The much-hyped cryptocurrency market has come crashing down and while institutional investors have escaped the carnage, there is concern that many high-net-worth Asian investors could take a hammering if the market doesn't stabilise.
Index provider MVIS estimates that approximately $14 billion in assets are currently invested in crypto-based financial products and separate industry research suggests as much as 40% could be emanating from private investors in Asia.
With MVIS's CryptoCompare Digital Assets Index -- which includes Bitcoin and Ethereum -- down more than 80% year to date, many of these Asian investors will be hurting.
Institutional investors have so far been cool to the crypto market, wary of the lack of operational due diligence and custody of assets that are the norm in mainstream investment markets. A relatively hostile reaction to the crypto market by regulators in the region, particularly in China, has also curbed their enthusiasm.
“Institutional money has been extremely cautious and indeed clever from day one … to ensure that questions around issues such as custody, regulation and ownership are dealt with properly,” Jolyon Ellwood-Russell, partner, financial markets at Simmons & Simmons in Hong Kong, told AsianInvestor.
In contrast, the retail market “is being far more impacted”, he said.
In spite of the remarkable growth of cryptocurrency assets over the last two years, the slump in the value of cryptocurrency indices so far in 2018 has come at a bad time for funds focused on the sector.
There is also genuine concern about the stability and security of the market, with hacking and cyber crime seen as part and parcel of the crypto universe.
The Asia-managed funds that invest in crypto assets are essentially hedge funds, taking advantage of the extreme volatility and potential arbitrage opportunities across a range of cryptocurrencies and exchanges.
Steve Knabl, chief operating officer and managing partner at Singapore-based Swiss-Asia Financial Services told AsianInvestor that the first of the firm's funds -- a high-frequency fund trading arbitrage opportunities -- was launched in April and has so far raised around $10 million from wealth management clients in Singapore.
The fund is still in its early stages, he said, "and we don’t want to push it right now, frankly speaking. We have to stabilise everything and once that is done and we are comfortable, we will start being a bit more active on the sales side."
As is commonplace in the hedge fund universe, transparency is not a strong point. Performance numbers are quoted but not easily verifiable. Knabl said Swiss-Asia is still calculating the June net asset value for the Kryptos Alpha fund and that right now, he estimates the fund is down “10% or so”, but that this is “within expectations”.
“From a performance perspective it’s not great, but it’s better than the market is doing. Obviously at the moment it is very volatile, but the managers like volatility, that’s what they need to benefit from the arbitrage opportunity."
One of the most common reasons for failure of hedge funds is a lack of operational efficiency. Knabl confirmed that while "trading is easy", the processes around it are more difficult.
"The information that is coming from the exchanges is sketchy," he said. "We have to plug our system into all the APIs (application programming interfaces) of the different exchanges. Reconciling our trades and data is very complex, as is the fund administration needed to build the whole portfolio."
"The speed of calculating NAVs will increase as we proceed," he added.
What guidance would he give to investors considering buying into the current weakness of the market?
“If you do invest in a crypto strategy, it’s important that you are not looking at one that is long only, because these asset classes are pretty special, and they will go up and down very fast. A long-only strategy is going to get squeezed."
Knabl said it was also important to invest in a strategy that is highly diversified across currencies and strategies. "And make sure they are not trading on one single exchange, or putting the coins on one exchange. You need a diversification across exchanges in the event that one goes down, or is hacked.”
Another Singapore-based manager, Helvetic Investments, launched its cryptocurrency fund in December 2017. AsianInvestor also approached Helvetica for an update on its fund performance, but none of their fund managers were able to respond to our enquiries by press time.
Looked at as a sector, cryptocurrency funds have had a bad year so far. The Eurekahedge Cryptocurrency Hedge Fund Index is an equally weighted index of 16 constituent funds and it is down 51.58% so far this year, with a standard deviation of 193%, Sharpe ratio of 0.78 and Sortino ratio of 4.37.
But then last year's gain was 1,708%.
Within the MVIS CryptoCompare Digital Assets Index, which is based on individual cryptocurrencies, the variance in price movement is immense. For example, on a 12-month view to the end of August, the best-performing components of the index, Stellar and EOS, were up 689% and 308% respectively, while Bitcoin is still up 65%. Most of that appreciation came in 2017 though, when crypto mania was at its height. Year-to-date Stellar and Eos are up 23% and 39% respectively, while Bitcoin is down 54%.
While it is too soon to call the end of the crypto boom, there is likely to be considerable volatility for the foreseeable future, according to industry analysts.
Henri Arslanian, PwC's fintech and crypto lead for Asia told AsianInvestor: “Whilst some of the crypto funds are set up with institutional best practices in mind, there are many others out there that would fail even basic operational due diligence from any institutional investor."
He added that it is during such volatile market conditions as we are seeing now that "institutional investors can test whether a fund will comply with best practices from fund governance and investor transparency to valuation policies and risk frameworks.”