After FTX's collapse, Caroline Ellison's approach to stemming losses was widely ridiculed by dismissive critics. “I just don't think they're an effective risk management tool,” she infamously told an audience during FTX's heyday. But was he right?
Venturing into the realm of crypto asset management presents a unique set of challenges that differ widely from the traditional fund space. In this primer, we'll delve into the obstacles aspiring fund managers face when launching a bitcoin sector fund and examine the key differences that exist when stepping outside the world of traditional asset management.
Volatility and risk management
One of the most important challenges facing funds in the bitcoin sector is the extreme volatility that exists within the cryptocurrency market. bitcoin price has witnessed strong bullish surges, generating excitement among investors. However, it has also experienced sharp bearish declines, leading to substantial losses for those unprepared for such price swings. Managing risk in such a dynamic environment requires sophisticated strategies, rigorous risk assessments and frameworks, and a deep understanding of market trends.
Unlike most traditional and blue-chip assets, which often experience relatively stable price movements, the price of bitcoin can change significantly in a matter of hours. Consequently, fund managers in the bitcoin sector must be well equipped to handle sudden price fluctuations and protect their investors' capital. Traditional stop loss structures may not work to the expected extent as the market close order may be executed well below the pre-set trigger price due to order book slippage and rapid price movements, the proverbial “catch a falling knife.” Using strict stop losses as a fundamental risk management mechanism can be your enemy. For example, in a flash crash scenario, positions can be automatically sold at a loss even if the market reverses a few minutes (or seconds) later.
Although stop losses are an alternative, they are not a option! Options are contracts that you can purchase that give you the right to buy or sell a given asset at a predetermined price (i.e. the strike price) at a given time (i.e. the expiration date). An option to buy an asset is a call option and an option to sell it is a put option. Buying a put option out of the money (i.e., well below the current price) can act as a floor for your potential losses if the price collapses. Think of it as a bonus paid to secure your position.
Sometimes, to defend against binary outcome events or time periods of particularly high volatility, you just have to flatten your positions and take no risks, living to fight another day in the bitcoin market. Think, for example, of key protocol upgrade dates, regulatory decisions, or the upcoming bitcoin halving; Although keep in mind that the market anticipates such events, so you may need to take action beforehand.
Creating an effective risk management plan for a bitcoin sector fund may involve the use of various hedging techniques, product and instrument diversification (potentially across asset classes), trading venue risk rating, and market-adjusted allocations. risk, dynamic trade sizing, dynamic leverage setups and solid employment. analytical tools to monitor market sentiment and potential market and operational risks.
Custody and Security
Custody of bitcoin and other cryptocurrencies is a critical aspect that distinguishes bitcoin sector funds from their traditional counterparts. A key difference is that unlike traditional exchanges that only match orders, bitcoin exchanges are responsible for matching orders, setting margins, liquidating, and custody of assets. The exchange itself becomes the clearinghouse, concentrating counterparty risk rather than alleviating it. Decentralized exchanges also carry a unique set of risks, from defending against value extracted by miners to being prepared to move assets in the event of a hacked protocol or bridge.
For these reasons, protecting digital assets from theft or hacking requires robust security measures, including but not limited to multi-signature protocols, cold storage solutions, and risk monitoring tools. The responsibility for securely managing private keys and choosing and monitoring trusted trading venues lies entirely with the fund manager. The burden of monitoring the market infrastructure itself introduces a level of technical complexity absent in traditional fund management, where custody and settlement are independent standardized and commoditized systems.
Custody solutions for bitcoin sector funds must be carefully selected, ensuring that assets are protected from cyber attacks and insider threats. With the history of high-profile cryptocurrency exchange hacks, investors are particularly concerned about the security of their assets; Any security breach could result in significant financial losses and damage the fund's reputation.
Conclusion
Launching a bitcoin sector fund is an exciting endeavor that offers unprecedented opportunities for investors seeking exposure to the rapidly growing cryptocurrency market. However, it is important to understand that launching a fund is not an easy task and that the obstacles go beyond the success of the business strategy. It is no surprise that every quarter fund closings coincide with fund launches.
Those entering the bitcoin fund space must approach it with a pioneering spirit, stay informed and embrace the dynamic nature of this exciting emerging market. While the path may be challenging, the potential rewards for successful fund managers in the bitcoin sector could be astronomical.
If you are ready to start your fund creation journey, are already on your way, or simply want to learn more, please contact us at [email protected].
This is a guest post by Daniel Truque. The opinions expressed are entirely their own and do not necessarily reflect those of btc Inc or bitcoin Magazine.