Think Quant Trading Doesn’t Work in Crypto? Think Again

Marc P. Bernegger started his first internet company in 1999 and had two successful exits. He began working with Bitcoin in 2012, is on the board of Crypto Finance Group, Swiss Blockchain Federation and CfC St. Moritz and is a member of the World Economic Forum’s (WEF) Expert Network for blockchain.

The recent CoinDesk opinion article “10 Reasons Quant Strategies for Crypto Fail” by Jesus Rodriguez makes for a great headline, but it overlooks relevant developments and key data in the sector. 

While Rodriguez makes reasonable points about the weakness of quant technology for crypto, a growing number of professional crypto quant fund managers address these through their strategies, demonstrating clear success. Going forward, crypto assets are set to become the perfect asset class for quant strategies.

The 2020 PwC–Elwood Crypto Hedge Fund Report says the most common crypto hedge fund strategy (48% of those surveyed) is quantitative (or taking a systematic approach to the market in either a directional or a market neutral manner), followed by discretionary long only (19% of funds; meaning funds that are long only and whose investors have a longer investment horizon), discretionary long/short (17% of funds; meaning funds that cover a broad range of strategies including: long/short, relative value, event driven, technical analysis and some strategies that are crypto specific, such as mining), and multi-strategy (17% of funds; meaning funds adopting a combination of the above strategies).

To understand why almost half of all crypto hedge funds worldwide are focused on quant strategies requires a look at the broader (crypto) hedge fund sector.

Quantitative characteristics

It is important to note that the models used by quantitative funds usually extend beyond digital asset datasets. Many quantitative crypto fund managers come from the traditional finance world, their strategies are defined based on decades of data from traditional asset classes, and these strategies are tested thoroughly before being applied to the crypto market. 

Additionally systematic strategies are superior to human decision-making procedures in an environment of irrational and volatile markets, which is definitely the case with most cryptocurrencies.

The crypto market is still dominated by traders making decisions by monitoring the price action on the charts. This increases the strength of trends and favors a quantitative approach based on time series analysis.

Traders can retrieve a vast amount of  information by analysing digital asset datasets – particularly when taking on-chain metrics into account (e.g. transaction values, miner fees, etc.). That can be used by quantitative funds to garner some element of predictability instead of relying on technical price data alone.

While Rodriguez makes reasonable points about the weakness of quant technology for crypto, a growing number of professional crypto quant fund managers address these through their strategies.

With outliers, most quantitative strategies can take advantage of the short-term inefficiencies presented by digital assets and actually profit from the outlier events. The key attraction of many quantitative funds is their informational market advantage and the hedging capabilities they offer, particularly during down-markets. As such, outliers may present a challenge, but these periods have been proven quite profitable for some quantitative crypto funds as evidenced by their track records.

Quant funds that generally trade very liquid exchange-listed crypto assets provide better liquidity to investors than a fundamental investor targeting early-stage projects or a multi-strategy, where the fund manager needs to consider the various strategies and instruments in its portfolio.

Relevant results

Most serious and regulated systematic crypto hedge funds are quite transparent with their numbers so investors are able to find actual assets under management or monthly performance figures on platforms like Barclay Hedge or Nilsson Hedge.

Based on available data, systematic crypto funds are outperforming “passive HODLing strategies” (meaning long only), discretionary long/short and multi-strategies significantly and generate sustainable alpha:

In 2019, the average crypto hedge fund performance by strategy was as follows:

Quantitative +58%

Discretionary Long/Short +33%

Discretionary Long Only +42%

Multi-strategy +19% 

In 2018, which was a very challenging year for digital assets, quant trading was the only strategy generating positive returns:

Median quant fund +8%

Median all funds -46%

Median fundamental fund -53%

Median discretionary fund -63%

Bitcoin -72%

So looking at the performance of crypto hedge funds in 2018 and 2019, it is obvious that crypto quant funds are working.

Growing ecosystem

A growing number of investors, including more and more fund of funds, are investing in systematic crypto hedge funds and crypto quants exclusively, which enables the whole ecosystem to evolve quickly.

With most regulated crypto hedge funds that accept money from external investors being quite transparent about fund performance and assets under management, the growth in investments is becoming apparent. Increases in assets being allocated to crypto hedge funds in the last few months and increasing indications that bitcoin is a digital store of value and a new hedge against inflation, show that the demand from investors is accelerating.

A majority of today’s crypto hedge funds, including crypto quants, were created less than three years ago, illustrating that this industry is still very young.

Assets under management of crypto funds worldwide doubled from 2019 to 2020 (from $1 billion to $2 billion) and there are clear indications that they will roughly triple till the end of this year. A big part of this new money will be allocated to systematic crypto funds.

As CoinDesk’s Noelle Acheson wrote recently, “the outlook for crypto hedge funds is sunny.” Investing in a crypto hedge fund instead of direct investment in the market is a more attractive option for many investors: they do not need to worry about custody, best execution, or liquidity crunches. These elements can be especially important for traditional investors, who are not deeply involved in the underlying technology and look at crypto assets primarily as a new alternative asset class to diversify their existing portfolio.

With these arguments, and professional crypto quant fund managers that address known challenges with their strategies to achieve both performance and growth today, the potential for systematic crypto funds to surpass other investment strategies and outperform the market by the end of 2020 looks increasingly probable.