There is no debate that digital assets have taken off in the recent years. Retail investors initially led the pack, but institutions are now becoming significant players in the space. The appeal to investors is obvious: digital assets offer uncorrelated value to other asset classes, innovative technology, high potential upside, and many other benefits. Retail investors have also taken notice of decentralized finance (DeFi) applications, and more recently non-fungible tokens (NFTs). The adoption of institutions is more gradual, however, as better financial, legal, and regulatory infrastructure is desired.
The appeal does not come without a cost. Digital assets also offer risk in the form of price volatility, new fundamentals, complexity, and lack of regulatory clarity. Consequently, institutions are looking for a reason to say no to this market and are unlikely to devote ample resources internally to understand the asset class.
At Level III Capital, the solution that we found to this was to create robust investment vehicles with a team that has a comprehensive understanding of digital assets for institutions to comfortably and confidently participate. This, however, posed a new problem. As it turns out, digital asset hedge funds have not performed to a standard that we accept. Pricewaterhouse Coopers’ Crypto Hedge Fund Report analyzed 150 active cryptocurrency hedge funds. By definition, a cryptocurrency hedge fund is one that participates in the digital asset market directly through price and not through venture or indirect investments. These hedge funds varied in their strategies with discretionary, or subjective, and quantitative, or objective, funds being analyzed. We concluded from the 2018 and 2019 returns data that discretionary funds are expectedly correlated to the price of Bitcoin, which holds the largest market capitalization and the most dominance in the digital asset space. Quantitative funds, on the other hand, were more consistent and stable in their returns.
The definition of a quantitative fund can vary. There are high-frequency, arbitrage, market-making, and systematic strategies. Level III Capital follows a systematic approach based on applied mathematics operating on a proprietary, automated trading infrastructure. We have taken a quantitative approach for many reasons: lack of project fundamentals, youth of the market, abundance of inefficiencies, etc. Fundamentally, however, there is a larger reason.
It is our belief that price is a data representation of human emotion, or, in other words, the result of natural phenomena. Many investors in this space will attempt to break down the markets by analyzing events, outflows/inflows, on-chain metrics, or the development of the project. We believe this is an inefficient way to digest something that is obviously the result of a very complex web of activities. Our operation assumes that every piece of information that has affected an asset lies in its price. This is our Occam’s razor methodology when creating our quantitative strategies.
We have found that investors want to participate in the bull market and be protected in the bear market, but many funds have shown that they are unable to accomplish this. Seeing that many funds have employed discretionary approaches and the lack of robust, automated, and systematic quantitative funds, Level III Capital is filling a void that institutions and individuals are looking for by offering the Level III Quantitative Fund and Level III Opportunistic Fund.
We have observed a lack of active management, quantitative thinking, and institutional preparation. Level III Capital is a creation in spite of everything the digital asset hedge fund industry lacks. The world is experiencing a capital transition from centralized entities to decentralized ones. The change will not be sudden, however. It is a collective process that requires time, but this can be expedited through market ‘bridges.’ Ventures that create the structure by which others can transition will further the process along. Our fundamental goal is to be the bridge that institutions and individuals walk across to gain exposure to digital assets, therefore increasing legitimacy and adoption for the youthful but growing asset class.