After FTX collapsed, disdainful critics widely derided Caroline Ellison’s approach to stemming the losses. She infamously told an audience during FTX’s heyday: ‘I don’t think it’s an effective risk management tool.’ But did she have a point?
Entering the cryptocurrency asset management space presents a unique set of challenges that differ significantly from the traditional treasury space. In this primer, we will examine the obstacles aspiring fund managers face when launching a Bitcoin sector fund and examine the key differences that exist when breaking away from the world of traditional asset management.
Volatility and Risk Management
One of the most important challenges facing Bitcoin sector funds is the extreme volatility that exists in the cryptocurrency market. The price of Bitcoin has shown a strong upward trend, sparking excitement among investors. However, it also experienced strong downturns, resulting in significant losses for those who were unprepared for these price movements. Managing risk in this dynamic environment requires sophisticated strategies, rigorous risk frameworks and assessments, and a deep understanding of market trends.
Unlike most traditional, mainstream blue-chip assets that experience relatively stable price fluctuations, Bitcoin’s price can change meaningfully within a matter of hours. As a result, Bitcoin sector fund managers must be well-equipped to handle rapid price fluctuations to protect investors’ capital. Traditional stop loss structures may not work as well as expected because of order book slippage and rapid price movements, or “catching a falling knife,” which can cause closing market orders to execute well below the preset trigger price. Using outright stop losses as a fundamental risk management mechanism can be your enemy. For example, in a sudden crash scenario, positions may be automatically sold at a loss, even if the market recovers minutes (or seconds) later.
Although stop loss is an alternative, option! An option is a purchasable contract that gives you the right to buy or sell a specific asset at a predetermined price (i.e. strike price) at a specific time (i.e. expiration date). An option to buy an asset is a call option, and an option to sell an asset is a put option. Buying an out-of-the-money put option (i.e., well below the current price) can act as a floor for potential losses if the price collapses. Think of it as a premium paid to secure your status.
Sometimes, defending against a binary outcome event or particularly volatile period requires leveling out your positions and not taking risks to fight another day in the Bitcoin market. Think of major protocol update dates, regulatory decisions, or the next Bitcoin halving. However, markets move ahead of these events, so you may need to act proactively.
Developing an effective risk management plan for a Bitcoin sector fund requires a variety of hedging techniques, product and instrument diversification (potentially across asset classes), trading venue risk scoring and risk-adjusted allocations, dynamic trade sizes, dynamic leverage settings and strong May include use. An analytical tool to monitor market sentiment and potential market and operational risks.
Storage and Security
Custody of Bitcoin and other cryptocurrencies is an important aspect that distinguishes Bitcoin sector funds from traditional funds. One key difference is that unlike traditional exchanges, which only match orders, Bitcoin exchanges perform order matching, margin, settlement, and asset custody. The exchange itself becomes a clearing house, focusing rather than mitigating counterparty risk. Decentralized exchanges come with unique risks, from protecting the value extracted from miners to being ready to move assets in the event of a protocol or bridge hack.
For this reason, strong security measures are required to protect digital assets from theft or hacking, including but not limited to multi-signature protocols, cold storage solutions, and risk monitoring tools. The fund manager is solely responsible for safely managing private keys and selecting and monitoring trustworthy trading venues. The burden of monitoring the market infrastructure itself introduces a level of technical complexity that is not present in traditional fund management, where custody and settlement are standardized, commoditized, standalone systems.
Management solutions for Bitcoin sector funds must be chosen carefully to ensure assets are protected from cyberattacks and insider threats. The history of high-profile cryptocurrency exchange hacks has investors particularly concerned about the safety of their assets. A security breach could result in significant financial loss and damage to the Fund’s reputation.
conclusion
Launching a Bitcoin sector fund is a thrilling endeavor that offers an unprecedented opportunity for investors seeking exposure to the fast-growing cryptocurrency market. However, it is important to understand that launching a fund is not an easy task, with pitfalls that go beyond the success of the trading strategy. It is not surprising that fund closures fall within the same range of fund launches each quarter.
Those entering the Bitcoin sector fund space must approach it with a pioneering spirit, stay informed and embrace the dynamic nature of this exciting emerging market. The road may be difficult, but the potential rewards for successful Bitcoin sector fund managers can be astronomical.
If you are ready to start your capital building journey, are already on it, or would like more information, please contact us at advisory@satoshi.capital.
This is a guest post by Daniel Truque. The opinions expressed are solely personal and do not necessarily reflect the opinions of BTC Inc or Bitcoin Magazine.