Understanding Actively Managed Crypto Strategies

The investing world is largely divided into two camps: active and passive. 

Passive investors shun investment risk and often purchase securities in funds that track bellwether indexes such as the S&P 500. They spread their investments across hundreds of equities or bonds and are content to pocket whatever the market gives them. 

Active investors, on the other hand, embrace risk. They want to pick stocks and other securities that will beat the market. They look for promising trades by analyzing the earnings of publicly traded companies and economic trends. True to their name, active investors constantly adjust their portfolios, use leverage to multiply gains, and deploy short-selling tactics to bet on troubled companies and hedge the risk of a bear market.

The same goes for cryptocurrencies: There’s been a loose mix of active and passive strategies for managing crypto for the past decade. More risk-averse investors have opted to ride the crypto rollercoaster through peaks and valleys. These traders embrace “HODL,” or “Hold On for Dear Life,” slang for holding Bitcoin through downturns no matter what, and this is essentially a passive approach. Likewise, investors who have opted for offerings like the Grayscale Bitcoin Trust, which is pegged to the CoinDesk Bitcoin Price Index, are also largely tracking the market in a passive manner.

What is active management in crypto?

Investors who embrace active management in crypto behave similarly to their counterparts in stocks—they trade in and out of positions to time the ups and downs of Bitcoin, Ethereum’s ETH token, and other digital assets. They pore over pricing patterns using what’s known as technical analysis to anticipate future moves. And they employ leverage and derivatives—complex instruments usually employed by professionals—to magnify their gains (and risk). The giant crypto exchange FTX caters to such investors with what are known as perpetual futures contracts. Trading those is a decidedly active move.

With the cryptocurrency market booming—it recently exceeded $3 trillion in total market capitalization—active management is evolving beyond trying to time a market that’s becoming vastly more complex. There are now thousands of digital tokens and scores of exchanges offering all manner of digital wallets to hold them. Moving tokens between all these platforms can frustrate even the most experienced crypto investor. And dealing with the tax implications of crypto is yet another challenge.

If that wasn’t enough, decentralized finance, or DeFi, has exploded as the next chapter of the crypto story. Savvy investors are expanding their focus from Bitcoin to Ethereum, the second most valuable cryptocurrency. The Ethereum blockchain supports numerous new projects that are designed to do more than be an alternative form of money.

The most well-known development is non-fungible tokens (NFTs)—the programs that make digital assets and files such as JPEGs unique. NFTs have become so valuable that top investment firms such as Andreessen Horowitz are investing hundreds of millions of dollars in new funds to back their development.

What’s the appeal of active management for crypto?

Investment firms see an opportunity to help clients navigate the labyrinthine world of crypto and manage their portfolios. Professional money managers can also help clients make sense of a market where separating truly promising assets from laggards is getting tougher. Just like the stock market, managers are now offering investors active strategies that seek to outperform Bitcoin and benchmarks such as the Nasdaq Crypto Index, which contains eight of the top digital tokens.

The challenge with Bitcoin and its ilk is that there’s no easy way for portfolio managers or amateur investors to understand how digital currency is valued and why their prices go up and down. They don’t produce earnings or other financial data to analyze, and they often appear to move on speculation and psychological forces largely apart from the laws of economics.

At the same time, the cryptocurrency market is roiled by extreme volatility. Ethereum, for instance, jumped more than 85% in the space of two weeks in the spring of 2021 only to plunge by more than half over the next 10 weeks. There was speculation that the sell-off was triggered by everything from a regulatory crackdown in China to so-called whales, or large holders, selling their positions, but no one knew for sure.

Even so, cryptocurrencies are increasingly being accepted as a viable new cog in the financial system. Payment stalwarts such as PayPal, Visa, and MasterCard are incorporating digital assets into their product offerings, and investment giant Fidelity is showcasing Bitcoin as part of a diversified portfolio. In October, the U.S. Securities and Exchange Commission permitted the rollout of the first Bitcoin exchange-traded fund, although it was pegged to Bitcoin futures contracts and not the token itself. As crypto goes mainstream, more investors are bound to pile into the market.

The upshot of all this action is clear: Crypto has become wildly complicated and investors want to profit from its growth. The question is, how?

The rise of actively managed crypto strategies

Although this new asset class is still in its early stages, a raft of approaches are emerging. Naturally, many firms concentrate on Bitcoin because it accounts for about 44% of the sector’s total market capitalization. The Amplify Transformational Data Sharing ETF is an actively managed fund that invests in the stocks of companies that serve the cryptocurrency industry instead of tokens themselves. The fund, for example, owns shares of Coinbase, the publicly traded cryptocurrency exchange, and Nvidia, a chipmaker that specializes in cryptocurrency mining processors. 

Meanwhile, funds such as DeFi Capital are focusing on platforms that are either based on or inspired by the Ethereum blockchain instead of Bitcoin. Ethereum enables software developers to create decentralized applications, known as dApps, and in the last year there’s been a blossoming of projects that let investors borrow, lend, and trade in myriad tokens. There are a number of hot gaming plays, too. The token for Axie Infinity, a blockchain-based game that’s drawn legions of players in the last year, multiplied in value 290 times in 2021 and sports a market value of $10 billion.

Unearthing potential blockbusters like Axie Infinity is precisely what active investors aim to do. As the cryptocurrency market evolves, it’s ripe for the same type of stock-picking that’s long held sway in the traditional capital markets.

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