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Welcome to Crypto Long & Short! This week, Alex Botte, partner at Hack VC, argues that dispersion – or the range of returns available – is a defining feature of crypto markets, one with benefits for investors.
Then, Gregory Mall, head of investment solutionsat AMINA Bank, says crypto markets have historically been inefficient due to low liquidity, regulatory uncertainty and speculative behavior. But the strategies to overcome this. As always, get the latest crypto news and data from coindeskmarkets.com. – Ben Schiller, head of Consensus Magazine at CoinDesk
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Dispersion Is Defining the Current Crypto Market |
One of the most interesting features of the current crypto markets is the elevated level of dispersion, or range of returns across different parts of the market. In today's liquid markets, sectors focused on infrastructure and technology have significantly outperformed more consumer-oriented categories like gaming, metaverse, and entertainment-related tokens. CoinDesk sector indices' performance since November 2021 (the peak of the last bull market) reveals this trend. |
The "range" value, which shows the difference between the maximum and minimum cumulative returns at each point in time, highlights the level of dispersion. Dispersion started high in the fourth quarter of 2021 due to a surge in culture and entertainment-related developments. It then dropped in 2022 as the market collapsed, correlations rose, and assets largely traded in sync. However, dispersion has been rising since 2023, picking up meaningfully in the fourth quarter of last year, with Currencies and Smart Contract Platforms (infrastructure) breaking away from the rest of the market. In 2024, dispersion is at a high over this period, with tokens in the Culture & Entertainment sector continuing to draw down, while BTC, ETH, and other smart contract platform tokens are outperforming. Take a few examples to illustrate this last point. The overall market’s current maximum drawdown (using the CoinDesk Market Index) was -33% over this period. Compare that to some of the largest consumer tokens in the Gaming and Culture & Entertainment sectors, including Axie Infinity (game), Decentraland and The Sandbox (metaverses), and Apecoin (token associated with the NFT collection Bored Ape Yacht Club). These tokens’ maximum drawdowns were -96%, -94%, -96%, and -96% respectively. They have not participated in the market’s recovery this cycle. |
Another way to view dispersion is through the rolling 30-day average of the daily standard deviation of returns across the CoinDesk sector indices. Since the fourth quarter of last year, sector dispersion has mostly been above average. This elevated level of dispersion indicates that the market is no longer moving in unison, and individual sectors are experiencing different growth trajectories based on their underlying fundamentals and investor interest. |
To delve deeper, we examine the number of billion-dollar-valued tokens in each sector (sectors are defined by Hack VC) as of five years ago compared to today. In 2019, Currencies dominated the market: BTC and BTC competitors. Today, half of the tokens are in the infrastructure sector (layer 1 and layer 2 blockchains). This sector has seen massive growth over the past five-plus years. We also see new sectors emerging. AI, for example, is a relatively new part of the market that brings together two of the most exciting emerging technologies: crypto and AI. While there is a lot of hype and promise, real benefits exist today. In the next five years, we expect additional sectors and sub-sectors will emerge. |
This dispersion and development of new sectors over time is positive for active managers. It indicates growing market sophistication, with value being rewarded and fundamentals becoming increasingly important. Dispersion also offers significant opportunities for generating alpha. It makes it easier for active managers with alpha to outperform the market, though it also increases the risk of underperformance without a strong strategy. In this environment, investors must be more selective and knowledgeable about the sectors and projects they invest in. Active management becomes crucial as the market rewards those who can identify and capitalize on trends. These markets are also particularly favorable for investors with a deep understanding of technological advancements and the ability to discern long-term value from short-term hype. |
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The Evolving Efficiency of Bitcoin Markets |
Despite rapid growth and increasing attention from investors and regulators, cryptocurrency markets remain largely inefficient. Although the market has become more efficient over time, studies show that even large-cap cryptocurrencies do not always fully reflect available information, leading to significant inefficiencies. Reasons Behind Crypto Market Inefficiencies Several factors contribute to persistent inefficiencies in cryptocurrency markets: |
- Low Liquidity: Compared to traditional financial markets, crypto markets have lower liquidity, making them more susceptible to large price swings and manipulation.
- Regulatory Uncertainty: Inconsistent and evolving regulations across different jurisdictions create uncertainty, impacting investor behavior and market stability.
- Market Fragmentation: Numerous exchanges with varying prices and trading volumes lead to inefficient price discovery and arbitrage opportunities.
- Speculative Behavior: A significant portion of crypto trading is driven by speculation rather than fundamental value, leading to volatility and inefficiency.
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Mental Biases in Crypto Investing Unlike stocks, which can be analyzed based on well-established valuation methodologies, cryptocurrencies tend to be less driven by fundamentals in the short- to medium-term. Since much of the value derived from cryptocurrencies is based on future assumptions, the asset class is susceptible to large swings based on market sentiment and liquidity. Empirical studies show that cryptocurrency investing is closely associated with speculation and mental biases. Here are some prominent biases in crypto-investing: |
- Overconfidence Bias: Investors often overestimate their knowledge and predictive abilities, leading to excessive trading and risk-taking.
- Herding Behavior: The tendency of investors to follow the crowd can result in buying into cryptocurrencies when prices are rising, and selling when prices are falling, contributing to market bubbles and crashes.
- Anchoring: Investors may fixate on specific price points, such as all-time highs, and make decisions based on these anchors rather than considering broader market conditions.
- Loss Aversion: The fear of losses can cause investors to hold onto losing investments for too long or sell winning investments too early.
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Leveraging Inefficiencies with a Systematic Momentum Index Technical analysis can work if assets do not behave in a random-walk fashion. A systematic momentum index can effectively capitalize on market inefficiencies while mitigating the psychological biases that plague individual investors. Here's how: Exploiting Market Inefficiencies: By systematically analyzing price trends and momentum, the index can identify and exploit inefficiencies in the market. This approach is grounded in the observation that assets with strong recent performance tend to continue performing well in the short term. Overcoming Psychological Hurdles: A systematic approach helps to avoid common biases such as momentum chasing and loss aversion. Instead of following the herd, a momentum index relies on objective data to make investment decisions. This reduces the emotional impact of market fluctuations on investment choices. Added Value for Investors For the average investor, a systematic momentum index offers several benefits: |
- Consistency: By adhering to a rules-based approach, the index ensures consistent investment decisions, reducing the impact of human error and emotional bias.
- Risk Management: The systematic nature of the index allows for better risk management through predefined entry and exit points, improving overall portfolio stability.
- Enhanced Returns: By taking advantage of market inefficiencies and avoiding common psychological pitfalls, a momentum index has the potential to generate superior returns compared to a purely passive investment strategy.
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In conclusion, while cryptocurrency markets are inherently inefficient due to various structural and behavioral factors, these inefficiencies present opportunities for systematic investment strategies. A momentum index not only leverages these opportunities but also helps investors overcome the cognitive biases that often lead to suboptimal investment decisions. By doing so, it offers a valuable tool for navigating the volatile and rapidly evolving world of digital assets. |
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Here's some news worth knowing, from CoinDesk deputy editor-in-chief Nick Baker: |
- ETHER ETFS: Ether (ETH) ETFs are a thing now in the U.S. Trading started Tuesday. Optimism abounded more than six months ago as bitcoin ETFs marched toward approval, and it seems fair to say reality matched the hype. In terms of inflows, it was the most successful ETF launch ever. Bitcoin soared to a record high a couple months after the spot bitcoin ETFs started trading. With ether ETFs, however, excitement is far lower, if not lacking entirely. A big source of pessimism: regulators didn't let issuers stake the ETH the ETFs hold, cutting off a source of income for investors in the funds. It's almost like launching an S&P 500 ETF but being told you can't collect dividends and distribute them to shareholders. And there's also the fact that bitcoin, for better or worse, is the best-known cryptocurrency – the one normies are more likely to be drawn to via the ETF business. Watch those inflow figures.
- TRUMP: Donald Trump speaks Saturday at the Bitcoin 2024 conference in Nashville, and hopes are high about what he might say. Some speculate he'll announce a plan for the U.S. government, if he's elected president in November, to hoard a bitcoin (BTC) reserve – something bitcoin bulls will undoubtedly latch onto as they engage in their bullishness. There's no evidence that he either will or won't say that, or even how such a thing would work beyond being a PR stunt, so we watch and wait. But Trump's appearance at the event, and recent embrace of crypto, feels significant. As my columnist colleague George Kaloudis recently put it: "To me, it appears that in this election cycle, crypto is standing in as a feather in the cap for the individual freedom talking point GOP voters love, to the point where Trump has completely backtracked on his anti-crypto rhetoric." The big unknown, though, is that since Kaloudis wrote those words, Joe Biden dropped out and Trump appears headed to face Vice President Kamala Harris in the election. Where does she stand on crypto? Well, there's speculation she'll be less punitive, if not exactly friendly, toward crypto than the administration of her current boss, President Biden. The crypto industry has financially aligned itself solidly behind pro-crypto candidates and against crypto's detractors, so there's real money at stake. (Anthony Scaramucci, who says he won't vote for his former boss Trump, just told CoinDesk that Democrats have made a "horrible mistake" being so against crypto.) Don't expect any quiet moments through Election Day.
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