Arca Chief Investment Officer summarizes nine important gains from managing cryptocurrency funds over the past five years.

Arca CIO summarizes key gains from managing crypto funds in the past five years.

Jeff Dorman, Chief Investment Officer of Arca, believes that market interpretation is more important than reaction speed, and detailed records are crucial. It is also important to hire people who are passionate about the industry. And don’t forget, the most important factor in achieving success in the field of cryptocurrency assets is confidence in the future.

Article by: Jeff Dorman, Chief Investment Officer of Arca

Translation by: Felix

Jeff Dorman, Chief Investment Officer of Arca, has been operating a cryptocurrency fund for 1825 days. Arca has just achieved an important milestone, setting a record for external capital managed in a liquidity hedge fund in the past five years.

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In any other industry, five years may not seem like a long time range, but in the cryptocurrency field, five years is a relatively long time. Because of round-the-clock trading, one year in the cryptocurrency industry can be equivalent to five years in a traditional industry. In the past five years, I have seen many peers come and go, and Jeff Dorman has left some survival insights in cryptocurrency asset management.

Jeff Dorman, a columnist for CoinDesk, is the Chief Investment Officer of Arca, leading the Investment Committee and responsible for portfolio scale adjustments and risk management. He has more than 20 years of trading and asset management experience at companies such as Merrill Lynch and Citadel Securities.

As the Chief Investment Officer responsible for overseeing this fund and three other funds under Arca, Jeff Dorman has firsthand experience of the evolution of this industry, including prosperity, adversity, and constant innovation. The following are the most important gains in managing cryptocurrency investment portfolios over the past five years.

In short: The cryptocurrency investment market is very challenging.

Adjusting assumptions and risk models

For anyone who has invested in this market, it is obvious that adjusting assumptions and risk models is necessary, but investing in cryptocurrency assets is not an easy category. For newcomers, frequent booms and busts can create a false understanding of liquidity, as well as inaccurate descriptions of expected beta (measuring the price fluctuations of individual tokens relative to the overall market) and returns. All risk models, expected loss reserves, and scale parameters are based on historical data and correlations, and the speed of change in these data and correlations is very fast. For those who manage liquidity, it is a game of constantly adjusting assumptions and risk models.

Interpretation surpasses speed

Contrary to popular belief, the cryptocurrency market can be traded 24*7 globally without the need for round-the-clock trading coverage. Excessive trading with every price change is costly in any asset class, and the round-the-clock nature of cryptocurrency trading often tempts you to engage in more trading activities. But the reality is that the decentralized global investment pattern actually gives you more time to react to news and information. Although there are always robots and algorithms that react to news immediately, these initial subconscious reactions are often wrong. Due to time differences, one-third of the world’s population is always asleep, so true market reactions often take several days to materialize. Correct interpretation of information is much more important than reaction speed.

Detailed documentation is crucial

24/7 trading indeed brings challenges that are not present in traditional markets. In traditional financial markets, even the worst day/week eventually comes to an end, giving you ample time to readjust and think through decisions during market closures without being blinded or influenced by price fluctuations. However, in the crypto space, these breaks don’t exist.

Take the Terra/Luna incident, for example, where a $30 billion ecosystem collapsed within three days. There were continuous trades and new information flowing during these 72 hours. The decisions made by traders during that time are now remembered with little time constraints, and crypto enthusiasts have gradually learned how to better implement risk management under such urgent deadlines in the future.

In hospitals, errors usually occur not because doctors are overworked or fatigued, but because information is incorrectly passed on to the next doctor due to incomplete records provided by the previous doctor, resulting in a lack of complete information for the next doctor. Similar knowledge transfer and documentation are needed for crypto asset management.

The balance between short and long

In debt and equity markets, calm periods (summer, holidays) usually lead to slow price increases. The cost of shorting is high, and dividends and interest payments accumulate, adding more buying interest to the market. The situation is quite the opposite for crypto assets. Since most crypto projects accumulate value through network activities, periods of stagnation often slow down the upward momentum of assets. As most assets have no cash flow distribution, the cost of shorting is low. When the market is sluggish, negative price trends are often more common, making it difficult to make decisions on hedging and long exposure.

Therefore, active management is superior to passive indexing. Rule-based passive index strategies simply cannot keep up with the innovation and changes in the crypto market. Similarly, passive indexing cannot take advantage of market volatility to generate significant alpha. Over time, this situation may change as the market matures. But the crypto space has not reached that stage yet.

Hiring people passionate about the industry

Building an excellent team is the foundation of success and also extremely challenging.

In the past 25 years, Jeff Dorman has worked at 7 different financial companies. Jeff Dorman has seen thousands of resumes and interviewed hundreds of people. Jeff Dorman has worked firsthand in almost every financial department (banking, trading, research, sales, business development). If a traditional Wall Street financial company is looking for a candidate, Jeff Dorman can easily find the most suitable candidate for their needs.

What are the best attributes and qualifications for a cryptocurrency research analyst? What makes the best trading operations personnel? Who is best suited to handle investor relations? These are still not easy questions to answer in the crypto space. In the first few years of Arca Fund’s establishment, anyone who wanted a job, Arca would hire them. The salary was low, the working hours were long, and the future was uncertain. In 2018, those who wanted to find a job in the crypto industry had a genuine passion for the success of blockchain and were willing to learn any knowledge and skills required for the job. Most of the people who joined the industry before 2020 are still working in the industry, and their job responsibilities are also changing in real-time. By 2021, Arca can personally pick anyone they want from major banks, brokerage firms, and hedge funds, none of whom have crypto experience, but they see the potential for significant wealth in the future, and resumes are pouring in. But by 2023, only those who are passionate about this industry will remain.

Everyone has multiple roles

This is a highly practical business, where research analysts must test the functionality of applications, challenge existing financial models, and engage in real-time communication with other industry veterans at meetings. Traders must switch back and forth between the macro environment in the United States, the Asian currency market, and the specific trends of chain wallets based on current relevance. Back-office staff must test new service providers every three weeks to keep up with evolving regulations, optimal paths, and LP requirements, while also dealing with bankruptcies, closures, and hacking attacks.

Their commonality seems to be a genuine willingness to test new ideas. If you provide the same information to 10 stock analysts, they will give you roughly the same answer and provide homogeneous modeling to arrive at that answer. If you provide the same information to 10 cryptocurrency analysts and traders, they will likely provide 10 different answers using completely different analytical models. This is refreshing and often brings significant alpha, but it also presents challenges in creating repeatable successful patterns.

Trading operations are the most important department

When Jeff Dorman worked at a credit and equity fund company, he found that back-office work was being neglected. These employees are often seen as kids who are eager to become “real” trading roles as soon as possible. Back-office work is basically ensuring trade settlements, ensuring broker reports are accurate, and ensuring that fund administrators do their job.

But in the crypto field, it should be fortunate.

Trading operations are the most important job in the crypto field. You have to deal with these assets every day, and one mistake could cost the company millions of dollars. Therefore, these people not only need to be the most trustworthy people in the company but also may be laid off, but even if they leave, the company can still operate. Entering a trading operations position is more attractive than leaving because those working in this department will learn the most about blockchain knowledge.

Similarly, compliance is not an afterthought in the crypto field. Unlike traditional financial markets, you cannot assume that your employees are familiar with the rules because most employees have backgrounds that are completely different from Wall Street. Continuous education and supervision are necessary. In addition, compliance officers cannot just read the rules and assume compliance because there are almost no clear rules to follow (although Gary Gensler has a different view). Being a trustee and a compliant company at the same time is a challenging task.

Sellers are doing better and better

In traditional finance, sellers play a very important role. They underwrite new transactions, create innovative financing ideas, advise companies on how best to participate in the capital market, facilitate the trading of existing securities, and write research reports on new and existing securities. Investment banks and brokers/traders that provide comprehensive services exist, but whether you use a one-stop shop or provide services to multiple companies separately, the service itself is included.

Although sellers in the encryption field are getting better, they are still very decentralized, and many services still do not exist. Therefore, fund management companies are often on isolated islands, forced to seek their own transactions, build their own financing structures, and do their own research from scratch. Although the number of research reports published by OTC platforms has greatly increased and the quality has also greatly improved, the transactions themselves still rely heavily on exchanges (which can be said to be the black box of the aircraft). Currently, there is no investment bank that provides comprehensive services. In fact, providing underwriting and advisory services for token issuance may be the biggest market gap in the future.

Jeff Dorman has always been shocked by the lack of well-known capital market tools in the encryption field. The issuance of most tokens is doomed to fail from the beginning. From low circulation/high fully diluted valuation (FDV) token issuance, to direct listing at crazy prices, to poorly written token economics, token issuers (usually developers lacking financial knowledge) have to enter the market without third-party assistance. This subsequently leads to poorer investment returns for asset management companies.

Some service providers are getting better, such as custody solutions, OTC trading, and options liquidity. However, the situation for others is getting worse, such as fund managers and auditors who are withdrawing from these products after the collapse of FTX.

In terms of technology and research, Bloomberg’s encryption services are still not ideal. The coverage list, index, and all functions are still from 2017, without considering the development and extent of the industry. Fortunately, new companies such as Nansen, Messari, Glassnode, Dune Analytics, Telegram, etc. are innovating fast enough to occupy this market, and I would like to express my gratitude to these companies. By 2023, it is entirely possible to operate a cryptocurrency fund without logging into the Bloomberg terminal.

Overall, fund management still faces the challenge of a lack of seller tools. With the improvement of sellers, the scale and breadth of funds will also improve.

Investor groups are becoming smarter

When Arca Funds were established five years ago, Arca believed that the education journey of future investors would be long. Arca has been constantly learning in the investment process and making every effort to educate interested investors in real time, but it is unrealistic to expect those who do not devote full time to this industry to keep up with the pace.

Today, the script has completely flipped. Investors are becoming more and more knowledgeable about asset classes and investment areas, and therefore they are asking better questions. In some cases, investors now know more than fund companies because the different areas they come into contact with may not be the focus of daily attention for fund companies. In other words, a large amount of misinformation continues to be spread to investors through “media” and “KOL” accounts, which often surprises fund companies when investors consider certain topics to be hot but the companies consider them irrelevant.

As investors become more knowledgeable about cryptocurrency assets, they desire more control over their investments and seek personalization. Asset management companies in this field have launched highly specialized funds in response to investor demand, including funds focused on DeFi and NFTs. Many asset management companies, including Arca, have started creating “Funds of 1” that allow for more targeted investments while still providing professional team management.

With easier access to information and improved project UI/UX, there is a shift from relying on professional fund managers to encouraging retail investors to conduct their own research and investments. However, having professional fund managers who can leverage real-time news, market volatility, and a complex regulatory environment to generate alpha remains valuable in a situation of information asymmetry.

Conclusion

In summary, operating funds in this new and innovative field is highly beneficial and is expected to continue over the next five years. Fund managers will continue to seek new investment opportunities beyond liquidity mining, airdrops, and testing new applications that are limited to the crypto domain.

The most important factor for success in the cryptocurrency asset field is confidence in the future. It is necessary to believe that the crypto industry is at the forefront of creating a new financial system with the capability to transform society. While there will be obstacles along the way and resistance from certain enterprises, as long as progress continues, necessary changes are pursued, and adjustments are made as needed, this industry will succeed.

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