Trading Turds or Transformative Technology?

Solving the Crypto Investment Problem

1. What do celebrity investors and traders think about Bitcoin and crypto?

• Charlie Munger (RIP Charlie!): “It’s like somebody else trading turds and you decide I can’t be left out.” (The Guardian, 2023)
• Warren Buffett: “It’s a delusion.” (CNBC, 2021)
• Bill Ackman: “The emperor has no clothes. Bitcoin is a massive pyramid scheme.” (Twitter, Sept 2023)
• Jeremy Grantham: “Crypto is in the greatest bubble ever, even compared to the dot-com bubble.” (Bloomberg, Nov 2023)
• Jamie Dimon (CEO of JPMorgan Chase): “Bitcoin is tulip mania 2.0. It’s nothing but a speculative frenzy.” (December 2023)

• Paul Tudor Jones (Legendary trader and Hedge fund manager): “I do own Bitcoin. I think it’s a worthwhile insurance policy…There is a chance that Bitcoin could become the single most important financial asset in the world.” (CNBC, April 2023)
• Stanley Druckenmiller (Iconic Hedge Fund Manager): “I can make the case that Bitcoin could be worth $10 million an ounce in 10 years. Now, I want to be very clear, I’m not saying it will be. I’m saying there’s a chance of it.”
• Ray Dalio (Bridgewater Associates Founder): “Bitcoin is like gold — a digital gold. There’s a limited supply, and people can’t create more. There’s a lot of merit to that.”
• Larry Fink (BlackRock, Financial Management Giant): “I believe crypto will play that type of role, as a flight to quality.” (October 2023, The Block)
• McKinsey & Company (Global Consulting Firm): “Blockchain and cryptocurrencies have the potential to disrupt numerous industries, and their impact is only just beginning.”

Well, this doesn’t help us much, does it? Let’s get some AI-assistance:

Hey ChatGPT, Considering the above divergent opinions of famous and successful investors, who should we believe?

ChatGPT: (AI genius with an LLM degree 😉)“Remember, even famous and successful investors can have biased opinions or limited insights. There is no guaranteed answer to who is “right” or “wrong” in this evolving field. By taking a responsible approach, conducting thorough research, and managing risk effectively, you can make informed decisions about whether or not cryptocurrencies align with your individual investment goals.”

🙄 I guess cutting corners by copying what famous investors do, or asking a chatbot for investment advice won’t help us much here. We’ll have to do the work after all….

2. So, what is the Crypto Investment Problem exactly?

1. The complexity of blockchain and cryptographic technologies can be daunting and often surpass the grasp of many investors.
2. The potential use cases of these technologies are not yet clear, demanding a fair bit of imagination to foresee future applications that might drive widespread adoption.
3. The crypto sphere is riddled with scams and Ponzi schemes, necessitating extensive due diligence to separate the wheat from the chaff.
4. Frankly, the regulatory landscape for cryptocurrencies is a mess.
5. The notorious boom-bust cycles of crypto is simply too much to stomach for most investors.
6. From a price action point of view, the regular occurrence of 70–90% drawdowns, is a bitter pill to swallow, even when keeping the 10–20X upside in mind.

For many capital allocators, these attributes render the asset class un-investable.. Yet, in every bull run, these same investors can’t help but feeling left behind, even though they are convinced that it is probably for the better.

So, how does one invest an insignificant amount in crypto — a stake small enough to lose without much agony — while still capitalizing on most of the upside, and crucially, safeguarding gains against those infamous 90% crypto drawdowns?

3. Possible Solutions

1. Wait until there is more clarity on the potential use-cases, regulatory environment, and scams are rooted out before entering the market. However, by then, most of the profit potential will already be realized, leaving only a limited upside. To achieve significant gains at this stage would therefore require a substantially larger investment than the ‘insignificant amount’ considered above.
2. Another approach might be to diversify by investing across the entire cryptocurrency market, thereby avoiding the guesswork of selecting individual winners. While this could mitigate the risk of choosing the wrong coin, the growth potential of the entire market, currently valued at $1.55 trillion, might be inherently limited. Can the market realistically grow fivefold or tenfold in the current cycle? It’s possible, but this strategy doesn’t align with the risk-return profile we had in mind here, especially considering it doesn’t address the 90% drawdown-problem.
3. A more straightforward strategy could be to invest in Bitcoin, the most established crypto asset with a proven track record. While this might not be a bad idea, it has the same limitations of the previous approach. With Bitcoin’s market capitalization already at $0.74 trillion, significant future growth could be challenging, and this method introduces a heightened risk of market concentration, focusing too much on a single asset.Top of Form

4. Our Solution

Man + Machine = Centaur

The Crypto Centaur Long/Short Momentum Strategy

To address the problems we’ve discussed above, we’ve developed an automated algorithmic crypto futures trading strategy integrating the following key features:

1. Crypto assets are renowned for their high volatility, both on the upside and downside. Our strategy is designed to capitalize on these movements in either direction, aiming to significantly outperform long-only strategies like those previously mentioned. While our back-testing validates this, the ultimate test will be long-term live-trading results, which will serve as the definitive measure of our success.
2. By monitoring the top 400 crypto assets daily and ensuring exposure to those coins demonstrating strong momentum in either direction (up or down), there is no need to analyze each asset’s fundamentals to estimate its valuation relative to its market price. The market does this work for us, bypassing the challenges in fundamental analysis of crypto projects highlighted in the ‘Investment Problem’ section above.
3. Maintaining a diversified portfolio of up to 120 long and short positions mitigates the aforementioned concentration-risk by limiting the size of individual positions to predetermined risk levels.
4. Appropriately using leverage, while controlling risk, can significantly enhance the risk-to-reward profile of the strategy.
5. The ability to switch between individual long and short exposures within the portfolio as market momentum shifts allows the strategy to scale back net exposure near market peaks and increase it near market troughs. The read on inflection points is organically built into the system as the net exposure is the sum of all the individual long and short exposures. There are always some coins that lead others during major market inflection points which means that the appropriate positioning evolves as the inflection point is approached.
6. Incorporating volatility shock absorbers into the system to protect capital against tail-risk events can further reduce risk and enhance performance.
7. Aiming to maintain market-neutral positioning when the market chops sideways — until a clear trend re-emerges — can mitigate the slow bleed during extended consolidation periods.

The methodology we used to design a system with the aforementioned characteristics is known in the trading industry as ‘Trend Following.’ We have adapted this time-tested approach to suit the unique dynamics of the crypto markets. Since our initial development phase in 2019, we’ve integrated numerous proprietary enhancements to refine and customize the methodology beyond its traditional application in commodity futures markets.

Purpose of the strategy:

In a nutshell, the core objective of our strategy is to actively participate in potential crypto bull runs, capitalizing on significant gains. Crucially, our approach is designed to secure the lion’s share of these gains against the inevitable catastrophic drawdowns associated with crypto markets. Furthermore, a fundamental goal is to safeguard the original invested capital, ensuring resilience even if the anticipated bull market does not materialize.

5. Risk Replacement

Any experienced investor or trader who is worth his salt, will recognize that the proposed strategy does not eliminate all risk, it merely replaces the risks mentioned in the “Investment Problem” section, with other types of risk, such as:

• The risk that the algorithm doesn’t do what we expect it to do.
• Bugs in the code.
• Counterparty risk of the exchange
• Risk that we make bad decisions in future changes or improvements to the algorithm.

Like energy, risk cannot be destroyed — it can only be transformed. Our strategy is underpinned by a philosophy that the transformed risks we now face are more manageable and controllable than those inherent in conventional crypto investment approaches, such as simply buying and holding assets through volatile boom-bust cycles. This reorientation towards a more manageable risk profile, presents what we believe to be a far more favorable risk-to-reward ratio for discerning crypto investors.

6. Answering the Big Question:

“Trading turds or transformative technology?”

While we certainly have our opinions on the technology, it is irrelevant. Our trading system is built to make money, not to pick technologically transformative crypto projects. If turds end up in our portfolio, it will only be because they’re flying turds. Besides, the strategy is designed to dump them long before they get flushed away.

In future articles, we will describe the strategy in more detail and analyze the back-testing results and live trading performance. Spoiler alert — hold on to your hats!

For some background on Numeta Strategies read the article below:

Catching Waves

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Disclaimer

The views expressed in this article are the views of Numeta Strategies and are subject to change at any time based on market and other conditions. This is not financial or investment advice, nor a solicitation for investment funds and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.