Venturing into the crypto asset management realm presents a unique set of challenges that differ widely from the traditional fund space. In this primer piece, we will delve into the obstacles that aspiring fund managers face when launching a bitcoin sector fund and examine the key differences that exist when you step outside the world of traditional asset management.

Volatility and Risk Management

One of the most significant challenges faced by bitcoin sector funds is the extreme volatility that exists within the cryptocurrency market. Bitcoin’s price has witnessed strong bullish surges, driving excitement among investors. However, it has also experienced strong bearish declines, leading to substantial losses for those unprepared for such price swings. Managing risk in such a dynamic environment requires sophisticated strategies, rigorous risk frameworks and assessments, and a deep understanding of market trends.

Unlike most traditional and mainstream blue chip assets, which often experience relatively stable price movements, bitcoin’s price can change meaningfully within a matter of hours. Consequently, bitcoin sector fund managers must be well-equipped to handle sudden price fluctuations to protect their investors’ capital. Traditional stop loss structures may not work to the extent expected, as the closing market order may get executed far below the preset trigger price due to orderbook slippage and rapid price movements, the proverbial “catching of a falling knife”. Using tight stop losses as a foundational risk management mechanism can be your enemy. For example, in a flash crash scenario, positions may be automatically sold at a loss even though the market reverted a few minutes (or seconds) later.

While stop losses are an alternative, they’re not an option! Options are contracts you can buy that give you the right to buy or sell a given asset at a predetermined price (i.e., the strike price) at a given time (i.e., the expiration date). An option to buy an asset is a call and an option to sell one is a put. Buying an out-of-the-money put (i.e., far below the current price) can act as a floor on your potential losses if the price collapses. Think of it as a premium paid to insure your position.

Sometimes to defend against binary result events or particularly high volatility timeframes you just have to flatten your positions and take no risk, living to fight another day in the bitcoin market. Think for example of key protocol update dates, regulatory decisions or the next Bitcoin halving; though note the market moves ahead of those events so you may have to take action beforehand.

Creating an effective risk management plan for a bitcoin sector fund may involve using various hedging techniques, product and instrument diversification (potentially across asset classes), trading venue risk scoring and risk-adjusted allocations, dynamic trade sizing, dynamic leverage settings, and employing robust analytical tools to monitor market sentiment and potential market and operational risks.

Custody and Security

The custody of Bitcoin and other cryptocurrencies is a critical aspect that distinguishes bitcoin sector funds from their traditional counterparts. One key difference is that unlike traditional exchanges that only match orders, bitcoin exchanges do the order matching, margining, settlement, and custody of the assets. The exchange itself becomes the clearinghouse, concentrating counterparty risk as opposed to alleviating it. Decentralized exchanges come with a unique set of risks as well, from fending off miner-extracted value to being ready to move assets in case of a protocol or bridge hack.

For these reasons, safeguarding digital assets from theft or hacking requires robust security measures, including but not limited to multi-signature protocols, cold storage solutions, and risk monitoring tools. The responsibility of securely managing private keys and choosing and monitoring reliable trading venues rests entirely with the fund manager. The burden to monitor the market infrastructure itself introduces a level of technical complexity absent in traditional fund management where custody and settlement are standardized and commoditized standalone systems.

Custodial solutions for bitcoin sector funds must be carefully selected, ensuring that assets are protected against cyberattacks and insider threats. With the history of high-profile cryptocurrency exchange hacks, investors are particularly concerned about the safety of their assets; any breach in security could lead to significant financial losses and damage the reputation of the fund.

Conclusion

Launching a bitcoin sector fund is a thrilling endeavor that offers unprecedented opportunities for investors seeking exposure to the fast-growing cryptocurrency market. It is important, however, to understand that launching a fund is no easy feat with pitfalls going beyond the success of the trading strategy. It is no surprise that every quarter the fund closures are in the same range of fund launches.

Those entering the bitcoin sector fund space should approach it with a pioneering spirit, stay informed, and embrace the dynamic nature of this exciting emerging market. While the road may be challenging, the potential rewards for successful bitcoin sector fund managers could be astronomical.

If you’re ready to start the fund building journey, already en route, or would just like to learn more, reach out to us at [email protected].

This is a guest post by Daniel Truque. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.

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European millennials have been dealt a bad hand, but Bitcoin will show them the path to financial freedom.

This is an opinion editorial by Imo Babics, CMO of Relai, a Swiss-based, bitcoin-only investment app.

Europeans are not taking advantage of their purchasing power and it’s hurting their pockets. It is estimated that the financial wealth of Europeans would be €1.2 trillion higher if savers had invested their money instead of keeping it in the bank.

Yes, you’ve read that right — keeping money in the bank. Keeping cash in bank accounts for emergencies is still the most common way Europeans save their money, despite high inflation. And only 17% of Europeans reported that they owned bitcoin in 2021. Data suggests that the number is similar when it comes to investing in stocks, with only 15% of Germans doing so (rookie numbers compared to 55% of Americans).

The Struggle Is Real

A lack of financial literacy and self doubt about their investment ability are apparent hurdles, but there are several other reasons why Europeans aren’t being smarter with their money:

• Lack of trust in the financial system: European millennials came of age during the great recession of 2008. Many of them have experienced firsthand their parents losing employment, their homes or their life savings. They have seen the big banks, the architects of this disaster, go unpunished. This led to a general lack of trust in Wall Street, banks and the financial system as a whole among millennials. Many believe that traditional financial institutions are not to be trusted (rightly so) and that the system itself is rigged.
• Debt: Owning a home is a symbol of stability and security. With soaring real estate prices in Europe, owning a home often comes with a 30-year mortgage. Add to that a car lease, credit cards, and, depending on the country, student loans and all of this debt can make it difficult for young people to save and invest, as they focus on paying off their debts first.
• Job (in)security: Millennials have only ever known a challenging job market. Most of them entered the workforce after the 2008 financial crisis, being faced with a lack of opportunities and stagnating salaries. Just as things started to turn for the better, their careers were dealt another blow with the COVID-19 pandemic, the war in Ukraine and sky-high inflation. All of these things caused widespread job losses and a global economic downturn, making it difficult for them to plan for the long term.
• Lack of financial literacy: Many Europeans lack the basic financial knowledge and skills needed to manage their finances more intelligently. I will not get into the debate about whether the lack of financial education in the European public school system is a bug or a feature, but we are not being taught about money. Our parents were not taught about money, and this ignorance is being passed on from one generation to the next. Only a quarter of millennials in a PwC study demonstrated adequate financial knowledge. They feel intimidated by the investment process, leading to a paralyzing fear of making a mistake and losing money.
• Short-term thinking: High time preference, or valuing the present more than the future and sacrificing long-term benefits for short-term gains, is not a new phenomenon. To quote “Fight Club,” a cult classic from the late ’90s: “Advertising has us chasing cars and clothes, working jobs we hate so we can buy shit we don’t need, and the things you own, end up owning you.” In the world of uncertainty that we currently live in, short-term thinking is more convenient as the benefits of investing don’t exist in the present.

Bitcoin: A New Hope

Many Bitcoiners, myself included, will tell you that discovering Bitcoin and going down the rabbit hole has had a significant impact on our lives and the way we think about money and saving. One of Bitcoin’s strengths, in my opinion, is that it promotes a low time preference, and encourages you to give up instant gratification and look to the future instead. Having a low time preference results in saving, it results in thinking before doing and considering the consequences of your choices. This mindset is essential for long-term financial stability and growth, and Bitcoin fosters this behavior by its very nature. 

First and foremost, Bitcoin’s limited supply of 21 million coins means that scarcity is a built-in feature. This scarcity protects value across time. And it creates a strong incentive for you to hold onto your coins rather than spend them.

This mindset can be applied to every aspect of your finances, transform your life and help you break the hamster wheel by saying no to a 30-year-long mortgage, cutting your credit cards in half or stopping “saving” your money in your bank account.

Bitcoin Is More Than Just Speculation

Price volatility is a big problem for Bitcoin-curious newbies.

“How can bitcoin be a safe option for my money, if the price crashes every time?”

But price volatility is another way that Bitcoin changes your time preference. Yes, the short-term negative price movements can be significant, but it has shown strong growth over the long term. This has encouraged many to view Bitcoin as a long-term investment, rather than a short-term speculative asset.

I’ve established above that Europeans don’t trust the financial system anymore. Bitcoiners will tell you that Bitcoin fixes this, too. It’s decentralized, and it operates independently of traditional banking systems, putting the custody of your money back in your own hands. Bitcoin will change the world, but before it does, it will change how everyone thinks about money. Helping everyone build long-term financial stability, freedom and security.

This is a guest post by Imo Babics. Opinions expressed are entirely his own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.

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While the collapse of the crypto exchange FTX and its affiliate Alameda Research is thought to have left many crypto players, including market makers, in the worst possible position, according to Andrei Grachev, managing partner at DWF Labs, this incident may have helped to “flush out companies that were not sustainable enough to operate during a storm.” As a result, the “market will be healthier” going forward.

The Art of Market Making

Besides weeding out weak players, Andrei Grachev suggested in a written response to questions from Bitcoin.com News that the collapse of key crypto industry players like FTX and Terra has highlighted the importance of adopting measures that protect users. One such measure, which can be used by global digital asset market makers like DWF Labs, is the so-called pump-and-dump protection scheme. The scheme is essentially a liquidity management technique across exchanges.

Meanwhile, Grachev also shared his views on topics that range from the misconception about market makers to how market-making differs between centralized exchanges (CEXs) and decentralized exchanges. Below are the managing partner’s responses to the rest of the questions from Bitcoin.com News.

Bitcoin.com News (BCN): Can you briefly define market making as well as what happens when a user buys a crypto asset on a centralized exchange or sells this on a decentralized exchange?

Andrei Grachev (AG): A market maker creates liquid markets, quotes order books (puts buy and sell limit orders in order books) and maintains spread. In simple words – market makers create tradable markets. [Decentralized exchanges] DEXs (especially the automated market maker-based) are a bit more limited in terms of market-making tools, but even here – a market maker maintains a sufficient liquidity level across AMM [automated market maker] pools and does some additional work in order to maintain the same price level across centralized and decentralized exchanges.

Because market makers make money by spreading between the bid and ask prices, based on a given proposal, the market maker would [for instance] sell a token on Coinbase a few [basis] points (bps) higher than on a DEX and sell a token on the DEX a few bps cheaper than on Coinbase.

BCN: What would you say is the common misconception about market making?

AG: This is very close to a conspiracy theory: while a token goes up, the market maker is pumping; while a token is going down, the market maker is dumping. You know that situation when you bought something and then it went down instantly? The same. A market maker had a look at your position and traded against you.

The reality is completely different – a market maker maintains liquidity on both sides (buy and sell) and keeps a narrow spread. More advanced ones can also take limit orders from an order book in order to improve the market and boost organic volumes.

BCN: Does market making differ between decentralized exchanges and centralized exchanges?

AG: I would divide it a bit differently – order book based (it could be CEXes and DEXes) and other ones (only DEXes. It includes the AMMs on DEXes and concentrated liquidity on Uniswap V3).

Order books based exchanges allow market makers to use different order types (limit, Immediate-or-Cancel, market, etc.) in order to create a market and provide or take liquidity from the books.

AMMs are much less flexible because the trades happen in liquidity pools. The biggest challenge for AMMs is to maintain the same price on DEXes as their centralized counterparts by adding or removing liquidity as needed. They also constantly monitor large and predatory trades to mitigate their impact.

Concentrated liquidity is similar to AMM, but it allows traders and market makers to decide a price range for liquidity provision. It gives much more flexibility compared to AMM, but it’s still less flexible than the order book-based platforms.

Given that advanced market makers use their proprietary systems for operations, most of them, including DWF Labs, interact with DEXes via a virtual order book that is emulated based on blockchain transactions and the status of the AMM and concentrated liquidity pools.

BCN: How has the collapse of FTX and Alameda Research affected market makers and how is the market dealing with the crypto liquidity crisis? Also, are whales now wary of trading large volumes?

AG: First of all, all proper market makers had funds on FTX, because it was not possible to avoid trading on the second-largest exchange in the crypto world. Some of them were badly affected and collapsed. Many others are going through a rough financial situation now.

In general, it’s a very sad event, but it’s good for the long run. The market is flushing out companies that were not sustainable enough to operate during a storm. As a result, the market will be healthier.

Regarding whales and trading volumes, we observe a lot of activities on the over-the-counter (OTC) market as the exchange liquidity has declined dramatically since the crash. For example, the same tokens that used to see only [a] 10-12% price drop after a $500,000 sell order won’t even be able to absorb a $100,000 sell order now without the prices crashing 60-70%.

Fortunately, the market is recovering. We have begun to see this positive dynamic since the beginning of January 2023.

BCN: There is this notion among some project founders that liquidity is not a function of the market but of marketing. In fact, some founders believe that making sure there are enough buyers for sellers of their tokens is enough to solve their liquidity issues. How correct are these assertions?

AG: It’s true and not true simultaneously. Without marketing, liquidity is kind of inactive and artificial. If nobody trades or trades rarely, it would prompt a market maker to predict price deviations properly and they would need to increase the spread in order to maintain an acceptable risk level. That could lead to a death spiral – the spread gets worse and trading volume falls further, which results in an even worse spread.

In another scenario, let’s say a project relies entirely on organic traders. It’s possible – Bitcoin started without any market makers and it was fine. But it can be challenging to repeat this success.

Traders go to the market and have a wide range of tokens available for trading. If we are talking about a developing token – it would probably have a weak market structure even with good marketing. Why? Because compared to market makers, organic traders trade by their own vision instead of quantitative models. That makes spreads wider and execution speed slower because retail orders have to match against each other, instead of being bought and sold by a market maker instantly. For example, DWF Labs has a market share of 40-70% of trading volumes for many tokens and in case if we remove our configs from those markets, volumes would collapse.

BCN: Some market players have incorporated what is known as pump and dump protection. Can you briefly explain what this is all about and how market makers use this to ensure that the participants are safe in the event of extreme price volatility?

AG: If we exclude really dramatic events like FTX or Terra LUNA market crashes when the selling pressure was insane and nobody could help, we would see that market makers mitigate price actions by liquidity management across exchanges. In 99% of cases, pump or dump is executed on a particular exchange and then extended to other venues as a plague. If it’s not so dramatic, the plague could be prevented by fixing the price on the particular exchange. If it doesn’t work, market makers let the price discovery take place organically, and maintain a relevant market depth around the spread.

BCN: On the surface, market making seems like the smartphone industry where the products on offer are seemingly indistinguishable. How then do market makers differentiate themselves from the competition?

AG: [The] times market makers could offer just a simple bot to build an order book are gone. Market makers play an important role in the markets. We are not visible, but without us, the market would be much less efficient and spreads would be much wider.

I also believe that a proper market maker is also a proper partner, advisor and sometimes even investor that can leverage their knowledge and relationships with exchanges, funds and portfolio companies in order to push the project up and let it grow. DWF Labs builds relationships with projects only in this manner, acting not just as a market maker but also as a partner. As you said, it’s like the smartphone industry, but there is only one Apple even in the smartphone industry.

BCN: Many projects are often said to be wary of launching their tokens in a bear market. Is this true (and if so does this makes sense)?

AG: There are two sides to every coin. During a bull market, a project could raise at a massive valuation, get listed on exchanges with a large market cap, and be pumped further by the market. Most such projects come crashing down once the market turns bearish. It’s hard to survive and meet the expectations of investors, especially when the ground reality lags far behind.

Compared to bullish markets, bearish markets have some beauty. Yeah, it is true that it’s more complicated to raise funds and valuation is usually smaller. But when a project goes to an exchange with a small cap, it is highly likely to be pushed by the market and then stabilized. Then given the fact that the project went to the market when everything was selling at depressed valuations, the market can only reverse to a bullish mode – which will push the project up and give it additional chances to succeed.

What are your thoughts on this story? Let us know what you think in the comments section below.

Terence Zimwara

Terence Zimwara is a Zimbabwe award-winning journalist, author and writer. He has written extensively about the economic troubles of some African countries as well as how digital currencies can provide Africans with an escape route.