*Jeff Dorman, partner at crypto asset management firm Arca Funds, spent 18 years on Wall Street and in fintech before turning his focus to developing crypto asset strategies and products.
This article originally appeared in ‘Institutional Crypto,’ a weekly CoinDesk newsletter focused on the nexus of Wall Street and crypto assets. The opinions expressed in this article are the author’s own. *
Through meetings with over 100 institutional investors over the past four months from California to New York, one thing has stood out most − an overwhelmingly positive response.
These endowments, family offices, pensions and other institutions are enthusiastic about crypto assets despite an overall pullback in crypto valuations upwards of 75 percent from their all-time highs.
This is remarkable.
Though the majority of these investors want to dip their toes in the crypto pool, they come from varying backgrounds and have different levels of knowledge:
Those just beginning their crypto educational journey
Those that didn’t have a “crypto specific mandate,” but are evaluating crypto managers in the same way they evaluate all emerging fund managers
Those that are well versed in crypto, and considering an immediate allocation.
Not surprisingly, each category of investors had different questions and goals.
The ‘Beginning’ Investors
Learning a new industry can be daunting.
The typical learning curve looks something like this:
- Phase I: The first time you hear about blockchain or crypto –> Skepticism
- Phase II: You spend the next six months researching and learning –> Optimistic but confused
- Phase III: You spend the next 12 months going deeper down the rabbit hole until you want to dedicate the next 20 years to this new technology –> Passion and full adoption
Most investors considering digital assets are somewhere between “Phase I” and “Phase II” and, even if they weren’t thinking of allocating, it was not uncommon to hear some variation of “crypto is hard to ignore right now.”
Two points resonate universally with this group:
- You’re 100% long the financial system right now! Even if you moved to 100 percent cash across all of your investments, you are still 100 percent long the financial system (via the banking system). As we saw in the 2008 banking crisis, 2011 European sovereign crisis and the 2018 emerging market currency crisis, there is systemic risk out there that investors want to hedge against. Crypto offers investors exposure outside of the traditional financial system, and many argue it is actually more dangerous NOT to have some exposure to crypto than it is to have a small allocation.
- Crypto is both an asset class and an infrastructure. As an asset class, there are opportunities today to participate in the growth of emerging technologies. The pie is growing even as prices collapse and, with enough research, you can figure out which slices of the pie to grab.As an infrastructure, you have time to wait. But you’ll want to familiarize yourself today because one day soon, every asset class you own may be represented in digital asset form (equities, fixed income, real estate, hard assets). Viewing the utility of cryptocurrencies through price alone misses the fundamental revolution. Cryptocurrency and blockchain have uses far beyond price.
What matters most is understanding how crypto assets can meet their goals and fit within their risk tolerances, as well as how it fits as a smaller piece of an overall balanced and diversified portfolio.
Understanding every nuance is secondary. For example, most investors who invest in healthcare equity funds don’t fully understand Medicare reimbursement, hospital admissions and patent processes. Instead, these investors know enough to recognize that they want exposure to healthcare, and then hire experts to express the individual views for them.
This is likely what will happen in crypto.
The ‘Traditional Hedge Fund Due Diligence’ Investors
Investors in this camp spend most of their time seeking out strategies that expose them to the potential upside while limiting downside risk:
This is what most often gets their attention:
- Don’t focus on how high it can go; focus on how low it can go. A good fund manager in any asset class tries to capture most of the upside, while ensuring that downside risk is mitigated. This is an especially important message for investors to hear in crypto, since most of what they see and hear strictly focuses on outlandish return potential.
- DO NOT short this market today. I’ve spent my entire career trying to isolate idiosyncratic risk and removing market risk through cap structure arbitrage trades and long-short trades, but this strategy does not yet work in crypto for a variety of reasons (asymmetric upside, low liquidity, high costs, etc). As such, the best hedge today is simply not to own a token that you don’t like. Currently, the best way to protect against the downside is by sizing positions correctly according to risk/return profiles, taking chips off the table when this equation is no longer favorable, and using derivatives to hedge tail risk.
- A top-down AND bottom-up approach. Active management matters in crypto, perhaps more than in any other asset class, because of the large swings and bifurcations between top performers and underperformers. Understanding the macro landscape (top down) while simultaneously searching for value (bottom-up approach to security selection) is how to take advantage of current market conditions. Few investors want to hear about best ideas because they are not ready to execute them on their own − but they do want to understand the process.
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