Since the launch of the Bitcoin in 2008, interest in cryptocurrencies continue to increase exponentially over the years. As the space matures, investors are increasingly eager to add cryptocurrencies into their portfolios for more diversification, whether it is for long-term value investing or short-term profit maximization. Investors can no longer afford to ignore the impact of digital assets.
We conducted an interview with Founder and CIO of CryptAM, David Demmer, who has years of experience in traditional banking and financial industry. He is also a Co-founder of HKDAIA (Hong Kong Digital Asset Investment Association) charged with setting active and proper regulatory standards within the Asian crypto community.
What is the difference between cryptocurrency investment solution vs traditional investment solution?
Traditional markets are very different from the digital asset space. Traditional market construction risk factors are academically proven and have been around for a long time. While in the cryptocurrency market you use different risk and return factors. That mean basically only sentiment and momentum generally work well. Recent studies show that those risk factors have nothing in common compared to the traditional asset space. The digital asset space is still new. Its return drivers are uncorrelated to the traditional markets.
That said, this is a volatile market and has risk levels of around 100%. Comparing that to the return volatility of equities, 15-25%, and bonds, 4-10%, there is a meaningful gap between the digital asset space and traditional markets.
Trading in digital assets is a whole different game, when compared to traditional investing. A simple example will be that digital assets trade on a 24/7 basis where traditional markets trade only 5 days a week during pre-defined/required hours. This has a big implication on risk measurement and trading behaviors. Simply put, when calculating risk (standard deviation), 365 days is used in the calculation for the digital asset market, whereas 255 trading days are used for traditional markets. As you can see, there is a significant increase in risk associated with the digital asset market.
In addition to market risk, the digital asset market requires you to place a large emphasis on operational risk and counterparty/credit risk when dealing with exchanges. Operationally, as institutional investors get involved, the regulatory standards of digital assets will continually try to mirror those of traditional market as regulation increases.
Why is having a digital asset portfolio crucial for traditional investors?
For traditional investors that have equities, bonds, real estate and commodity exposure, we believe that it is crucial to continue to diversify. For example, an investor that holds the S&P500 (US stocks), the US’s most mature equity and liquid market, they would have seen an improvement of their longer-term risk-adjusted performance numbers by adding digital assets in small amounts, such as Bitcoin. By doing this you can significantly improve the return/risk efficiency of your long-term asset allocation portfolio.
The nature of the crypto market means that it is generally uncorrelated and hence, by adding this to your portfolio, especially now at the current state of the market, the overall asset allocation return profile can be improved. As investors gain access to this market in the future, they should be on the lookout for asset managers that can control the risk to levels they are comfortable with.
Because of the technologies driving blockchain-related digital assets, this market presents a market big opportunity as more people are looking to invest. They are all doing their homework, and they now recognize it as a new asset class. This is the reason we are a very strong believer in the cryptocurrency space, and we are excited to be here.
What are the typical challenges when creating a well-diversified digital asset portfolio compared to traditional assets?
To meet the challenges of trading in this market, we created several market timing models within our multi-strategy offering. Given the high levels of inefficiencies in this market we believe that an active management/trading approach is warranted.
It generally comes down to one thing, the correlation between different asset pairs within the crypto market. At present, crypto markets are very correlated and the intra-correlation between coins is very high. This means when the market rises/falls, most coins tend to move together in the same direction. This was true in 2018 but less so in the run-up of years 2016/2017. The only way to hedge against the risk of falling prices is to use futures as a hedge or sell out completely and re-enter at a cheaper level.
Within the crypto market, we firmly believe in diversification in the long term as this will get exposure to those potential massive outperformers. However, for the medium to short term, we expect Bitcoin to remain a top coin because of its position as a coin of liquidity and a relatively large network, which provides dispersion and distribution of power to avoid any one government controlling its fiscal and monetary characteristics.
What are the different types of digital asset portfolios?
They are the same as in traditional markets – you have active and passive management approaches. With passive funds, you track the market, and here at CryptAM we built standardized index methodologies. Examples include the FTSE and MSCI indices covering equities in the traditional markets. Digital assets are a multi-billion-dollar industry that the market does not recognize yet and we have yet to truly monetize the area of market indices.
In terms of the active approach, CryptAM focuses on delivering value through a quantitative bias. We have techniques using relative overweight/underweight approaches and/or using various market timing approaches. There are also market-making and arbitrage funds, in addition to the pure venture capital style funds, which invest into projects and companies
We are an asset management company rather than just a fund. An asset management company requires many more components such as compliance, front office, back office, proper managing directors.
What are the key components to look for when choosing a secure and well-diversified digital asset portfolio?
The key component is to know all different types of portfolio construction methodologies. There are only two things that add value – liquidity and risk. This is key because without these, we would not be different from any other fund and this is where we truly add value for our customers.
Why did you choose to start this business?
Very early on, we realized that digital assets are new asset class. And now, digital assets are also recognized by institutional investors and this is a key factor for everyone in the game. We see this trend continuing even though the market is down and filled with negative news and sentiment. Banks are continuing to work with digital assets, and this is great for everyone in the game. I am also here trying to help educate all the readers out there about digital assets and this is an essential part of the game as this is still such a new area. We need to all get out there and continue to have meaningful discussions about digital assets to promote further growth and innovation.
What is so special about CryptAM? How do you differentiate yourself in the market?
We are trying to become an institutional-grade player and that is why we are still here, while many other players have dropped out since they were not conservative enough and grew too quickly. Many members in the management team are well experienced, which results in a more conservative approach overall. This is the main reason why we are different.
We welcome regulation and are open to educating and working with various jurisdictions on how to make this space more proper. Here at CryptAM, we understand that digital assets will be around whether we exist or not, but our purpose is to make this market a more professional marketplace. We add value to our customers because we:
1. provide easy access solutions for investors wishing to get broad exposure into digital assets
2. work closely with custodians to strengthen governance measures
3. aim to work closely with external administrators to ensure all the investment vehicles have proper accounting
4. work with OTC providers to access the best liquidity possible
5. have our own indexing methodologies which gives us better access to the market and risk measurement tools
What is the long-term vision of CryptAM?
Delivering value to all our clients who wish to diversify their traditional portfolios.
What types of companies or individuals use your services?
Anyone with multi-asset allocations and wants more access to diversification would be potential clients. This typically means high net worth individuals or any professional type of investor such as big institutions or multi-family offices. Digital assets will be able to provide more diversification in the future through new coins, and this includes stable coins, public coins and interesting technology projects.
How is security guaranteed and cryptocurrency hacks prevented? And how your company can balance the trade-off between security and efficiency?
Security is key. One thing to take note is that blockchains generally cannot be hacked. There have been a lot of companies that have been hacked, but you don’t read much about it. It doesn’t matter how great the fund is, without security everything falls apart. We work together with credible partners and IT security professionals to help make our company more secure. It all comes down to identity management and password management. When you talk about password management, you want to make sure that your password is not easily accessible. And in terms of identity management, you want to take active precautions such as making sure your intern doesn’t have access to trading.
Therefore, we are very strict with security. We have routines and security checks, but there is a trade-off between security and efficiency. Some things must be done manually and there is no way everything can be automated. You must make sure that the right people have the right controls at the right time. Therefore, one can not be completely efficient.
How your company deal with the extreme price differences across different platforms for the same cryptocurrency?
We see that there are more and more arbitrage deals as the market is getting more efficient. We are assuming that the market will soon eliminate this pricing differential. We have our best execution, which is driven by liquidity because we trade in large amounts and we need to make sure that we trade those amounts efficiently in the favor of our clients. That means we are naturally accessing the most liquid and efficient exchanges, and inevitably, we will experience very small price variances between exchanges.
As liquidity increases, the market becomes more efficient and, as a result, arbitragers and market makers will make less money. We see experienced market makers from traditional markets entering the digital asset market and we are not trying to compete with them. We would much rather focus on the area we’re better at, which is portfolio construction and generating alpha for our clients through quantitative research.
What are the main implications for the current trends in digital asset investment?
Prices in the digital asset market are not yet news-driven as they are in traditional markets. The digital asset market is more driven by liquidity and can be very event-driven, but not news-driven. For example, if Apple has a product release, everyone trades upon the news, and because of this reason the price will eventually fall as a result. When dealing with the digital asset market, participants are not trading based upon the news yet, as this often is not readily available for regular market participants.
Going back to your question, STOs (security token offerings) are a big topic. Stablecoins are a type of STOs. They are a type of asset backed security. Currencies such as the USD and HKD, and commodities such as gold and oil are being tokenized as asset backed securities. As a portfolio manager, I look at the underlying asset and this provides me with a lot of diversification. Digital assets will be a key component for accessing the most diversification possible. We consider digital assets the final asset class because everything will be tokenized onto the blockchain. Not only currencies and commodities, but also funds and indices are also being tokenized, which opens access to a wide range of assets and makes diversification much easier. Therefore, we support the community since we see that the community will continue to make advancements and grow in the future.
How do you see the trends and developments of digital asset investments in Hong Kong?
This is mostly a question related to regulation. Hong Kong follows common law and because the HKD is pegged to the USD, Hong Kong tends to follow what the US is doing. As a government, you decide to create a currency and have a monetary authority to govern it or you peg it to another currency, which provides you with a lot of advantages, and yet has its risks at the same time.
So far, this strategy has helped Hong Kong significantly and Hong Kong is striving to become more relevant in the fintech sector and innovative, but at the other end it has a legal counsel. Regulation of exchanges and asset managers will be the key for the future.
In November 2018 the SFC provided a sandbox for exchanges and regulation for asset managers, and slowly Hong Kong is working towards better regulation in this area. That said, cryptocurrency is a global game. We actively search for a regulatory environment that works for us and our prospective client base. We would like to work closely with global regulators. As entrepreneurs, we strive to make social impact to make the world a better place, increasing financial inclusion, and creating value to all clients and stakeholders alike.
What are the typical concerns for individuals when they choose to invest in digital assets?
Customers are usually concerned about factors such as custody, market manipulation, credit risk, lack of regulation, licensing, KYC and AML. KYC and AML are special ones, because with Bitcoin you can see where the money is coming from up until the origination. Money is inherently anonymous so you wouldn’t know if the money originated from illegal transactions such as drug dealing, but with Bitcoin you do know. With the added transparency, which is an advantage to many people, comes new issues that arise.
What are the challenges for cryptocurrency’s transition from simply a mining process to a mature and mainstream investment option?
We want to be an exclusive asset management company for exclusive and explicit people. At the same time, we happily provide education to the public, our main purpose is to provide custom tailored solutions for specific needs. We are more like an asset management boutique because we custom-tailored solutions for eligible people. As mentioned earlier, we have provided a risk averse portfolio for one customer reducing the market risk from 97 to 37, to allow for him to manage drawdowns in crypto and wanted to have a low beta. As asset managers coming from the traditional space, this is where we feel we truly add value.
What are some of the factors that affects the cryptocurrency market and how does your company take these factors into account?
Liquidity and momentum. Liquidity is the money going in and out, the decision to enter the market. This is isolated and money either increases or decreases and because of this there is a trend of actions that follow as money flow follows the price action and creates a natural and organic momentu
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Disclaimer: The views and opinions expressed in this article are those of the interviewee and do not necessarily reflect the view of blockchain.news
This is one of several interviews coming up in the “Blockchain 2019: Industry Leaders and Voices” series aimed at raising awareness of the blockchain community. If you are interested and would like your project to be covered in one of our upcoming interviews, please contact Henry Chan at henry.chan@blockchain.news for more details