Can speed-hungry hedge funds make hay from crypto volatility?

Richard Balmer, director of network product strategy at IPC, explains how massive price swings in the digital asset space could provide an enticing opportunity for computer-driven fund managers.

After a prolonged period of low FX market volatility, quant focus hedge funds, renowned for transacting a large number of orders fractions of a second faster than regular investors, are now setting their sights on crypto.

With Bitcoin up 10% over the past 24 hours, it is not hard to see why there is so much interest. After all, these guys live and breathe big price swings. And with crypto pairs valued differently across multiple markets, there is no shortage of opportunity for computer driven fund managers to profit quickly from extreme price differences.

Cryptoassets grew by roughly 200% in the last year, from just under $800 billion to $2.3 trillion. While the $2.3 trillion needs to be viewed in the context of the $250 trillion global financial system, one of the central reasons behind this expediential growth has undoubtably been the lack of oversight opening up market making opportunities. PwC’s latest annual crypto report found that quantitative trading strategies are the most popular among hedge fund managers when trading crypto.

These strategies, which look to simultaneously buy and sell assets to make money on price differences between coins, lend themselves perfectly to compliance light and highly liquid markets. Hedge fund managers do need to go to appease investors given how flat FX markets have been. The challenge is that the more participants the greater the competition, which puts a greater emphasis on quickly evaluating vast quantities of crypto pricing data.

This is where the quant focused hedge funds can steel a march, by using their more sophisticated analysis to do what they do best – trade on information quicker than the rest of the market. Where these firms can really get ahead of the game is by executing orders to ensure the latest activity reflects the last market price of say, Bitcoin. On top of this, their algos can provide almost real-time insight on the best execution of a crypto trade.

One of the attractive elements about crypto right now for the algo driven hedge funds is that the completely unregulated nature of the market is yielding some very strong returns for investors.  Whatever its role in the wider institutional trading world, the inclusion of crypto currency as part of a wider trading strategy will require infrastructure to support it. In order for the crypto market data mined to be valuable, it has to be easy to access and analyse, allowing electronic traders to isolate what is useful from the large volumes of noise. Not difficult to manage in theory, but the relevant connectivity to new venues is required to ensure a sudden spike whenever the next crypto coin craze materialises.

Hedge funds will need a complete solution for their existing trading requirements to plug in to raw and normalised market data – not only connecting them to regulated crypto exchanges, but also to transit through to those major counterparty-to-counterparty hubs. With the estimated value of the global cryptocurrency market now above $2.3 trillion billion and rising, only those hedge funds quickest who fine-tune their trading behaviour will be able to thrive in this fast-evolving market.