When crypto’s own hedge fund geniuses failed

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Yet hedge funds set up to deliver market-beating returns in crypto look blindsided. Average estimated returns for those providing daily data were -24 per cent in April, -32 per cent in May and -28 per cent in June, according to industry database NilssonHedge. A large number of managers have “simply stopped trading,” it says, with the total tracked falling to 325 from 510 in January.

Juiced returns prove unsustainable

The risk of a generalised crypto slump – the kind that humbled token-picking strategies in 2018 – doesn’t seem to have been high on their radar. The kind of strategies exploiting inefficiencies between exchanges that might bring in 6 per cent -10 per cent returns have been juiced by funds using DeFi lending platforms offering lucrative rates, which are proving unsustainable. As one hedge funder tells me, it’s like picking up BMWs rather than pennies in front of a steam-roller. The end result still involves getting squished.

With more than 40 per cent of crypto funds using borrowing and lending strategies, according to PWC, the current turmoil feels like a rug-pull rather than vindication of trading smarts. The winners are probably those that simply got their money out in time. Two-thirds of crypto funds are likely to fail, reckons Mike Novogratz. Short-sellers seem to be in short supply.

Three Arrows’s Zhu perhaps spoke for many investors earlier this year when he said the lesson of 2018’s slide was to stay bullish and not give in to “despair.”

Hence, his praise for all sorts of clearly speculative shenanigans like Axie Infinity, a crypto game that pays people who spend their days breeding virtual pets that’s been battered by deflating hype and a $US620 million hack. His justifications seemed wrapped in futurism rather than risk management: His “bible,” the 1997 book The Sovereign Individual, foresaw some of the social upheaval of the internet age.


Maybe Zhu should have been reading When Genius Failed. As Novogratz has observed, what’s happening in crypto echoes the 1998 blow-up of Long-Term Capital Management, a hedge fund stuffed with very smart people, including a pair of Nobel laureates, dealing in sophisticated arbitrage strategies juiced by derivatives.

When the unthinkable happened and losses piled up, banks called in their loans and eventually took over the firm.

The silver lining is that there seems to have been little bank involvement in the crypto slump – probably just as well, given the risks of contagion spreading to a real economy that’s already battered by rising inflation and weak economic growth.

But that doesn’t change the fact that real losses are being racked up by funds and punters who are least able to afford it. Whatever happens to Three Arrows, the lesson of 2022 – crypto prices can go down and can keep going down – shouldn’t be forgotten the way 2018 was.

Bloomberg Opinion