4th Annual Global Crypto Hedge Fund Report 2022, produced together with the Alternative Investment Management Association (AIMA) and Elwood Asset Management (now part of CoinShares).

It showed, too, that approximately one in three of hedge funds surveyed are currently investing in digital assets, compared to one in five surveyed last year (increasing to 38% from 21%).

For quant funds, the volatility of crypto can be turned to an advantage. Price falls can actually offer a trading opportunity for quantitative hedge funds. They can afford to be indifferent about whether prices rise or fall, as long as there is a clear trend in one direction to trade.

The Financial Times reports that increasingly large quant hedge fund firms are diversifying into more niche markets such as crypto futures to avoid top heavy positioning in traditional markets and improve returns.

Quantitative crypto hedge fund Cambrian Asset Management, however, has just launched something entirely different. It now has two new actively managed trusts, one trading Bitcoin and one trading Ethereum in order to manage downside risk.

Cambrian states that this hands-on strategy has helped its hedge funds cut downside volatility by over 70%, while delivering higher returns than a digital asset passive index in the past three years.

Conversely, Amphibian Capital is taking a different approach. It is a market-neutral financial vehicle designed only for investors who want exposure to cryptocurrency as an asset class, with strong diversification and much lower volatility. It is a fund of funds so rather than being exposed to one fund, it invests across multiple crypto hedge funds.

Its strategy? It states that a fund of funds makes sense as Amphibian Capital continues to stay on top of the market as it evolves and adapts the portfolio as new strategies become available. It is a matter of taking the best crypto investment strategies and putting them together, it believes.

The future of the success of quant investing in digital assets is as yet unwritten. But more is certainly to come.

PwC reports that the percentage of crypto hedge funds with AUM over US$20 million increased in 2021 to 59%, from 46%, which is significant as $20m is the threshold for “critical mass” in the traditional hedge fund world

With the hopes of further regulatory clarity, next year adoption is likely to increase.

Why? Because both types of investors – the crypto specialists and the traditional hedge funds – appear to be equally optimistic about the long-term future of digital assets and their value.