Author: Jeff Dorman, Chief Investment Officer of Arca; Translation: Felix, LianGuaiNews
Jeff Dorman, Chief Investment Officer of the cryptocurrency investment firm Arca, has been operating a cryptocurrency fund for 1825 days. Arca has just achieved an important milestone, refreshing the record of external capital managed in its liquidity hedge fund in the past five years.
In any other industry, five years may not seem like a long time, 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, many peers have come and gone, and Jeff Dorman has gained 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 size adjustments and risk management. He has more than 20 years of trading and asset management experience with companies such as Merrill Lynch and Citadel Securities.
- How SBF’s Elite Parents Help His Cryptocurrency Empire
- Arbitrum agrees to donate $42 million to prevent Layer 2 competitors.
- The fire of RWA finally ignites.
As the Chief Investment Officer responsible for overseeing this fund and three other funds under Arca, Jeff Dorman has personally experienced the evolution of this industry, including ups and downs and continuous innovation. The following are the most important achievements 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, adjusting assumptions and risk models is self-evident, but investing in cryptocurrency assets is not an easy category. For newcomers, frequent booms and busts can lead to a mistaken understanding of liquidity and an inaccurate description of expected beta (referring to the price volatility 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, which change very quickly. For those managing liquid funds, it is a game of constantly adjusting assumptions and risk models.
Interpretation is better than speed
Contrary to popular belief, the cryptocurrency market can trade 24*7 globally without the need for round-the-clock trading coverage. In any asset class, excessive trading on every price change is costly, and the round-the-clock nature of cryptocurrency trading often tries to entice you to engage in more trading activities. But the reality is that the dispersed global investment landscape actually gives you more time to react to news and information. While there will always be robots and algorithms reacting 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 manifest. The correct interpretation of information is much more important than response speed.
Detailed documentation is crucial
Round-the-clock trading does bring difficulties 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. But in the cryptocurrency field, this doesn’t exist.
Take the Terra/Luna incident as an example, where a $30 billion ecosystem collapsed within three days. During these 72 hours, there were continuous transactions and new information flows. The decisions made by traders during this time are now remembered with little significance, and crypto enthusiasts have gradually learned how to better implement risk management in such urgent situations.
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. Similarly, crypto asset management requires knowledge transfer and documentation.
Balance Between Short and Long
In the debt and equity markets, calm periods (summer, holidays) usually lead to a slow rise in prices. 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 online activities, the momentum of asset appreciation tends to slow down during periods of stagnation. As most assets do not have cash flow distribution, the cost of shorting is low. Negative price trends are often more common when the market is sluggish, making it difficult to make decisions regarding hedging and long exposure.
Therefore, active management is superior to passive indexing. Rule-based passive indexing strategies simply cannot keep up with the innovations 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 field has not reached that stage yet.
Hiring Passionate Individuals in the Industry
Building an excellent team is the foundation of success, and it is also extremely challenging.
In the past 25 years, Jeff Dorman has worked in seven different financial companies. Jeff Dorman has reviewed thousands of resumes and interviewed hundreds of people. Jeff Dorman has worked firsthand in almost every financial sector (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 operator? Who is best suited to handle investor relations? These are still not easy questions to answer in the crypto field. In the first few years of Arca Fund’s establishment, whoever 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 were truly passionate about 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 constantly changing in real-time. By 2021, Arca can personally select anyone they want from major banks, brokerage firms, and hedge funds. They may not have crypto experience, but they see the potential for significant wealth in the future, and their resumes keep pouring in. However, by 2023, only those who are passionate about this industry will remain.
Everyone Wears Multiple Hats
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 experts at meetings. Traders must switch back and forth between macroeconomic trends in the US, the Asian currency market, and specific trends in on-chain wallets based on current relevance. Back-end employees must test new service providers every three weeks to keep up with changing regulations, optimal pathways, 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 crypto analysts and traders, they are likely to provide 10 different answers using completely different analytical models. This is refreshing and often leads to significant alpha, but it also presents challenges in creating replicable successful patterns.
Trading Operations is the Most Important Department
When Jeff Dorman worked at credit and stock fund companies, he noticed that back-end work was being neglected. These employees are often seen as apprentices, eager to become “real” trading roles as soon as possible. Back-end work is essentially ensuring trade settlements, ensuring accurate broker reports, and ensuring that fund administrators do their job properly.
But in the crypto field, they should count themselves lucky.
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 individuals in the company but they may also be laid off, and yet the company can still function. Entering a trading operations position is more attractive than quitting, as those who work 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 understand 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 simply read the rules and assume compliance, as there are hardly any clear rules to follow (although Gary Gensler has other explanations). Being a trustee and a law-abiding company is a daunting task.
The Situation for Sellers is Getting Better
In traditional finance, sellers play a very important role. They underwrite new transactions, create innovative financing ideas, advise companies on how to best participate in the capital market, facilitate the trading of existing securities, and write research reports on new and existing securities. Investment banks and broker/dealers that provide comprehensive services exist, but whether you use a one-stop shop or provide services to multiple companies in a fragmented manner, the service itself is included.
Although sellers in the encryption field are getting better, they are still very scattered, and many services still do not exist. Therefore, fund management companies often find themselves on an island, forced to seek their own transactions, build their own financing structures, and start their own research from scratch. Although the number of research reports released 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 planes). Currently, there is still no investment bank that provides comprehensive services. In fact, providing underwriting and consulting services for token issuance may be the biggest market gap in the future.
Jeff Dorman has always been shocked by the limited use of well-known capital market tools in the encryption field. Most token issuances are 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, over-the-counter 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, indexes, and all features are still from 2017, without considering the industry’s development and degree of development. Fortunately, new companies such as Nansen, Messari, Glassnode, Dune Analytics, and Telegram are innovating fast enough to occupy this market. I would like to express my gratitude to these companies. By 2023, it is entirely possible to operate cryptocurrency funds 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.
Investors are becoming smarter
When Arca Fund was established five years ago, Arca believed that the educational journey of future investors would be long. Arca continues to learn during the investment process and tries its best to educate interested investors in real time, but it is unrealistic to expect those who do not devote themselves full-time to this industry to keep up.
Today, the script has completely changed. Investors are becoming more and more knowledgeable about asset classes and investment areas, and are asking better questions. In some cases, investors now know more than fund companies because the different areas they are exposed to may not be the focus of daily attention for fund companies. That being said, a large amount of misinformation continues to be spread to investors through “media” and “KOL” accounts, which often surprises fund companies when it comes to topics that they consider irrelevant but investors consider hot.
As investors become more knowledgeable about crypto assets, they want more control over their investments and demand greater personalization. Asset management companies in this field have launched highly specialized funds to meet investor demands, including funds focused on DeFi and NFTs. Many asset management companies, including Arca, have started creating “Funds of 1” to allow for more targeted investments while still providing professional team management.
With easier access to information and improved UI/UX of projects, there is a shift from relying solely 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 fluctuations, and the ambiguous regulatory environment is still valuable for generating alpha in the presence of information asymmetry.
Conclusion
In summary, operating funds in this new innovative field is highly beneficial and holds promise for the next five years. Fund managers will continue to explore new investment opportunities beyond liquidity mining, airdrops, and testing new applications, which are limited to the crypto space.
The most crucial factor for success in the crypto asset field is confidence in the future. It is essential to believe that the crypto industry is at the forefront of building a new financial system capable of transforming society. Although there will be obstacles along the way and resistance from some organizations, as long as progress continues, necessary changes are pursued, and adjustments are made as needed, this industry will succeed.
Like what you're reading? Subscribe to our top stories.
We will continue to update Gambling Chain; if you have any questions or suggestions, please contact us!
