Given the sheer breadth and complexity of the digital asset markets in 2023, cryptocurrency asset management is a somewhat nebulous term that can encompass managing a single asset, such as Bitcoin, to handling an entire portfolio of coins and tokens. Crypto asset manager roles now exist in a wide range of organizations, from traditional banks and financial institutions to crypto-native funds, projects, and DAOs operating treasuries.
Nevertheless, regardless of the type of firm, size of the investment, or the diversity of the portfolio, there are some common challenges facing digital asset managers of all stripes. This article considers these challenges and the role that an effective cryptocurrency portfolio management system plays in keeping the focus on alpha generation.
The fundamental goals of crypto asset management are the same as in TradFi – to generate growth while mitigating risk. However, the operational reality of managing digital assets – even a single asset – is starkly different. Before considering the specific challenges involved with digital asset management, it is necessary to understand the differences in areas such as market structure and custody arrangements compared with traditional assets.
Unlike traditional financial markets, crypto markets are mostly characterized by a lack of regulation and underlying banking infrastructure combined with high fragmentation and little standardization. Digital assets are borderless by nature and historically, anyone could set up a crypto exchange with relatively few barriers to entry. Crypto is now traded across many hundreds of centralized and decentralized trading venues. Some may have user bases more concentrated in particular geographies, but there is no central trading venue for any given jurisdiction in the same way as for assets like equities. Even in countries such as Switzerland, which has a comprehensive regulatory framework for digital assets, there are many other regulated platforms on which crypto can be traded besides the Swiss Digital Exchange (SDX), an offshoot of the Swiss SIX exchange.
As such, without a central trading pool, digital asset liquidity is highly fragmented. Furthermore, each trading platform operates its own market, meaning that there is no universally agreed price for any given asset. This situation is improving with the emergence of more robust and transparent price indices and data providers. However, a key challenge facing crypto asset managers is the fact that pricing remains somewhat inconsistent and unstandardized.
A historic lack of regulation means that the crypto markets evolved separately from the banking sector, and as a result, custody has been a longstanding challenge for anyone holding digital assets. There are only two practical options – self-custody or custody by a service provider. However, each also comes with its own benefits and trade-offs.
Institutional self-custody solutions include cold storage wallets (meaning wallets that are not connected to the internet, whether they be hardware security modules (HSM) or wallets using security protocols such as multi-party computation (MPC) that are kept offline) and hot wallets. Typically, cold wallets are used for secure storage of large sums, while hot wallets are used for operating capital. Self-custody wallet providers include Ledger, Fireblocks, and MetaMask Institutional, while larger banks such as Standard Chartered have developed their own custody solutions.
Self-custody gives the user complete control over their funds; however, it also comes with operational considerations such as delegation of responsibility for private keys. Historically, the most compelling argument for self-custody was the unreliability of crypto exchanges and service providers. Indeed, the high-profile collapses of 2022, including FTX and Celsius, attest to the dangers of storing funds with third parties.
However, there is a market for institutional digital asset custody, with many reputable providers – and in some jurisdictions, such as Switzerland, regulated crypto banks. Digital asset custodians will use either in-house or third-party cold and hot wallets to store customer funds on their behalf. Many also provide insurance for custodied funds as standard, which is an additional consideration if using a self-custody solution.
To mitigate the risk of losses, digital asset managers typically operate a diversification strategy, storing funds across multiple cold and hot wallet solutions so that if one is compromised, only a section of the overall portfolio is affected. However, this can introduce some complexity in tracking performance, or even the presence, of assets. Furthermore, it can be difficult to gain an accurate view of counterparty risk and the extent of exposure to any given provider in the context of the wider portfolio.
Along with an understanding of the market structure and custody considerations, crypto asset managers also need an in-depth knowledge of the various macro factors that can affect token prices. Short-term volatility in crypto is often inexplicable, but the markets are subject to many complex forces affecting longer-term price movements.
One example is Bitcoin’s periodic halving events, where the mining rewards are halved every four years. These events are thought to be strongly correlated with Bitcoin’s long-term price cycles, with Bitcoin, as the largest-cap crypto asset, exerting a “spillover” effect on the rest of the market. However, it is possible for individual assets to perform contrary to BTC based on fundamental price factors.
Regulatory decisions are also a factor in planning crypto asset management strategies. Short-term decisions or unfolding events in a long-running case like the SEC versus Ripple may generate short-term volatility, but regulatory action can also mean a rethink of the entire asset strategy. For instance, the recent US regulatory action against the BUSD stablecoin will eventually see the asset completely drained of liquidity, while the ongoing developments around CBDCs could prove to be an existential threat to the future of stablecoins.
Other factors to consider are the increasingly apparent correlation between crypto and TradFi markets, such as stocks, and that the level of interconnectedness within the sector is still often opaque – as evidenced by the “contagion” effect following the collapse of Terra Luna and FTX.
Asset managers need access to high-quality, real-time data from various market and on-chain sources to map the potential impacts of all this complexity onto a portfolio of crypto assets.
Digital assets now offer plenty of ways to generate returns, but there are risks and trade-offs, many of which are unique to the sector. Staking can involve lockup periods, which may be prolonged in some cases. For instance, anyone who staked ETH on Ethereum’s Beacon chain in December 2020 had a long wait until the April 2023 Shanghai upgrade to be able to unstake their funds. Many platforms operate an unlocking period and contain terms around “slashing” – penalizing poor behavior, even if it is inadvertent. Asset managers will need a full view of all the risks involved prior to locking up funds in staking programs.
Staking via a staking pool or exchange staking program can avoid lockup periods. However, providers can fail, as Celsius users discovered in 2022. Furthermore, staking providers have come under scrutiny in some jurisdictions, such as the US, where providers are being forced to shutter their programs.
The emerging field of decentralized finance also offers plenty of opportunities for returns. An increasing range of institutional-grade tools and platforms, such as Aave Arc, offer features such as permission-only access based on KYC and AML/CFT checks. However, the market is highly immature and volatile in terms of platform and provider risk, as well as price risk.
Any venture into these nascent markets requires a robust risk management approach together with the right tools to ensure assets and returns are continuously monitored.
With such complexity and diversity at play, an effective cryptocurrency portfolio management system is an essential prerequisite for managing your crypto assets. Even for a single asset, asset managers require a comprehensive portfolio tracker to connect to all custody providers, wallets, and exchange accounts, in order to aggregate all assets and venues into a single view and enabling performance monitoring in real-time. Furthermore, with crypto assets spread across multiple exchanges and wallets, the ability to calculate and track counterparty risk exposure is a critical element for effective portfolio management.
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