On July 6, the Financial Conduct Authority (FCA), licensed Crypto Facilities, the largest cryptocurrency futures exchange in Europe, as a fully recognized multilateral trading facility (MTF).
The company – which offers a venue for leveraged, cash-settled futures contracts to traders seeking exposure to Bitcoin and other crypto assets without holding or accepting delivery of the underlying – becomes the first crypto exchange to achieve such recognition.
With this new licence, it will be able to serve institutional clients who are mandated to trade only on licensed platforms and to increase its product offering.
London-based Crypto Facilities, which has pioneered cryptocurrency derivatives since 2015, was acquired in February 2019 by US-based Kraken, a leading cash and spot-trading exchange for 30 crypto and seven fiat currencies.
Hinting at the long slog to satisfy the FCA’s requirements, Jesse Powell, chief executive and co-founder of Kraken, says: “We undergo these licensing efforts because Kraken is about making crypto accessible for everyone.
“This particular licence means that a sophisticated class of investors, limited by their own requirements to interface with a regulated venue such as an MTF, will now have access to crypto derivatives in Europe for the first time.
“More participants means more liquidity and a better experience for everyone.”
It’s hard to interpret this move from the FCA as anything other than an endorsement of the validity of dealing in leveraged crypto derivatives for institutional accounts and an acknowledgement of cryptos’ enduring and increasing allure to retail investors.
At the end of June, the FCA released research estimating that 2.6 million UK consumers have bought cryptos such as Bitcoin, Ripple and Ether. That is up by 1.1 million from a similar survey one year ago.
It also found that consumers are heavily influenced by advertising and that 83% have bought crypto assets through non-UK based exchanges.
On the same day, the UK government’s Insolvency Service wound up GPay Ltd, a cryptocurrency trading platform that used phony endorsements from TV personalities to lure retail investors. Investigators discovered that 108 clients had lost $1.5 million to the scam.
Our experience from the last three years shows it is possible to profit through algorithmic strategies from the volatility in a new, growing and inefficient marketplace for crypto-assets
– Yuval Reisman, YRD Capital
If retail buyers are going to expose themselves to the ridiculous volatility of cryptos, at least let them do it on regulated exchanges, seems to be the message from UK regulators.
Institutional-grade infrastructure first started building around crypto currencies in late 2017, during the extraordinary climb in the price of Bitcoin from $228 in September 2015 to $6,323 at the end of October that year, when the CME announced it would launch Bitcoin futures.
The price went up to close to $20,000 in December 2017 before it crashed to $3,264 a year later. Institutions lost interest.
But by February 2020, the Bitcoin price was back to $10,368, and as global stock markets grew nervous that the new virus circulating in China might even interrupt the long bull run, promoters once again talked up crypto as a non-correlated source of alpha and a hedge against inflation.
Tracker funds emerged with full insurance and institutional-grade custody.
Then in March, the uncorrelated return thesis turned out to be bunk. Bitcoin crashed once again, this time by 45%, in line with equity markets. Some crypto funds collapsed. But Bitcoin survived.
By July 7, it had crawled back up to $9,279 and the question remains: could there possibly be a safe and sensible way to invest, or is punting on Bitcoin and other cryptos no better than backing the fifth horse in the sixth race at Ayr?
Fund of funds
While retail investors are lured in by wallet providers and so-called exchanges, high net-worth individuals, family offices and institutions seeking exposure to cryptos allocate to specialist hedge funds.
YRD Capital suggests a fund-of-funds approach, allocating to different managers applying different quant-based strategies to crypto assets.
Yuval Reisman, co-founder and chief executive, tells Euromoney: “We don’t pretend to know whether the price of one Bitcoin should be $100 or $10,000, but our experience from the last three years shows it is possible to profit through algorithmic strategies from the volatility in a new, growing and inefficient marketplace for crypto-assets.”
This approach thrives on volatility not price direction.
YRD Capital selects quant fund managers according to certain key criteria. They must trade crypto-to-fiat and offer monthly liquidity out of properly structured funds with full independent administrator, audit and legal functions.
And they cannot be long-only: their performance should have low correlation to the price of Bitcoin.
YRD has six funds in its basket, and targets, given fund capacity constraints, from nine to 12, across a mix of long-short strategies such as arbitrage, market-making, momentum, event-driven and others.
Operating since 2017, initially with the founders subscribing much of its assets under management (and still with skin in the game, holding a percentage of assets under management worth over $10 million), YRD Capital now has a three-year track record it can show to family offices and high net worth investors.
Reisman claims the firm has had just one down month since December 2017. He says: “It is easy to buy and hold a long Bitcoin position: no need to pay fees for a fund manager to do this for you. Actively searching and analyzing funds, monitoring the portfolio, and keeping up to date with new solutions that reduce the risk is a whole different story.”
How did YRD fare during the great crash of 2018 and the crypto winter that followed?
“In 2018, the year Bitcoin crashed by 85%, with very high volatility and volume, YRD Capital returned 65% net of fees,” Reisman says.
It was its best year.
“In 2017, YRD returned 25%, last year we returned 22%, and we are up 7% year to date,” he adds.
The firm charges 1% management and 15% performance fees, while seeking to negotiate better terms for its customers – discounted fees, a high level of transparency and regular monitoring reports and updates – from quant crypto managers.
The firm is also its customers’ eyes and ears on due diligence over fund structure, style drift and delivery of returns within agreed risk limits.
It can be very rewarding to identify such talents and build relationships early on when they struggle to get a hearing
– Ian Morley, YRD Capital
Reisman says: “We found one manager who had left a leading fund and whose strategy we really liked. However, our due diligence showed there was no walled garden. He could have, if he had wanted to, syphoned money off to a private wallet. So, we introduced him to the CEOs of three possible crypto assets custody providers and one of them sat down with the manager and structured a bullet-proof solution for him.”
While many large quant hedge fund groups – Renaissance, Jump Trading, Two Sigma, Brevan Howard – have been running crypto funds for several years now, some of their managers are starting to leave and set up on their own.
It’s a familiar pattern in the hedge fund world, where there is no shortage of egos and some managers think their own contribution is overlooked and under-rewarded.
There are perhaps 150 to 200 quant crypto funds, and YRD’s task is to find the best ones while offering a diversity of strategies and risk-and-return profiles.
As in any market, some of the highest average returns come from those with the highest possible drawdowns. For a fund-of-funds manager, certain disciplines transfer well between new crypto assets and established markets.
“Whether you are tracking correlations between soft commodity prices or arbitraging the Bitcoin prices on different exchanges, it doesn’t really matter,” says Reisman. “We found some quants from Goldman and Citi who had built a fiat currency algo, then applied it to crypto assets and found it worked even better.
“And we are working with one team that developed an artificial intelligence strategy for crypto that they are now applying to mainstream equity.”
Lessons from history
In June, YRD Capital announced that Ian Morley would be its new chairman.
Morley is a veteran of the alternative investments world, who has advised central banks and international regulators on managed derivatives and hedge funds and now runs a family office.
Morley tells Euromoney: “As well as this being the three-year anniversary of YRD Capital, it is also 30 years since I founded The Alternative Investment Management Association (Aima), the world’s global trade association for the hedge fund industry.
“Many of the same debates and arguments about hedge funds from back then are being repeated today about investing in crypto. All the large investment houses are looking at it; all the central banks are looking at it. It’s a complex asset class in which very few people have the knowledge to conduct proper due diligence on managers. That is why a fund-of-funds approach makes sense.”
The crypto trading eco-system is treacherous and carries higher risk of getting scammed or hacked than conventional financial markets. That’s why the emergence of properly regulated central exchanges is so important.
Then, the trading and investing strategies of the brightest and best might be worth a look for larger institutional investors seeking diversification within their allocations to alternatives.
They’d want a much bigger fund of funds to make it worth their while putting enough money to work while holding only a single digit percentage of a fund, though, and perhaps a broader range of strategies than purely quant investing.
In the meantime, Morley hears other echoes from the early years of hedge funds.
He says: “One thing I like is meeting smart traders who may have written the code for market-beating algos but are just trying to set themselves up as managers.
“It can be very rewarding to identify such talents and build relationships early on when they struggle to get a hearing. It’s also true that you can meet all manner of crooks and conmen.
“And even when you do meet a genius investor with six PhDs, they may not be the person you’d trust to walk across the road and buy themselves a sandwich. They might need a chief operating officer type next to them that can put in proper structures and processes and audit.”