Alpha, Beta, and Crypto Funds


HFR just debuted new indices aimed at blockchain and cryptocurrencies. HFR stands for Hedge Fund Research and the new indices measure the performance of twenty hedge funds investing in blockchain and trading cryptocurrencies.  So far this year, the HFR Cryptocurrency Index alone has risen 1,635%. But one must wonder if that performance is skill or just luck?

In the hedge fund world there is either alpha or beta returns. Beta returns are earned from just going with the market and don’t require great expertise. Whereas alpha returns required something extra, something more. If the S & P 500 Index is up 20% in one year, then you would want your hedge fund manager to earn more than that, but most do not. For in most professions there are the Jordans, Kanyes, and then everyone else.

Alpha returns in crypto may eventually come from some type of edge: a social network, a technology insight, or a trading acumen.

For example, former Fortress employee and macro  trader, Mike Novogratz, who made his $250 million crypto fortune from a “small” bet on ether back in 2016, will open his first fund next year, called Galaxy Investment Partners. Olaf Carson-Wee co-founded Polychain Capital with money from Andreesen-Horowitz  and USV. Carson-Wee’s edge comes from his social and intellectual capital developed as one of the first employees of Coinbase.

Recently Techcrunch founder, Michael Arrington, announced in late November his own fund focused on blockchain and crypto. As a former venture capitalist, Michael Arrington will be leverage his own social network and tech expertise. Out the gate, Arrington did score a first by establishing the first fund denominated in XRP, the cryptocurrency of Ripple Labs.  The XRP Capital Fund will only use XRP as investment from and redemptions to limited partners.

Since crypto funds are relative new, investors won’t really know for a while whether they’re paying for alpha returns from fund managers. It’s worth noting that most of the run up in the HFR Cryptocurrency Index came in 2017 when lots of new money flowed into the crypto-space.

So right now there might only be beta returns in the new crypto funds.


The Big Short, Again?


Just in time to burst a bubble, there comes this Sunday bitcoin futures come the Chicago Board of Trade (CBOE) and more later from the CME. Now there is way to bet against the tremendous rise in bitcoin. It’s almost similar to the housing bubble a decade ago when credit default swaps were applied to mortgage backed securities to short the real estate market. But in this Big Short, who will be on either side of the trade?

Unlike the stock exchange, in the futures market there is only one winner.  For every short position, there needs to be a long one since futures are a zero sum game. In effect, the short trader is betting prices will go down while the long trader hopes prices will go up. In order for a futures market to survive, there needs to be enough shorts and longs; or said another way, there needs to be enough hedgers and speculators.

Who would do the bitcoin short trade? Companies, firms, and individuals who are holding lots of bitcoin and who may not like the price of bitcoin going down. For them, the short trade is a side bet: if bitcoin goes down in value, the losses are offset by gains from the futures contract. Given the volatility of bitcoin, anyone doing business in bitcoin can not necessarily afford loses after receiving payment in bitcoin.

Online retailer, Overstock, who receives bitcoin and other cryptocurrencies as payment could be a short seller, a hedger. Overstock may use futures to lock in the value of their bitcoin holdings. Circle Financial may be another hedger given the volume of cryptocurrency transactions used its cross-border payment business. Circle no longer deals directly in bitcoin, after pivoting to doing payments. Its product is free and Circle makes money by trading bitcoin and other cryptocurrencies.

While it’s hard to predict the success of bitcoin futures, it’s helpful to remember that the CME lists futures contracts on real estate, based upon the Case/Shiller Home Prices Index. Despite being listed since 2006, the real estate futures never took off due to a lack of hedgers, speculators, and market liquidity.

Other than hedge funds and some business, who is willing to bet against the rapid rise of bitcoin?


Wall St. Comes to Bitcoin, For Good.



As announced by the CFTC, new bitcoin derivatives were self-certified by the CME, the Chicago Board of Trade (CBOE), and the Cantor Exchange this week. That news means that bitcoin futures and binary options will soon be listed and provide another way to trade bitcoin. While the CFTC did not actually approve the new contracts, its involvement may benefit traders of bitcoin futures.

Trading bitcoin futures has advantages over trading real bitcoin. Besides leverage and shorting, bitcoin futures receive a preferential or lower tax rate on gains. Trading actual bitcoin could mean any gains are taxed as ordinary income. For example, if one trades bitcoin and is in the 35% tax bracket, then a gain of $10,000 would mean taxes of $3,500 due to the government. But with bitcoin futures, the amount due is only $2,600.

For tax purposes, it appears that bitcoin futures will qualify as Section 1256 contracts. That designation means that sixty percent of the gains are taxed as long-term capital gains and the remainder as short-term capital gains. It also results in the favorable tax rate.  Section 1256 contracts are futures contracts that are subjected to marking for market for margin purposes  and trade on a qualified board or exchange (QBE).  

A QBE is a domestic exchange that operates under the oversight of the CFTC such as the CME or Chicago Board of Exchange.  The CFTC regulates futures on commodities  and two years ago it stake a claim on regulating bitcoin futures. In a case against Coinflip Inc, the CFTC said among other things that bitcoin was a commodity; that meant futures on bitcoin would be regulated by the CFTC.

In 2014, the IRS classified bitcoin for tax purposes as property rather than as a commodity. As property, gains from trading bitcoin can be subjected to ordinary income tax rates, which can be large for people in high tax brackets. But those same people could have lower tax bills when trading bitcoin futures rather than real bitcoin.

Disclaimer: This post is intended only for educational purposes. It should not be relied upon for investment or tax advice. Interested parties should instead consult with their investment and tax advisers.


Bitcoin Futures for the People



Dueling bitcoin futures come out soon from Chicago. One from the CME and the other from the Chicago Board of Exchange (CBOE). Much has been made of futures contracts on bitcoin, but the contract specifications themselves are most important for market participants. CME’s bitcoin futures favor institutional investors while those from the CBOE are beneficial to individuals.

Futures are financial contracts for the delivery of and payment for commodities on a date in the future. In the past, the commodities were physical assets such as corn and then financial assets like bonds and stocks, starting in the 1970s. Now, bitcoin is the commodity. Futures can be use to shift risk, speculate on price, and act as a substitute for the commodity itself.

Futures contracts can be purchased on margin, similar to the down payment when buying a house. Each futures exchange (CME, CBOE) sets the margin percentage and amount of margin is based upon the contract’s value. So if margin is 30% and the contract value is $10,000, then only $3,000 is needed to purchase the futures contract.

Contract value is based upon a multiple of the underlying commodity, in this case, bitcoin. CME’s  bitcoin futures multiple is five while only one for CBOE’s bitcoin futures. So if one bitcoin is worth $10,000, then contract values are $50,000 and $10,000 respectively. This means, that less margin is required to trade the CBOE bitcoin futures and than for those from the CME.

It also means bitcoin futures from the CBOE will favor the individual, rather than the institutional investor.


Coinbase Custody: Cheap?


Coinbase found another way to make money off cryptocurrencies with its custodial services for institutional investors. Announced this week, Coinbase Custody will charge sovereign wealth funds, traditional hedge funds, family offices, and others 10 basis points to store digital assets, such as bitcoin, litecoin, ethereum, and ERC 20 tokens. For some, there may be cheaper way to own digital assets.

At this moment in time, cryptocurrencies acts less like currencies and more like commodities. Often bitcoin is called digital gold; a storer of value rather than means of payment. This is due in part to the limited transaction processing of the bitcoin protocol. But owning digital asset presents custody issues for institutional investors.

The situation is no different than fifteen years ago when institutional investors wanted to own real commodities, such as industrial metals and agricultural products. As with digital assets, owning real assets is challenging due to storage, transportation, and insurance costs. Back then Wall Street solve the challenge by providing institutions with synthetic exposure with derivatives: commodity swaps, exchange traded futures, and structured notes.

So it is ironic, that this week the CME announced the terms of its BTC futures contracts. The CME is home to many of the future contracts that make up the commodity indices that institutions invested in many years ago; this includes the Goldman Sachs Commodity Index. CME’s bitcoin futures could be listed in the second week of December and will required more margin than “traditional” contracts.

While sovereign wealth funds or hedge funds may opt for real digital assets, others may want only synthetic exposure. CME’s BTC futures contracts offer another way for institutions, including mutual funds, to provide bitcoin exposure by rolling over the futures contracts, much the same way as with traditional commodity futures. BTC futures can also simplify ownership for retail investors with the creation of synthetic bitcoin exchange traded funds; one of which was recently proposed by Proshares.


Apple Really Likes Trump’s Tax Plan



Facebook, Alphabet, and especially Apple will really like Trump’s Tax Plan.  Under the various proposals, repatriated overseas cash receives a special tax break for US corporations.

Per the most recent SEC filings, 60% of Alphabet’s cash was overseas, Facebook held about 37% of its cash, overseas, and 94% of Apple’s cash was held overseas.

Yale Earns 15% From VC


The Yale Endowment’s venture capital assets earned about 15% over the ten year period ending on June 30, 2017. In addition, venture capital now makes up 17.1% of the Endowment; which is an increase from the 16.2% of the prior fiscal year.

Those facts come from the recent Yale’s 2016-2017 Financial Report. As previously reported, the Yale Endowment grew assets to $27.2 billion after earning 11.3% for the 2017 fiscal year. Not yet disclosed: the Endowment, overall, earned 6.6% for ten years ended June 30, 2017, which is a lot less than its venture capital returns.
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No Monero or Dash Investment Trust?

This week Grayscale filed the with the SEC to bring the Zcash Investment Trust to accredited investors for about $11 million. So far, Grayscale has done Investment Trusts for Bitcoin, Ethereum Classic, and now Zcash; but why no Monero or Dash Investment Trust?

Barry Silbert preannounced the Zcash Investment Trust on Twitter earlier this year. He also implied the Trust would be offered due to investor demand and the investment case for Zcash.  The Zcash protocol does employ zk-SNARK for the exchange of payments without revealing participant information. In addition, Zcash is the third most popular** coin offering privacy, anonymity, and fungibility. So why no Monero and Dash Investment Trust?

Besides the underlying protocol, a coin’s scarcity of supply makes them more valuable to investors. Zcash’s total monetary will be 21 million coins. When Zcash launched last year, stakeholders would be receiving 10% or 2.1 million coins of the total monetary base. Most stakeholders would receive their “founders reward” over four years, but investors received their coins in the first year.

Could this be why there is no Monero or Dash Investment Trust?

Barry Silbert and his Digital Currency Group were both early investors in Zcash, the protocol and the company. They are also the same parties behind Grayscale. Now after the launch of Zcash, they should have received all of their Zcash coins. A great way for Silbert and DCG to unload their Zcash holdings, and not depressing the market, would be selling them to accredited investors through an Investment Trust.

Zcash Investment Trust shares can be bought and sold without impacting the  Zcash coins in circulation.  Is this why no Monero or Dash Investment Trust?

LedgerX Bets on BTC Options


LedgerX has quietly listed bitcoin financial contracts: swap and options. After touting a trading volume of $1 million, LedgerX now offers hedge funds, family offices, sovereign wealth funds, and others a way to play bitcoin. Of the two instruments, the bitcoin options may be the most popular among institutional investors.

As the name implies, day ahead swaps last only one day. The swap buyer agrees to pay today for tomorrow’s delivery of bitcoin by the swap seller. If the price of bitcoin increases after one day, then money is made by the swap buyer; money is lost if the prices decrease. While called day ahead swaps, these financial contracts act more like commodity futures.

With a futures contract, the seller agrees to deliver goods at a future date and the buyer promises to pay an agreed upon price. In addition, swap agreement usually required a swap of payments between the buyer and seller. With the day ahead swaps, the buyer makes a payment, but seller’s obligation is satisfied with the physical delivery of bitcoin. Cash-settled bitcoin futures are planned to be listed by the Chicago Board of Exchange.

Bitcoin options maybe more important for investors. Options provide the buyer with the right, but not the obligation, to either purchase or sell an asset from the option seller. With equity options, the option buyer has the right to sell (put) or buy (call) stock from the option seller at specified price during an exercise period. For the right to put or call an asset, the option buyer pays the option seller a premium.

Option allows investors to bet on price swings. For example, you think Apple price will not rise this year, so you sell and collect a premium for a call option. The call option give the holder the right to purchase Apple stock from you at $160 per share. If Apple’s price increase to say $200, the option is exercised, but if not then the seller gets to keep the option premium. If you think Apple will go up, then you would sell a put option.

So replace equity with bitcoin, and you can see how options can be used by institutional funds to trade crypto-prices.