How to Outperform Bitcoin: Guide for Crypto Hedge Funds

Hey, Contora.ai team is here. We couldn’t pass through one of the most discussed topics in the crypto world in recent days — the reports from Bloomberg and 21e6 Capital about crypto hedge funds performance in the first half of 2023.

Long story short — in the recent report by 21e6 Capital, it was revealed that directional funds, despite performing well, underperformed Bitcoin by more than 40% (Bitcoin added about 80% in value by the half of the year):

Today we will delve into the reasons behind crypto hedge funds underperforming Bitcoin in 2023 and explore the potential of alternative data (which is often referred to as supplementary data or off-chain) to reshape investment strategies. While traditional market data has long been the go-to for decision-making, recent reports show that basing your strategies solely on this data won’t be enough.

Harnessing Traditional and On-Chain Data

Market data provides insights into cryptocurrencies price trends, trading volumes, and liquidity. And crypto hedge funds have relied on this information for a long time to analyze the projects’ health and transaction patterns. In recent times, quantitative funds, which use mathematical models and algorithms, have struggled to keep up with the rapidly changing and often volatile cryptocurrency market.

The quantitative models, often driven by trend-following strategies, didn’t show the best performance due to unpredictable market momentum and regulatory uncertainties. This resonates with a broader trend — even during a market upswing, which characterized the first half of 2023, crypto hedge funds didn’t get the desired results.

While market data has its merits, the complex and rapidly evolving nature of the crypto landscape requires a more nuanced approach. Traditional data sources, though valuable, often struggle to capture the intricate dynamics and sentiment shifts that characterize the crypto market.

The Paradigm Shift: Alternative Data

Unlike conventional data sources, alternative data sticks to metrics that are left behind the chain — including social-related data, technology trends, and news sentiment analysis.

Imagine having the ability to analyze not just price trends, but also the sentiment of news articles mentioning target assets, the buzz within social platforms, and the state of the market from the social perspective, in real-time frequency. The described approach to data collection and analysis is a departure from traditional methodologies and presents a more nuanced perspective.

We at Contora.ai have been providing alternative data for the crypto market for 2+ years, and based on the feedback from our clients, alternative data metrics really bridge the gap between market events and investor reactions.

Alternative Data’s Predictive Power

But does alternative data really wield predictive power? A few months ago, we have already proved that asset mentions on social media networks and their sentiment have predictive power, you can take a closer look at our findings here: https://medium.com/contora/leveraging-alternative-crypto-data-for-quantitative-trading-social-signals-and-sentiment-analysis-e482f39efcbe

Recently we have connected the new data stream — an AI-scored news feed with 10-minute granularity of updates, and decided to analyze this kind of data for predictive power as well. By processing thousands of news articles mentioning Bitcoin, our study revealed that positive and negative sentiment scores could be used to construct trading strategies with impressive returns. The result? Up to 80% in returns.

News Sentiment Analysis: The Game-Changer

Our research extended the approach of analyzing news sentiment beyond Bitcoin to altcoins. To analyze the predictive power of this data for Bitcoin, we collected 100,000+ news articles that mention “Bitcoin” in their title over a period of a year and a half (starting from January 2022). Using an advanced AI model, we processed each title to determine the sentiment of the news (positive, negative, or neutral) for the price of Bitcoin.

We then calculated the mean score for each day, and this daily sentiment score served as the basis for a simple strategy: opening the long position of Bitcoin (1-day duration) on days when the sentiment score was positive and opening the short position (1-day duration) on days when it was negative.

This approach gave impressive results, yielding a return of 80% over the period under consideration. The picture below demonstrates the forecasted returns with this simple strategy:

After conducting this analysis for Bitcoin, we applied a similar strategy to Ethereum, XRP, BNB, and Cardano — and the results showed 20–50% returns for a 7-month period. The image below shows the cumulative returns for Ethereum over the first 7 months of the year 2023:

If you want to get access to our detailed research paper, please drop us a line at Contora.ai

Alternative Data Advantage for Your Investment Strategies

The power of alternative data lies in its ability to escalate existing investment strategies. By integrating traditional market data with real-time alternative data insights, the investors could get:

• Stronger Decision-Making: Alternative data brings a fresh dimension to decision-making by considering social buzz, technology trends, and sentiment shifts.
• Seizing Momentum: Alternative data empowers investors to capture momentum shifts and proactively respond to emerging trends. And considering that our data has an almost real-time frequency of updates, this could be beneficial for your strategies.
• Navigating Volatility: Crypto markets are infamous for their volatility. Alternative data equips funds with timely insights that can guide decision-making during turbulent times.

As the crypto investment landscape evolves, we at Contora.ai understand that the significance of alternative data becomes clearer than ever. Among the underperformance narratives we faced in the first half of 2023, the integration of real-time news sentiment and social-related data has the potential to catalyze a paradigm shift. We also proved this statement by analyzing the predictive power of our data metrics and gathering feedback from quantitative funds.

Get in touch with us to see how we can help you enhance your trading strategies with the power of alternative data.