Adventures in cryptocurrency and what’s next

The Eurekahedge Crypto-Currency Hedge Fund Index was up 26.96% in April, which was its strongest performance in two years.

Bitcoin led the way, up 35.31% for the month. Fund managers focusing on cryptocurrencies rode this favorable wind like caped heroes.

But was April a one-off? As with the answer to every question in finance these days, the answer to this one begins with COVID-19. Early on as pandemic-related news sunk in, the reaction for bitcoin, as for so much else, was negative. Bitcoin suffered a sharp sell-off of roughly 40% on March 12. But it quickly began to recover, largely on the sense that if the pandemic itself is a long-haul, confidence in fiat currencies will suffer, and cryptocurrencies (especially the mother of them all) might be beneficiaries.

Raoul Pal, founder of Real Vision, a business/financial media platform, told an interviewer as April got underway that the pandemic would likely be “a much longer event — in terms of economic impacts — than anybody is pricing in”. He said this by way of explaining why he has moved 25% of his portfolio into Bitcoin.

In the Bitcoin world, this post-selloff bounce has acquired resonance from an unrelated fact, a coincidence of timing: the Bitcoin halving. On May 11, for the third time in its history, Bitcoin halved: that is, the block reward for the “miners” at the base of the electronic creation of the currency fell by 50%. Such a halving occurs at four-year intervals — it is part of the original Satoshi Nakamoto system for containing the growth of the currency and so preserving its value over time. This year the halving occurred as the effects of the pandemic dragged on, but as some countries badly hit initially such as China and Italy showed hopeful signs of a return to economic health.

There were as May approached mutually contradictory theories afoot as to what consequence the newest halving would have for the market. The obvious observation is that the baked-in event would have long since been discounted and should not have been a source for consternation at all. That, at any rate, is how a rational-expectations theorist would see the matter.

In early May, the value of Bitcoin approached and briefly surpassed $10,000. The passage of round numbers with a lot of zeros is, like the halving, the sort of event that ‘should not’ impact the markets on the assumption they are rational. Nonetheless…this market pulled back vigorously from the $10,000 mark. Through some combination of factors (throw together the coronavirus, the halving, the big round number, and lots else into the stew) the value fell by 15% over the following days.

As I write, with the halving safely behind it, miners have presumably adjusted and Bitcoin has recovered some of that ground. It is in a trading range of $9,000.

So: where does Bitcoin go from here? And, accordingly, where will bitcoin (and more generally, crypto oriented) hedge funds go from here?

Some of the funds have historically marketed themselves on the classic hedge fund premise that they could arb their way to absolute return, regardless of the direction of the market. And indeed in the crypto space the same assets can have different values on different exchanges which sounds like a textbook opportunity for risk free arb.

But the whipsaw effect in recent months, the bloodbath in March and the felicitous eureka inducing recovery in April, and bits of both in May, combined with the liberal use of leverage amplifying all moves at the fund level, have decisively undermined the notion that the crypto funds are at all nondirectional. That undermining, in broader terms, may hurt with their efforts to package themselves as a wise choice for institutional firms. Few pension fund managers are looking to stock up on high-volatility and high-leverage directional bets just now. It may not hurt their appeal, though, to the classical investors on ‘wild west’ plays: the high-net-worth gunslingers betting on a story, and perhaps on the underlying libertarian philosophy of a new form of money free of governments or central banks.

The answer to the question with which we began is: Yes, April looks like a one-off. The crypto funds did especially well that month due to an unusual confluence of factors. The space remains what it was when this year began: it is highly speculative yet for many it will remain tempting. The world may indeed be ready for a move away from the fiat currencies, and the old-style alternatives to government fiat (the precious metals) may not for a range of reasons turn out to be the beneficiaries of that big turn when it comes. If an investor is on the right side of a historic turn, that investor will look like a genius.

One is entitled to speculate.

Christopher Faille

Christopher Faille has written on a variety of legal, regulatory, and financial issues for decades. He is the author of "The Decline and Fall of the Supreme Court" (1995), for example, and the coauthor, with David O'Connor, of "Basic Economic Principles" (2000). He was an early reporter with Lipper HedgeWorld and has contributed to Forbes and to the Hedge Fund Law Report.

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