Coinbase Report: Actively Managing Risk, Dollar-Cost Averaging BTC is the Best Choice
If you cannot outperform $BTC for a year or longer, consider adopting a passive strategy.Author: Crypto, Distilled
Compiled by: Deep Tide TechFlow
Coinbase has just released a report on how crypto hedge funds generate excess returns.
Here are the most valuable insights.
Report Overview
This report reveals the main strategies employed by active crypto hedge funds.
It provides valuable insights for any investor looking to achieve the following goals:
Better risk management
Capture excess returns
Deepen understanding of crypto
Passive or Active Strategy?
Regardless of your experience level, always compare your performance with $BTC.
If you cannot outperform $BTC over a year or longer, consider adopting a passive strategy.
For most investors, regularly dollar-cost averaging (DCA) into $BTC during a bear market is often the best choice.
Bitcoin -- Benchmark
$BTC is the preferred benchmark for beta in the crypto market.
Since 2013, $BTC has had an annualized return of 124%.
Over the past 11 years, it has been the best-performing asset class for 8 years.
- (Source: @coinbase) *
Do Hedge Funds Outperform $BTC?
In the crypto space, active management can outperform passive spot $BTC exposure.
The key lies in risk management and hedging.
On average, actively managed crypto hedge funds outperformed passive spot $BTC positions in 2017, 2018, 2021, and 2022.
Custom Hedge Fund Index
Coinbase created a custom index using data from over 50 hedge funds trading on Coinbase Prime.
The median fund outperformed $BTC with lower volatility.
However, the number of funds in the dataset is limited, which may introduce survivor bias.
- (Thanks to @coinbase) *
Best Active Management Strategies
Quantitative active and multi-strategy funds offer the best long-term performance potential.
They utilize advanced data models and diversified approaches.
Due to lower flexibility, single long fundamental strategies typically lag behind.
- (Thanks to @Preqin) *
Performance from Cycle Lows
Since the low in June 2021, multi-strategy funds have led with a +128% return.
Quantitative/active strategies follow closely with a +98% return.
Meanwhile, $BTC and market-neutral strategies also performed well.
Single long strategies lagged (+28%).
- (Thanks to @Preqin) *
Bear Market Resilience (June 2022)
During the bear market, only quantitative active strategies outperformed $BTC.
Other strategies performed poorly, highlighting the importance of adaptability.
- (Thanks to @Preqin) *
Why Do Single Long Strategies Underperform?
Single long strategies often underperform spot BTC for the following reasons:
Limited drawdown risk management
Investment in underperforming altcoins
Poor timing on rebounds
Controlling Volatility is Key:
Crypto hedge funds that control volatility can provide greater upside potential.
The top quartile of long-term performers in the crypto space primarily focuses on:
Managing downside risk.
Capturing significant upside potential.
Volatility and Performance
Non-directional funds provide crypto exposure with annualized volatility below 30%.
Quantitative systems and multi-strategy funds have volatility below 50%.
These strategies significantly outperform single long and $BTC spot exposure.
- (Thanks to @Preqin) *
Cross-Asset Class Diversification
"Structural diversification" is key. Why?
Because the crypto market trades 24/7/365 and is influenced by unique factors at different times.
Maintaining diversification outside of crypto can provide a good risk/reward advantage.
Managing Downside Volatility
Managing downside volatility is crucial for achieving long-term excess performance.
Market-neutral strategies have the lowest volatility and shallowest drawdowns.
Next are multi-strategy, quantitative active strategies, and single long strategies.
- (Thanks to @Preqin) *
How to Reduce Downside Exposure
Avoid Major Losses: Use stop-loss orders and clear investment thesis failures.
Long-Term Commitment: Diversify to spread risk and survive.
Long-Term Growth: Adjust positions based on market conditions to target volatility.
Personalized Strategies
While certain strategies may not be optimal, they may be the best fit for you.
Let’s delve into each strategy.
Directional Strategy: Single Long
Single long strategies target tomorrow's market leaders (very easy to follow).
Key metrics to consider: active users, strong fundamentals, total addressable market (TAM), value accumulation?
Return Summary (Thanks to @nilssonhedge)
Quantitative Systems: Directional
Systematic (long or short) strategies combine fundamental analysis with automation.
They use structured data and machine learning to control risk and reduce volatility.
Return Summary (Thanks to @nilssonhedge)
Hedging Strategy: Market Neutral
Aims to capture returns in the crypto economy while maintaining low/no directional risk.
They seek positive returns relative to cash, avoiding losses in all market environments.
Return Summary (Thanks to @nilssonhedge)
Diversification Strategy: Multi-Strategy
These strategies combine specific exposures to achieve diversification, manage risk, and capture diversified returns.
Example: A fund of funds combining 10-15 managers' crypto hedge strategies.
21/ Portfolio Breakdown:
Here is a breakdown of a typical portfolio based on your specific time frame:
- (Thanks to @coinbase) *
Due Diligence:
Once your strategy and portfolio are determined, the final step is due diligence.
Consider the following key questions:
Here is an overview of areas where a due diligence questionnaire can help fund allocators, along with some suggested questions to ask during the due diligence process.
Trading Strategy: Does the fund invest in token subscription rights, additional agreements, use liquidity pools, or participate in staking? How does the fund allocate returns from the same investment across these different investment tools?
Trading Infrastructure: How many centralized and decentralized exchanges does the fund use to obtain liquidity? What contingency plans are in place if an exchange fails?
Trade Execution: Given that cryptocurrency trading is 24/7/365 and has no closing prices, how does the fund measure price fluctuations without a closing price?
Counterparty Risk: How does the fund assess counterparty risk for exchanges, liquidity pools, and lending protocols?
Risk Management: How does the fund manage risk overnight and on weekends? How does the fund set targets for triggering risk avoidance or hedging?
Team, Research Process, Trade Evaluation: How does the fund and its team evaluate new investment opportunities?
Performance Measurement: Does the fund regularly provide daily or monthly performance data? What benchmarks are used, and why are these benchmarks suitable for its investment style?
Leverage Usage: Cryptocurrency itself is already highly volatile. If the fund uses leverage, how does it control excessive volatility?
Fund Service Providers: Does the fund allow limited partners (LPs) to communicate directly with all service providers during the due diligence process?
- (Thanks to @coinbase)*
