Bitcoin’s inefficiency creates arbitration trades for crypto hedge funds

As more hedge funds pile up into cryptocurrencies, market inefficiency and price dispersion are bringing fresh arbitration opportunities to managers.

During Bitcoin’s ongoing rally over the past year, the cryptocurrency rocketed to an all-time high of more than USD41,000 in early 2021, with many investors increasingly using it as a hedge against falling real yields and inflationary risks. stemming from quantitative easing of a central bank.

But as more hedge fund managers enter the digital asset arena, running a range of selective and quantitative strategies, the potential for alpha production will be “likely to moderate” in the coming months and years, a senior said -Lyxor Asset Management strategists Jean-Baptiste Berthon and Philippe Ferreira, and hedge fund analyst Pierre Carreyn.

There are now more than 800 active funds focused on blockchain and cryptoasset, of which 150 manage more than USD50 million in assets. Bitcoin’s payout helped bring stratospheric returns to crypto-focused hedge funds last year, with the HFR Blockchain Composite Index soaring to 190.1 percent in 2020.

But the market remains “extremely inefficient”, said Lyxor Asset Management strategists in a note this week, and “significant digital asset price spreads” provide an opportunity for arbitration opportunities.

Earlier this month, bitcoin’s momentum was halted sharply – with the currency plummeting more than 20 per cent – and Lyxor believes that institutional investor appetites are now likely to cool for the time being.

“Several key risks warrant high volatility,” said Lyxor strategists, pointing to the potential structural risk of stricter regulation, as well as speculation risk, that can be magnified by leverage and systematic trading, and the absence of a central authority to step in. in during emergencies.

“Pricing indicators continue to flash red, especially our macro models and market relationships. Normalization in momentum forces could also keep sales pressure. Yet liquidity metrics have not yet deteriorated in an exaggerated manner.

“We expect the latest cold shower to moderate the enthusiasm of organizations in the short term, providing time to prepare for a later third run, supported by more organization-friendly equipment, including central bank and bank initiatives commercial to offer more robust digital. exposure to assets. ”

Lyxor noted that the early days of simple long positions on cryptocurrencies like bitcoin, Ethereum, or Ripple have succumbed to more sophisticated strategies related to digital assets, which can employ cryptocurrencies exchanges, futures and options, as well as bets forward income generated by the underlying technology.

Man Group, a London-based hedge fund giant, recently said bitcoin volatility could be considered “price discovery” in a new asset class, which will eventually yield to more currency stability, and more credibility among investors.