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The key to long-term success in cryptocurrency is really no different than it is for any other growth-oriented, volatile asset class: Time in the market beats timing the market.
The problem is that severe downswings, characteristic of cryptocurrencies, can cause many investors to lose faith in buy and hold strategies. And the challenge, from an advisor’s perspective, is getting clients to stay invested.
The reason advisors should encourage their clients to stay invested is that the latest selloff provides an abundance of opportunities for investors.
Brad Roth, chief investment officer at THOR Financial Technologies, emphasized the importance of not only staying invested but adding to investments in the current market climate: “We’ve seen a 60% drawdown in bitcoin this year. Now is not the time to throw in the towel. It’s time to look for opportunities. We don’t want clients making the wrong decisions at the wrong times – because history repeats itself.”
Read more: Tesla's Musk Remains Open to Buying More Bitcoin After Selling in Q2 to Raise Cash
However, investors who can't stomach the full brunt of the volatility of crypto prices may want to consider risk-managed trading strategies.
While risk management comes at a price, that price may be worth getting clients some exposure to the growth that cryptocurrencies offer.
After the ups and downs of the past seven months, it feels like a good time to revisit how professionals are mitigating the volatility of digital assets.
Two Strategies to Manage Risk in Crypto
THOR Financial Technologies offers a pair of such strategies, designed to trade in and out of bitcoin and ethereum to avoid downside volatility.
“Our two main strategies are risk-managed spot bitcoin and risk-managed spot ethereum,” Roth said. “Relative to the amount of drawdown, we’ve done exceptionally well. Those strategies move to a risk-off mode or safe mode. Instead of investing in an altcoin or a stablecoin, we favor just putting them into cash.”
At the beginning of the recent drawdown, THOR’s strategies traded out of bitcoin and ethereum and into cash where they remain today. Roth said that his strategies are designed to avoid trading as crypto prices move sideways and that he probably won’t re-enter the market until bitcoin prices break above $24,000 or $25,000. At that point, THOR’s strategies will begin to compound in value again from the lower price without having taken the 50%-to-60% hit that most tokens have suffered in 2022.
Read more: How Are Institutions and Companies Investing in Crypto?ZX Squared, a digital asset hedge fund, also invests in bitcoin and ethereum. However, it manages risk using options and futures to achieve a higher Sharpe ratio, signifying better risk-adjusted returns.
“People are observing right now and trying to figure out how to get some exposure to this asset class. We think there’s an opportunity going forward, especially as this asset class goes through subsequent market cycles,” said CK Zheng, co-founder of ZX Squared. “This cycle is not unique – we’ve had three to four cycles before and each time a token like bitcoin can drop 80% – but they all come back.”
ZX Squared uses options to express short, medium and long-term views on the marketplaces in bitcoin and ethereum, helping Zheng and his partners find a better balance between risk and return in the crypto space.
“In equity you get around 20% to 30% volatility, but in bitcoin you get somewhere around 80% to 100% volatility,” Zheng said. “So step one for us is to reduce volatility – essentially 50% of volatility will be reduced.”
Unlike Three Arrows Capital – the hedge fund that collapsed earlier this year, sparking a series of failures of decentralized finance strategies and stablecoins and bankrupting some prominent crypto exchanges – ZX Squared does not use leverage, according to Zheng.
Over the past 12 months, ZX Squared’s strategy has experienced volatility around 30-35%, similar to a Nasdaq 100 stock, while targeting a Sharpe ratio of 2.0, double bitcoin’s Sharpe ratio of 1.0.
By comparison, U.S. equities have a Sharpe ratio of 0.5 – so on a risk-adjusted basis, bitcoin has offered a better return, according Zheng.
Sticking to the Big Guns
ZX Squared and THOR are running different strategies using the same two assets – bitcoin and ethereum. As a result, they naturally mitigate some of the risk in the crypto space by avoiding new, esoteric, small, and/or illiquid alt coins.
“I would say that as technological innovations, bitcoin and ethereum have first-mover advantage in the digitalization process,” Zheng said. “Whether or not they can be overcome or replaced by any other coin is really hard to tell at this stage.”
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Both Zheng and Roth argue that bitcoin is unique in its design and should become more of a currency in the future.
“We believe that at some point in time bitcoin can become another form of money,” said Roth. “The long-term price appreciation potential is significant.”
In recent months, however, Bitcoin has traded more like a technology stock and has actually correlated closely to stocks. Until that correlation is broken, Roth said that bitcoin is more of a growth investment than anything else.
Both also agree that ethereum is more of a growth play.
“We see ethereum more as a security than another form of money,” said Roth. “A lot of platforms are being built on it. That’s not going to change. There’s a massive growth opportunity in ethereum. It’s more like a high-growth stock.”