Crypto Bubble vs. Crypto Hedge Funds ^Featured

Today, we delve into one of the most intriguing and hotly debated subjects in finance: crypto bubbles. We'll explore the fascinating dynamics of these digital asset markets and consider whether investing in cryptocurrencies constitutes genuine financial strategy or simply a speculative gamble.

First, let's define a financial bubble as a situation where the prices of assets, such as stocks or real estate, become significantly inflated beyond their intrinsic value, leading to unsustainable levels that are not supported by the underlying fundamentals of the economy or the assets themselves. In the context of cryptocurrencies, a bubble occurs when the prices of digital assets skyrocket to levels that far exceed their intrinsic worth or utility. This often happens due to speculative buying fueled by hype and market frenzy rather than rational assessment of the asset's true value. As a result, when the bubble eventually bursts, prices plummet rapidly, causing significant losses for investors caught up in the frenzy.

The Intrinsic Value of Crypto Assets

The intrinsic value of crypto assets is a contentious topic due to the unique nature of digital currencies. Unlike traditional assets such as stocks or commodities, cryptocurrencies do not have physical properties or generate cash flows. Instead, their value is derived from factors such as technological innovation, adoption rates, network utility, and market sentiment. However, determining the true intrinsic value of a cryptocurrency is challenging because it's not tied to any tangible assets or earnings. Instead, its value is largely driven by speculation and market dynamics, including rumors, news, and investor sentiment. While some argue that cryptocurrencies have intrinsic value based on their utility as decentralized financial instruments or store of value, others contend that their prices are primarily driven by speculative trading and hype. As a result, the intrinsic value of crypto assets remains a subject of debate among investors and analysts.

In our view, cryptocurrencies don't have a clear intrinsic value and are mostly driven by speculation and manipulation. From this perspective, defining a 'crypto bubble' or determining when prices have reached bubble levels becomes challenging due to the absence of intrinsic values in cryptocurrencies. We hold the belief that the traditional definition of a financial bubble does not fully apply to cryptocurrencies, as they inherent bubble-like properties regardless of their price levels.

Crypto Investments vs. Gambling

Some argue that investing in digital assets is akin to gambling. However, this comparison is not entirely accurate. Unlike gambling, which is governed by probability laws that cannot be bypassed, investing in cryptocurrencies can be managed by employing various risk management techniques. To support this assertion, one can examine the performance of top cryptocurrency fund managers, who consistently demonstrate successful trends over time.

To sum up, in our view, cryptocurrencies lack intrinsic value, are driven by speculation, and can be manipulated. Essentially, crypto assets display bubble-like characteristics regardless of their price levels. So, what does this all mean? Interestingly, it doesn't really change much. People will keep investing in cryptocurrencies, even if they're in bubbles. Some will profit, while others will lose.

As mentioned, we believe that cryptocurrency risks can be controlled by applying advanced risk management techniques. Let’s dive into risk-return profiles of crypto hedge funds.

Crypto Hedge Funds and Their Strategy Indices

We began our analysis by selecting all active hedge funds with the strategy "Crypto Asset" from the EurekaHedge database. Funds without performance reports for the last 4 months were excluded from the selection, resulting in 62 funds. We then analyzed the correlations of all these funds against their index, the CBOE EurekaHedge Crypto-Currency Index, and plotted the Probability Density Function (PDF) of the correlation distribution as shown below.

The results are quite surprising. Firstly, the distribution displays multiple local peaks, indicating a multimodal distribution. Secondly, only 25% of funds exhibit a relatively high correlation with the index, surpassing 0.89. Moreover, 10% of funds show correlations exceeding 0.93. This suggests that using the Crypto Index to analyze global crypto trends may not be reliable. In fact, this behavior is typical of hedge fund indices, which may not be highly correlated with the corresponding strategy funds. For more insights, refer to our study "TAA - Is it Applicable to Hedge Funds?"

So, what's the takeaway? Each cryptocurrency hedge fund is unique, with its own performance profile that needs to be evaluated independently. A poor performance of the index doesn't imply that there aren't exceptional fund managers outperforming the index, and vice versa.

Best Cryptocurrency Funds

Given the challenge of using crypto indices for unbiased fund benchmarking, how can we accurately assess their performance and rate them accordingly? Cryptocurrency hedge funds represent a vastly diverse asset group with contrasting risk-return profiles. To illustrate, examine the chart below depicting VaR and Maximum Drawdown statistics, which showcase the risk-return profiles of cryptocurrency funds over the past three years.

It's clear that the group includes both highly risky funds, with Maximum Drawdowns of up to 80% and VaR as low as -40%, as well as low-risk funds with no drawdowns. To identify the top-performing funds, we used Risk Shell’s FlexiRank™ metrics, which incorporated the following risk statistics calculated since inception:

• Mean RoR
• VaR⁹⁵
• Maximum Drawdown
• Time-Under-Water
• Stress Drawdown Average
• Stress Drawdown Maximum
• Semi-deviation
• Downside Deviation
• Positive Return Ratio

When calculating stress statistics, we took into account 31 historical extreme events since 1998. The top 5 Crypto hedge funds and their Flexi ranks are in the following table:

Funds	FlexiRank™	Percentiles
		Mean	VaR95	MaxDD	TUW	Stress~	Stress^	SemiDev	DownDev	Positive %
Elysium Global Arbitrage Fund	35.547	0.488	1.000	1.000	1.000	0.324	0.698	1.000	1.000	1.000
Digital Asset Fund	35.364	0.586	0.990	0.980	0.970	0.150	0.460	0.958	0.981	0.998
Caishen SPC - Kernel Fund SP	31.222	0.318	0.967	0.978	0.485	0.319	0.699	0.991	0.983	0.505
Apollo Crypto Market Neutral Fund	29.297	0.254	0.904	0.827	0.364	0.324	0.641	0.820	0.879	0.846
QCAM FX BIAS	29.221	0.226	0.937	0.953	0.394	0.324	0.713	0.968	0.951	0.379

 

Finally, we conducted the multi-statistic peer group analysis for the top fund - Elysium Global Arbitrage Fund against two peer groups, one – Crypto Funds from the EurekaHedge database (Peer Ranks A) and the second one (Peer Ranks B) – all hedge funds employing a traditional Long-Short Equity strategy.

Extreme Event Stress Testing of Crypto Funds

One of the main drawbacks of investing in low-volatility funds with seemingly minimal drawdowns is that these funds may underperform during extreme market conditions. Additionally, if devastating macroeconomic events have not occurred during the fund's lifespan, we lack historical performance data for such events. To assess extreme event risks of the top ranked fund, Elysium Global Arbitrage Fund, we conducted stress testing using Risk Shell multi-factor models. The stress test results are shown below.

Conclusion

As mentioned earlier, we maintain the view that cryptocurrencies represent an investment bubble, characterized by extreme risks and susceptibility to manipulation. Nonetheless, they can be leveraged effectively by adept investment managers employing sophisticated trading strategies. Crypto hedge funds constitute a distinct and highly diversified category, encompassing a wide spectrum of investment risks. The top crypto funds have the potential to rival traditional hedge fund strategies and may effectively motigate extreme event risks. Investors keen on crypto assets should refrain from relying solely on indices as indicators of overall crypto group performance. Instead, they should conduct thorough and sophisticated risk assessments of each individual fund.

Feel free to reach out to us for a comprehensive risk assessment of any crypto hedge funds.

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